Tetra Tech, Inc. (TTEK) Earnings Call Transcript

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 Roger Argus, Chief Executive Officer and President; and Steve Burdick, Chief Financial 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. [Operator Instructions] With that, I would now like to turn the call over to Roger Argus. Please go ahead, Mr. Argus.

Thank you, Sasha. Good morning, and welcome to Tetra Tech's Fourth Quarter and Fiscal Year 2026 Earnings Conference Call. We finished a strong fourth quarter with backlog of 13% from last year, giving us a solid foundation for fiscal 2027. Throughout the year, our leading with science approach and focus on water, environment and sustainable infrastructure allowed us to grow up -- grow by rapidly adapting quickly to changes in client priorities. For government clients, we're helping our clients create new water supplies, automate their water facilities and manage extreme weather risks. For our commercial clients, we're addressing increasingly complex industrial water needs including water reuse and high-end treatment and providing digital automation solutions for industrial facilities. Our breadth of high-end services contributed to strong performance across both commercial and government markets in the U.S. and internationally. Looking ahead, the U.S. midterms introduced a new period of transition. Our broad-based client experience and contract capacity provide us with the ability to address current federal priorities and rapidly respond to new funding and programs at the U.S. federal, state and local level. I'll review our quarter and full year results as well as our outlook and guidance, Steve Burdick, our Chief Financial Officer, will also provide additional insight into our financial performance. We finished fiscal 2026 with record operating income and earnings per share. Fourth quarter net revenue was $1.15 billion, up 5% from a year ago. For the fourth quarter, EBITDA reached $194 million with our margin expanding 90 basis points year-over-year. To put that in context, our margins have expanded 240 basis points over the last 3 years. Fourth quarter earnings per share were $0.49, up 9% from last year. And perhaps most importantly, we ended the year with $4.7 billion in funded backlog up 13% from last year. I'll turn now to our fourth quarter performance by segment. The Government Services Group or GSG segment revenue increased to $513 million from $475 million last year, up 8% and delivered an exceptionally strong 18.8% margin. Growth was driven by strength in our municipal water programs and the federal infrastructure programs that we performed for the U.S. Army Corps of Engineers and U.S. Navy. The Commercial/International Group or CIG segment, revenue was $640 million, up 3% from a year ago. The CIG margin increased by 140 basis points resulting in a 16.2% margin. CIG growth was primarily driven by the U.K. and Irish water programs, digital automation and defense work in Australia, and broad-based infrastructure programs in Canada. Looking at the quarter by end customers, growth was broad-based across our markets. U.S. Federal work represented 26% of revenue in the quarter and grew 9%, led by U.S. Navy and U.S. Army core work in flight control, coastal resilience and defense facility modernization. U.S. state and local work grew by 6%, driven by municipal water treatment and digital automation work. Growth was primarily in states affected by water scarcity concerns, including Texas, Florida, California and Colorado as well as continued advancement of PFAS treatment in the central U.S. U.S. commercial also grew 6% and supported by feasibility and digital automation services for high-end industrial data center and power facilities and engineering work for high voltage power transmission programs. International work represented 43% of revenue and grew 3%. However, if you take into account the divestiture of our Norway operation earlier in the year, we were up around 5% to 6%. Growth was led by U.K. and Irish Water programs and our Canadian infrastructure programs. We ended the quarter with $4.67 billion in funded backlog up 13% from last year and the third sequential quarter with a greater than 1.1x book-to-bill rate. We received over $1.6 billion in new orders in the quarter, including $600 million in commercial orders globally. Orders were very broad-based across our geographies and clients. In the quarter, we also significantly expanded our contract capacity especially with large new awards from the U.S. federal government. In the quarter, we were awarded a new $1.4 billion NASA enterprise-wide technical support contract, expanding our scope of services with this long-term strategic client. We were also awarded a $145 million in new contract capacity with the U.S. Navy to support upgrading critical infrastructure worldwide. We further expanded our capacity with the U.S. Army Corps of Engineers in Europe by $85 million, facilitating our expansion of the long-term support we have provided to the U.S. government through this area. We were awarded a $49 million contract for NOAA, where we provide high-end geospatial and coastal analytical services and software. -- and further expanding our more than 40 years of support to the U.S. EPA, we added a total of over $220 million in new contract capacity. Collectively, these awards further strengthened Tetra Tech's competitive position with key U.S. federal markets we serve and enhance our ability to address the government's priorities, both now and into the future. I would now like to turn the presentation over to Steve to provide you with additional insight into our financial performance.

