TTEK - NASDAQ

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 Investor section of its website at Tetra Techh.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; Leslie Shoemaker, Chief Innovation Officer; and Joseph Fong, High Performance Buildings Lead. They will provide a brief overview of the results and 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 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 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 the conference for questions and answers after the presentation. With that, I would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you very much, Christine. And good morning and welcome to our second quarter of fiscal year 2025 earnings conference call. We just had one of the most interesting quarters in the history of the company. Never have we seen our largest client by revenue essentially disappear within just one quarter. If you’d asked me 20 years ago, what would have been the impact for quarterly results of this happening? I’m not sure I could have told you, but it certainly wouldn’t have been good. But today, in this quarter, through the incredible diversity of our clients, diversity of the services we provide and the geographies that we operate in, we had one of the best quarters in the company’s history. Our second quarter was one of the highest quarters revenue that we’ve ever had in the company’s history. It’s the third highest earnings per share and operating income we’ve had in the history of the company, and we increased margins in both of the segments. And we did all of this during the months of January, February, and March, which are typically our slowest quarter of the year, because of the winter months here in the United States, and in Canada, and in Northern Europe, and a lot of holidays that actually take place in those months in Australia. So it was particularly a very strong quarter for the company. I know I personally and management presenting with me today are looking forward to presenting our second quarter results and outlook and addressing your questions at the conclusion of the presentation. Presenting with me today will be Steve Burdick, our Chief Financial Officer, who will provide additional details on our financial performance and our new credit facility. Dr. Leslie Shoemaker, our Executive Vice President and Chief Innovation Officer, who will provide an update on water and environmental markets, primarily in the government sector; and Joseph Fong, a global leader in our High Performance Buildings practice, will provide remarks on some of our key data center and digital systems growth markets. Before we begin discussing the drivers and the outlook for 2025, I’d like to first share with you the results for our second quarter. We really had an excellent second quarter. We achieved new quarterly record results for revenue, net revenue, operating income, and earnings per share. Our net revenue increased to $1.1 billion in the quarter, up $51 million more than in the same quarter last year. Our operating income was $130 million for the quarter, which was an increase of 11% from the prior year. And we generated an earnings per share of $0.33 for the quarter, which is up 18% from the prior year. I’d like to go over our performance in each of our two segments. For the second quarter, our Government Services Group, or the GSG segment increased its revenue by 12% year-over-year to $521 million. Our GSG generated a 13.8% margin in the quarter, and that margin is actually inclusive of several million dollars of non-project reimbursable costs that we incurred during the quarter, closing out the majority of the USAID work. If we hadn’t incurred those additional non-reimbursable costs that margin would have been up an additional somewhere between 30 to 50 additional basis points from this already increased level from the prior year. Our GSG’s revenue growth was driven by work primarily in our state and local government areas, doing work in the water, environment, and disaster response areas. The Commercial/International Group, or the CIG segment, delivered a 13.2% margin for the quarter. Their revenue of $597 million was up just about 2%, with actually strong growth in our U.S. commercial environmental restoration projects and in our UK water programs, but was offset in bringing us down to being essentially flat year-over-year with about a 10% reduction in our Australia infrastructure work. For our performance by our end customer, work for our U.S. federal clients without USAID and the Department of State was up 16% from the same quarter last year, and now represents about 20% of our revenues in the business. About half of the growth of this 16% growth came from our disaster response activities, while the remaining other half or about 8% came from work that we did primarily for the Department of Defense and very large new programs for the Army Corps of Engineers. Our state and local revenues grew 44% year-over-year. Now that 44% just a little over half of that growth came from episodic disaster response activities that we performed during the quarter, while the other portion of the growth or just under half of that number was really growth from our ongoing municipal water programs, which were up 19% year-over-year. Our U.S. commercial net revenues were up 5% year-over-year, driven by growth in our environmental, energy, and transmission related work. And, finally, our international work represented about 38% of our revenues in the quarter. It was up slightly on a constant currency basis. I will note we did see double-digit growth in our United Kingdom and Irish water programs and in the United Kingdom’s defense services businesses, but this growth was offset by more than a 10% reduction in our Australian infrastructure work. I will say that the slowness in our Australian revenues have been attributed to a major election that took place just less than a week ago. On May 3, there was a new national election that had many funding programs put on hold leading up to the election that has now been completed and put behind them. I would like to discuss our backlog briefly, which represents work which we have that is contracted with our clients, it’s funded and it’s authorized for us to begin work directly by our clients. Tetra Tech’s updated backlog is now $4,310 million or $4.31 billion. This $4.3 billion captures the de-obligation of approximately $1.1 billion in USAID and Department of State projects that took place in the quarter. And within this $4.31 billion of backlog, we still have about $220 million in place with USAID, mostly for ongoing work in Ukraine in the energy sector. And we expect that $220 million to be spent in the second half of this fiscal year. Without USAID and Department of State, our backlog, if you’re following along on the webcast, you’ll see is highlighted there at $4.09 billion, which represents a solid book-to-bill of 1.1x for the quarter, driven by orders all across our global operations. We’ll also note there’s been a lot of questions on how does our book of business and our outlook in the U.S. federal government look on a prospective basis for both contract capacity and backlog. And I’m pleased to announce that we now hold over $30 billion in contract capacity across the U.S. federal government, primarily for defense and civilian agencies for services that we provide that are highly aligned with the administration’s priorities. In the United Kingdom, we also continue to see expansion of our framework contracts with the leading water utilities. And we added another $100 million in capacity in the UK water utilities to perform high-end water modeling and data analytic work. At this point, I’d like to turn the presentation over to our Chief Financial Officer, Steve Burdick, to provide additional details on our financials year-to-date and, importantly, an update on our capital allocation strategies. So, Steve?