Well, thank you, Roger. So I would like to now provide an update on our reported fiscal 2026 results, working capital, cash flows and capital allocation. So as Roger just discussed in this call, our market-leading focus on the front-end technical design and engineering for water and environmental projects are carrying higher margins across all of our end markets. As such, even as the reported revenue was down from last year due primarily to the decrease in revenue from USA and episodic disaster response, our operating income increased significantly, and adjusted EBITDA on net revenue for the year had increased by 90 basis points to 15.2% for fiscal 2026. These results further support our long-term strategic goals to improving EBITDA margins by an average of 50 basis points annually. More often over the last year or so, I've been asked by shareholders and analysts what our margins look like on a net service revenue basis, or NSR, which would be similar to how others in our industry report their margins. We've looked at that question and can tell you that our EBITDA margin would be higher by about 250 basis points for this year just on an NSR basis. As a result of our ability to enhance our profit margins and further manage our working capital, we were able to increase EPS and come in above our previous guidance range for both the fourth quarter and the fiscal year. Now regarding our working capital, cash flows generated from operations for the year came in at $523 million, which represents a significant 14% improvement over fiscal 202. Consistent with each of the last consecutive 21 years, our operating cash flows have exceeded net income. Our focus on working capital and cash flows has resulted in our DSO reflecting an industry-leading standard of 60 days, and the lower DSO metric provides significant insight into our core business as it reflects the outstanding work that our to lead relative to higher-quality projects and highly satisfied clients in our broad portfolio across all of our end markets and geographies. And so as we continue on high-quality operating results with increasing margins, operating cash flows in excess of net income and lower working capital KPIs, we will continue to provide higher returns for our shareholders and those higher shareholder financial returns are reflected in an improving return on capital employed, which stands at over 20%. With that perspective, I would like to now present our capital allocation strategy and overview. We have a very strong balance sheet and our operating cash flow was $523 million for 2026. Roger will discuss our strategic global areas in this presentation, but I do want to point out that our balance sheet and cash flows provide us with the capital available to invest in organic and acquisitive growth priorities in order to take advantage of these key business opportunities, such as technology and automation, which continues to provide us a dominant position in the market. Year-to-date and for the year, we have closed acquisitions of technical leaders focused on defense, such as Halvik in the U.S. and Providence in Australia. Now regarding our dividend program, I'm pleased to announce that our Board of Directors approved a quarterly cash dividend which is an 11% increase year-over-year to be paid in December. This is our 46th consecutive quarterly dividend with annual double-digit increases in the amounts paid. Our net debt target is about 1 to 2x, and our actual net debt on EBITDA was at a leverage of 1x at the end of this year, which is slightly higher than our leverage ratio 1 year ago when it stood at about 0.9x. Based on the lower end of our leverage target, we have continued our stock buyback program this year. And in the fourth quarter, we increased our buyback to $100 million. And for 2026, we bought back a total of $300 million in our stock buyback program. We do have about $798 million available in our stock buyback program that has been approved by our Board as part of our capital allocation strategy. I'm quite pleased to share these really strong results for fiscal '26, which has enabled us to increase shareholder value as we can pay increasing dividends, increase our stock buybacks, engage in accretive acquisitions, all the while leveraging our balance sheet to enhance shareholder value. I want to thank you for your support, and I will now hand the call back over to Roger to discuss Tetra Tech's global opportunities for 2027 and beyond.