Hey, thanks, Dan. So, I’d like to now provide an update for the first half of fiscal year relative to our record results, working capital, cash flows, and capital allocation. As Leslie will review later in this call, we continue to focus on our growing core front-end cycle for water and environmental projects, which are carrying higher margins across all of our end markets. In addition, Joseph will present our strategic focus on high-end data centers, along with the nexus of both water and power transmission, where we also expect higher growth and margins. And as we look back at our year-to-date results, even as revenue was up double-digits, about 11% over last year, our operating income and EBITDA for the first half of the year increased at higher rates of 17% and 12%, respectively. As a result of the double-digit top-line growth, along with our ability to effectively manage and allocate our capital, we were able to increase EPS by 21% over last year, which is just about 2 times our top-line growth. Now, in the first half of the year, our GAAP results include one-time non-recurring charges. So, please refer to the appendix of this presentation and our Reg G for reconciliation to the adjusted results. This strong financial and operating performance has resulted in the continued ability for the company to exceed and beat EPS consensus every quarter for the last 8 years and to improve our annual EBITDA margins by an average of 50 basis points each year over that same 8-year period. As you all probably know, about 1 month into the quarter, we saw our largest U.S. federal client put a pause on paying our invoices, which had a very negative effect on our working capital for the second quarter. I’m happy to provide a real time update to let you all know that since the end of the second quarter, our USAID client has paid on most of our past two invoices, and we have so far collected over $150 million, which equates to about a 10-day DSO improvement. Now, cash flows generated from operations for the trailing 12 months were $311 million. And these cash flows will continue to exceed our fiscal net income by more than 100%. Including the USAID-related receivables are consolidated DSO stood at 67 days. And as I noted that since the end of the second quarter, the payments received of $150 million from USAID has resulted in a consolidated DSO improving to about 57 days. This lower DSO metric 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 geographies. The net debt on EBITDA was at a leverage of 1.36 times, which is slightly lower than our average 1 year ago when it stood at 1.38 times. Now, since the end of the second quarter with the receipt of these additional payments, our net leverage has lowered to about 1.1 times. And as we continue to execute on high-quality operating results with strong cash flows and a healthy working capital, we’ve been able to payout higher dividends, increase the stock buybacks, and invest in strategic acquisitions to provide higher returns for all of our shareholders, all while delevering our balance sheet. So, for those of you following along on the presentation, I would like to now present our capital allocation overview. We have a very strong balance sheet and we further improve the balance sheet as we closed and funded on a new credit facility with a very supportive bank group such that over the next 5 years through 2030, we have access to more liquidity about $1.5 billion at more favorable terms and conditions. And as we’ve revised our capital structure over the last 2 years to take advantage of the credit market and to support our financing needs, I want to point out our ability to reduce our average interest rate from the second quarter of fiscal 2024 by 50 bps to 3.63% and this in an environment of higher uncertainty. So as I said earlier, as Leslie and Joseph will discuss our strategic growth areas later in this presentation. I do want to point out that we have significant amount of liquidity available to invest in both organic and inquisitive priorities and we have a well-balanced mix of fixed and floating rate debt to mitigate interest rate risk as we look to grow these higher margin priorities. Regarding our dividend program, I want to announce that our Board approved a quarterly dividend, which is a 12% increase to be paid in the third quarter. This is our 40th consecutive quarterly dividend with annual double-digit increases in the amounts paid. And based on the lower leverage which we did fall below onetime at the end of 2024, we did reinstitute our stock buyback program and in the second quarter we bought back $150 million in stock. We do have available a portion of the stock buyback plan approved by our Board of Directors back in 2022. But, furthermore, I’m happy to announce that our Board of Directors approved an additional $500 million for a total of $673 million for use in future stock buybacks as part of our capital allocation strategy. I am quite pleased, as you heard Dan, I’m also quite pleased to share these really strong results for the first half of fiscal 2025. I want to thank you for all your support and I will now hand the call over to Leslie and Joseph to discuss Tetra Tech’s future opportunities.

Thank you, Steve. For over 50 years, we’ve supported the U.S. federal government in addressing the nation’s highest priority needs. Today, I’d like to focus on our work with the U.S. Department of Defense worldwide. Highlighted on the slide is the $5 billion in new contract capacity we have been awarded just this fiscal year with U.S. defense agencies. The majority of them announced just within the last 100 days since the inauguration. Today, our largest client at Tetra Tech is the U.S. Army Corps of Engineers. The Corps has a dual mission to support both the nation’s defense programs worldwide and our nation’s infrastructure through their civil works programs across the United States. For national security, we provide engineering design of resilient infrastructure all over the world, including wastewater supplies and water supplies to support military facilities. Our recent awards include coverage of areas like the critical Middle East region, the Pacific region served by the Honolulu District, Central and South America served by the Mobile District, and global defense systems supported by the Huntsville District. For the civil works programs in the United States, we also support the Corps of Engineers and their partners at the state and local level with the high-end engineering analysis and design for essential flood control structures, including dams and levees. We also work on designing and managing the dams and reservoirs used for water supplies. And we work for the Corps to upgrade our inland waterway systems, the engineering of the locks and dams that support the U.S. internal trade and shipping routes. With the proposed increases in defense spending and the renewed interest in U.S. business investments, we see strong future growth opportunities across the defense-related services that we provide. I’d now like to talk about our locally driven work for water supply. This continues to be a high priority in the United States, the United Kingdom and Ireland directly in line with our long-term view on this market. Across these markets, we’re seeing continued double-digit growth in revenue through both new clients and new programs to address critical water needs. In the U.S., high-end water treatment demand continues to add and secure new water supplies for our customers. Our project in Cape Coral for brackish water treatment adds a new source in a rapidly growing high value region. We see continued demand expanding for potable reuse with the design of a first-of-a-kind plant in Oklahoma for indirect potable reuse to augment their water supply. And in areas at risk for coastal flooding with aging infrastructure such as Gloucester, Massachusetts, we see renewed demand for the modernization of wastewater treatment facilities. With our new contract capacity in the United Kingdom, we’re actually encouraged to see increased demand for our high-end science-based solutions to address water quality protection as a part of the challenge to materially reduce contamination across the country. And in Ireland, we are supporting the water utility in their program to fully reengineer their water supplies to meet Dublin’s expanding needs for drinking water. To support these clients in their large investments in Ireland and the United Kingdom, we’re pleased to have recently announced the addition of Carron + Walsh, a leader in program management services for utilities and government agencies. And welcoming them aboard will really extend our ability to provide more project management services. And with that, I’d now like to turn the presentation over to Joseph.