Thank you, Steve. I'll now review our fiscal 2027 outlook by end market. For U.S. commercial, we expect to see approximately 10% growth driven by increased demand for our advanced water-associated digital automation solutions that address the needs for water-intensive advanced manufacturing data centers and mining. For U.S. federal work, we expect to see 5% growth in the fiscal year 2027, primarily supported by current priorities in defense modernization and the design of resilient military infrastructure. As funding priorities transition we can leverage our federal contract capacity to add water, environment and infrastructure programs as they develop. For our international revenues, we expect to see approximately 5% growth. We expect continued strength in U.K. water programs for digital automation and especially strong broad-based growth in Canada across both government and commercial clients. For our U.S. state and local work, we expect our revenue to be relatively flat. We expect to see continued growth in our municipal water and digital automation programs for our more than 500 state and local clients, especially in the large Florida, Texas and California markets. However, we are anticipating a reduction in state and local disaster planning and preparedness work, which typically relies on federal grant funding. For our international business, I'll highlight our 3 principal regions: the United Kingdom and Europe, Canada and Asia Pacific. In the United Kingdom, Ireland and the Netherlands we are working for the major water utilities on rapidly expanding water programs. In the U.K. strong funding continues with the commitment of GBP 105 billion. Building on the U.K.'s initial focus on sewer outflows and water supply leakage, we are now seeing the focus expand to areas of strength for us, including flood protection, digital water and providing advanced water supply treatment such as desalination. We also see continued expansion of Ireland's EUR 13.6 billion water and wastewater program through 2029 and new initiatives for flood protection modernization in the Netherlands. We've long served Canada's industrial water and infrastructure markets. But now we are seeing unprecedented increases in investment. Infrastructure funding is projected to rise rapidly from CAD 37 billion in FY '26 to CAD 73.7 billion in FY '28, a 97% increase. For us, this creates opportunities along both coasts and across the far north where our coastal engineering, permafrost expertise, and experience providing remote communities with water supplies and infrastructure set us apart. And in Asia Pacific, mining activity is picking up, providing us new opportunities in mine water management and geotechnical stability analysis and digital automation services. Defense investment continues to be an important long-term driver with additional defense funding plan to slowly rise from about AUD 63 billion to AUD 80 billion by FY 2030. Australia Defense is one of our largest Australian clients where we provide infrastructure advisory, program management and digital automation services. I'd now like to highlight 3 U.S. commercial markets, which we expect to drive our growth. Water is essential to mining operations from the earliest development through operations and closure. In the U.S., there is renewed investment in domestic rare earths and critical minerals, including funding of the $7.5 billion of incentives from the one big beautiful bill. Our sustainable mining services span feasibility, water sourcing and permitting through operations, tailings stability, mine closure and cleanup. We help our clients reduce their water use, expand recycling and manage long-term environmental risks. We expect to see continued growth in the U.S. power transmission market. We have supported more than 15,000 miles, representing more than 15 gigawatts of capacity from early-stage visibility through high-voltage engineering solutions. Our in-demand high-voltage engineering services help utilities improve reliability and reduce transmission losses and congestion. We are supporting industrial facilities across the U.S. to modernize digital systems to support future AI-enabled automation and greater operational efficiency. Emerging cybersecurity concerns about interconnected systems are further driving this investment. We provide specialized expertise to commercial clients in data centers, power generation, oil and gas and mining, helping them modernize systems and secure infrastructure assets. I'd now like to present our guidance for the first quarter and fiscal year 2027. Our guidance is as follows. For the first quarter, net revenue guidance is from $1.04 billion to $1.08 billion. Earnings per share guidance is from $0.36 to $0.38. And for fiscal year 2027, our net revenue guidance is from $4.425 billion to $4.625 billion and earnings per share guidance is from $1.65 to $1.80. You can read the FY '27 assumptions on our slide, but I'll highlight a few. Intangible amortization of $24 million, depreciation of $25 million, interest expense of $30 million to $35 million and an effective tax rate of 27.5%. Please note this guidance does not include contributions from future acquisitions. In summary, we had a strong finish to the 2026 year and ended the year with 13% growth in funded backlog. Demand for reliable water, a cleaner environment, and resilient infrastructure continues to expand from communities securing water supplies to manufacturers and utilities improving efficiency. Our technical depth, long-standing client relationships and existing contract vehicles allow us to respond as priorities change. That combination supports our growth and margin objectives for fiscal '27 and beyond. I would now like to open the call for questions. Sachi?