Thank you, Leslie. Tetra Tech’s market-leading water and energy expertise has become a key competitive advantage in driving our high performance buildings’ fastest growth market, high-tech data centers. With over $500 billion in future investment forecasted in new computing infrastructure and current global energy consumption by data centers expected to double, not only are we seeing the increased demand for data center building design, we are seeing increased demand for our differentiated services, water and energy. Our strategy to focus on unlocking the bottlenecks that our data center clients are experiencing with water and power availability issues has provided Tetra Tech the opportunity to leverage our water and energy services to engage earlier in the development of data center projects. To meet the increased water demand and quality needs for our data center clients, we are bringing our expertise to source, treat, procure, and transport critical water supplies to support innovative liquid cooling strategies. On energy, the higher power loads needed to support AI data centers is driving increased demand for power, which is resulting in significant interest from our data center clients and land developers for our transmission services to bring these power sources to our prospective data center sites. This needed work outside of the data center building has created additional opportunities for Tetra Tech to support our global data center clients and positions us to win the downstream buildings work. With our hyperscale clients raising its spending forecast for data centers and related infrastructure, we anticipate continued growth in this end market for our water, energy, and high-performance building services. Through the first half of the year, our data centers and advanced manufacturing business is tracking towards $120 million this year, a 20% year-on-year growth. Having added several new contract vehicles this fiscal year to support our hyperscale and co-location data center clients in the U.S., United Kingdom, and Australia, we are anticipating 20% to 25% growth in the coming years. Just last week, we announced that the SAGE Group, a global leader in digital systems and automation, will be joining Tetra Tech. SAGE will bring to Tetra Tech over 800 digital automation experts and new software and proprietary technologies from their base of operations in Australia. SAGE significantly broadened our expertise to address the needs of client across water, manufacturing, and defense. SAGE joined Tetra Tech’s digital systems practice, where we today support water utilities across the United States and provide the high-end systems integration that is essential to optimizing utility operations and facilitating secure remote access and automation. Our team working together will continue to advance the science of digital automation, transforming operations to work more efficiently, access data more securely, and integrate the instrumentation that is rapidly expanding. The addition of SAGE Group further advances the strategy that we initiated in 2019 to expand in the areas of digital systems and automation. Since that time, the evolution of instrumentation technology and, more recently, the advent of generative AI has made digital systems even more integral to the operation of a wide range of water, manufacturing, industrial, and defense clients. Today, estimates of the future spending in digital automation and smart infrastructure exceed $2 trillion worldwide. Over the past 4 years, through a combination of organic growth and the acquisition of four companies, we have established a high-end digital systems practice that is working with the largest water utilities and major cities in the United States. With the addition of SAGE, Tetra Tech’s digital systems practice will broaden to additional clients and now serve our clients globally. This collective group, while significantly expanded expertise, shared proprietary technology, and significant partnerships with the top instrumentation vendors globally. We project growth to result in a $500 million annual revenue business for our digital systems practice by 2030. Given our significant home field advantage with clients in the areas of water and high performance buildings, Tetra Tech has uniquely positioned to deliver value from data centers and digital transformation investments across our key geographies in the U.S., the United Kingdom, Canada, and Australia. With that, I will turn the presentation back to Dan.

Great. Thank you very much, Joseph. I’d now like to present our guidance for the third quarter of fiscal year 2025 and updated guidance for the entire year. For the third quarter of fiscal year 2025, our net revenue guidance ranges from $1.1 billion to $1.2 billion of net revenue with an associated adjusted EPS of a range of $0.35 to $0.40. Our updated guidance, in fact, raised the lower end quite significantly based on this last quarter, is now a range of $4.4 billion to $4.765 billion with an associated adjusted earnings per share of $1.42 to $1.52. The midpoints of this annual guidance shows that 6% of net revenue growth with an adjusted earnings per share of 17%, and this is all-inclusive of USAID and other have been adjusted downward during the year. Some of the assumptions if you’re following along the webcast do include about $35 million intangible amortization cost during the year, which would actually be included and that includes $8 million in both Q3 and Q4. Effective tax rate at 27.5%, depreciation of $24 million, interest expense of $34 million to $38 million, and 267 million diluted shares outstanding. And it does not – this guidance does not include the contribution of SAGE, which we expect to close later in the year or any other acquisitions that we may transact after this phone call. In summary, we just had a great second quarter and really excellent first half of the year with record performance both in the first and second quarters. We continue to see strong demand for our differentiated leading with science services in the areas of water, environmental, and infrastructure markets that we work in. Our digital systems and automation growth strategy is actually working quite well and is advancing with the announcement of the SAGE Group that’ll be joining Tetra Tech, not only to give us more resources, bring us new clients, but it adds a big new geography for us with their presence in Australia. As Steve covered, I thought, quite well and it’s been really a highlight of the quarter for us, putting in place a new $1.5 billion credit facility, which is going to support all of our capital allocation strategies. And I would say Steve and our financial team just did a great job in coming up with better terms than we even had in our previous credit facilities. And all of this together just puts us in a great position to continue to grow our business and support our clients worldwide. And with that, Christine, I’d like to open the call up for questions.