[Operator Instructions] The first question is from Tim Mulrooney from William Blair.

So I wanted to ask about the -- I have 2 questions. One -- first 1 is on the backlog, which is up 13% year-over-year, book-to-bill above 1 again. the backlog growth, nice pickup compared to the last couple of quarters. Can you talk about what's driving the strength I know you addressed it a little bit in your prepared remarks, but would love to get a little bit more detail on the types of orders that are coming in and what you're seeing.

Thanks, Tim. A great question. One of the things I'm most excited about in terms of starting FY '27 is the continued growth in our backlog. And beyond the number, to me, that represents the projects that our staff are winning with our clients. It represents the confidence our clients have in our capabilities and our technical differentiation to continue to grow our business. The backlog growth really was broad-based across all of our end markets. And just as a reminder, our backlog is reported as contracted funding -- funded and authorized projects. These are projects that our staff can begin working on now. So it's a very strong metric for us to see 3 quarters of sequential growth puts us on a trajectory for growth into FY '27. And what was driving that were, as I said, broad-based awards across all of our end markets, including U.S. federal awards for resilient infrastructure, continued growth in our municipal water work commercial energy and environmental work. And you'll note from the slides in my prepared remarks, we had $614 million in commercial task orders. And Tetra Tech does over 100,000 projects a year. So this type of growth is important because it represents a broad support for growth across all of our end markets.

Yes. Got it. Understood. I appreciate the broad-based nature of it, not overly concentrated in any given area. The other question that I have is switching gears a little bit. It's just a technical guidance question around the U.S. federal business. It looks like it's expected to grow 5% year-over-year, and that includes Ukraine Department of State revenue. And I know you aren't breaking out you'd crane any more specifically, but I wanted to make sure that your guidance assumes less Ukraine revenue right now versus 2026? I guess, in essence, like assumed to be a headwind in your guide and not additive to revenue growth in your guidance assumption so that we can understand how the rest of the U.S. federal business is expected to perform?

Great. Thanks -- another great question. FY '26 was a transition year for us. We came off FY '25 where USAID was shuttered -- and through FY '27, our base business grew in the U.S. federal space quite nicely. We're through the year, and we reported that on a pro forma basis. Moving into FY '27 now, we want to report all in. And that's what you see in these forecasted growth rates is our all-in performance, not pro forming out any specific programs or projects. Department of State is an ongoing client for Tetra Tech. That's where the work that you referred to, the Ukraine work lies. It's with the Department of State. And you're right, if you look at -- because we did break out last year what we did for Ukraine. It's in the package. And while we're not now recording all in, we're not breaking it out at any longer. I think we do expect less this year. So it is a bit of a headwind, which to me means our underlying business in federal is actually growing at a greater rate than the 5%. So we do have a bit of a headwind, but we're committed to reporting and delivering on an all-in basis this year.

Okay. That's really helpful, Roger. We don't need the exact number, but it is helpful to know whether or not that's a headwind or additive to growth. It helps us kind of hone in on how the underlying business is doing. And good luck next quarter.

Thank you.

The next question is from Sabahat Khan from RBC Capital Markets.

Great. I guess just given some of the evolution in the backdrop with the election of stuff. Can you just based on past experience, talk about how long it takes for sort of the new administration, new Congress to start to make changes? And kind of like how are you thinking about that as is reflected in your guidance? Just curious sort of the time line usually will be the administration changes, people changing in seats and the kind of impact that could have on sort of the next quarter or a few quarters.

Yes, great question, Saba. Thank you Yes. I've been with Tetra Tech for 35 years now. I came up through operations and have lived through, and I would say, grown through multiple, many administration changes. And so to your point, the key, I think, for us is our strong backlog because that will carry us and carry our growth through a transition period. The federal government and state and local governments with federal co-funding will continue to award work during the period. So but we do expect the transition. The timing is unique with each transition, I think. For us, the results of the midterm elections seem favorable. If you look at the platform on which many of the candidates ran, it included affordability. This is water and energy affordability and included environmental issues as well. So we see it as a net long-term positive for the growth of Tetra Tech. So we're excited about that. But we are cognizant that we are in a transition. There is a dynamic between the congressional arm of our government and the executive arm of our government. So we're cognizant of that, which could affect the transition and the allocation of new programs from this new Congress. There's a lot of complexity to what's going on. In my experience, having been here for as long as I have, I've not seen such a dramatic shift or such a dynamic between the internal parties in the U.S. government. However, net positive, very exciting for Tetra Tech and the services that we provide over the long term. So perhaps in the second half of the year, we might start to see some impact from this transition in terms of growth -- extra additional growth to our business.

Great. And then over the -- I think kind of related to that, over the last while, there has been some commentary about the federal government maybe not stepping up on the funding front for state and local entities, ,water utilities being a part of that mix. At this point, how much of maybe the missing funding or lack of funding have they been able to offset? And where do they stand on just the ability to fund some of these programs? And how is that sort of reflected in your next year's guide? And then is that -- is the outlook there, maybe perhaps tied to the elections as that could maybe improve. Just an update on sort of the state and local, what this water utilities with that customer group.

Sure. Well, our municipal water practice continues to grow at double digits. So we haven't seen any change in the growth trajectory there. It continues to be very, very strong. There is proposed budget that would affect co-funding of federal dollars to U.S. state municipal programs, but that's not in effect yet. That's just been proposed. I'll say that last year, the federal government made the same proposal, and that was with an all Republican Congress, yet the state revolving fund was funded at the same level as the prior year. So this year, we'll have a Congress that might be more favorable to funding those programs, those grant programs. But we don't have the final budget yet. And who knows when we'll get it, I guess. Meanwhile, our clients have shifted towards state and local sources of funding, and it's resulted in us continuing to see double-digit growth in our municipal water program. So that part of it is very big. Now keep in mind that the state and local -- U.S. state and local component is 12% of our business, it's the smallest part of our business. It's a bit sensitive to fluctuations where we are seeing impact from the federal grant programs is in the disaster preparedness and planning work that we've seen. And that's resulted in the muted growth rate that we've offered for the coming year for U.S. state and local. So water program remains robust, very strong double-digit growth. Some of these grant programs for disaster planning and preparedness are causing us to be a little bit more prudent in our growth forecast for that being our smallest area of the company.

And maybe just one quick clarification one. So as we think about some of the department of estate work likely reflected in the outlook here, the guidance commentary, is that worth that sort of -- is that built into the backlog? Is that more of just a book and burn on a short-term basis? Understanding it's in the backlog to in the guidance outlook to some extent, how does it flow through the backlog numbers pass on.

Yes. The answer is we are reporting all in moving forward. And so the -- that Department of State work is in our backlog I don't know, Steve, do you want to offer a little more detail around that because we are, I guess, conservative about the amount of backlog that we in for the that Department of State work, just given the political uncertainties around the geopolitical relationships in the countries involved?

Yes. I think our backlog for the department state reflects what we think is going to be realized as revenue over the next fiscal '27. And so there is something in there. But we have a great amount of capacity but the amount of backlog does support the guidance in our revenue.

The next question is from Sangita Jain from KeyBanc Capital Markets.