The question-and-answer session will begin now. [Operator Instructions] Thank you. Our first question comes from the line of Tim Mulrooney with William Blair. Please proceed with your question.

Good morning, everybody. You had a really strong quarter in state and local, even excluding the disaster response. So one question we’ve been getting a lot is if the Trump administration’s efforts to reduce federal expenditures are going to leak into the state general funds, which in turn could negatively affect your state and local business. I know some of this business is backed by muni bonds and user fees, but for the parts that aren’t, can you talk about whether or not you’re seeing any pressure there or expect to see any pressure?

Thanks for that question, Tim. It’s a really good question. And I actually received the flip side of that same question about 3 or 4 years ago when the IIJA was put in place and when some of the ARA funding was put in place for additional funding at the state and local level. And at that time, the questions I was receiving were with this very large amount of funding coming from the federal government to the state, do you see your growth rates, which at that time, state and local were maybe between 15% and 20%. Do you see those growing substantially? And my comment was, I see those are going to be overflow to other areas, but not see a material increase. And I said I also expect that on the tail end of the funding of those programs when the federal government grants and other items and loans actually decline, I expect not to see decline at that time. And in fact, now we’re at the back end and we’re not seeing any reduction. I know that there have been with the current administration and their just this week proposed budget have talked about reductions in things like state revolving fund out of EPA. But, if you read a bit farther down into those documents, it actually says that it’s somewhat duplicative of the large funding coming out of WIFIA for EPA, which is water infrastructure funding mechanism. So, we have not seen that, any signs of any type of reduction or pressure at this time. And I will say the areas that we’re focused here are the very large population states in the southern part of the U.S., like Florida and Texas, which both have very large surplus budgets. And in places like California that were very large, where there are deficits in the general fund, we’ve seen very large bonds passed that will carry with this through a multiyear period. So I don’t know, at this point, I don’t see any near-term pressure in our state and local projects that we have. And a lot of these are multiyear projects that we get funded either semiannually or annually. So while it may not be in our backlog, we expect the next phases to move forward, because these are multiple year programs, and one quarter of a water supply system or one quarter of a wastewater treatment plant isn’t very valuable. So, even if there was an impact, these are typically very late cycle indicators with respect to our state and local. So no impact now. I don’t really see it coming in the near future. And if for some reason things change, I expect it would be a few year delay before we’d see it in our funding.

Okay. That’s really helpful. Thanks, Dan. We can also see it in the numbers. It seems like it’s performing at a really high level. So, that’s helpful color. Thanks. One more from me. I recently saw, Lee

Yeah,

Our next question comes from the line of Sangita Jain with KeyBanc. Please proceed with your question.

Yeah, good morning. Thank you for taking my questions. So, if I can just start on the core margin progression, how you think that works out once the dust settles on the USAID cancellations and productivity normalizes? I know you’ve given us a 50 basis point annual target at the Analyst Day, but just wondering how you think about it now.

Yeah. That’s a good question. That’s a really good question. I think one of the questions at the end of Investors Day was, what do you think about your business if all your USA work was gone? That was kind of I don’t know if that was prophetic or not. But my initial comment was, well, our margins are going up. So let me address that. Because I had indicated in Investor Day along with Steve Burdick and our other presenters that we would increase on an annual basis our margins by about 50 basis points, and that’s with AID. Now, I think that the baseline of our overall margin profile without AID is now higher. So, I would say that we were starting at a 13.5% or 14%, I think just with the removal of AID, the underlying business has about a 50 basis point increase, might even be slightly more than that, on the overall margin of the company. And I think that we didn’t expect that the margins were going to increase with respect to USAID work in the investor meeting that we had that called out our 2030. So without USAID in there, I think that the margins should grow slightly faster than the 50 basis points. So, I think, we have a new higher baseline, and I think we have a faster growth rate with respect to margin growth over the 5 years that we called out on Investor Day. So your question with respect to has our profile on margins been impacted by AID going away? I’ll go back to the comment I made a year ago on May 14. Yes. They’re going to be better, and they’re going to be higher. And that’s what we still see at this point.

Great. Thank you, Dan. And if I can ask a follow-up on the $200 million of USAID backlog that you still have, if you can comment on how you’re seeing that it burns thus far this quarter, so we can get a sense of what is left to burn.

Yeah. It’s interesting. So we have about $220 million in total. Most of that is for work in Ukraine. We currently expect based on tasks that we have that we’ll perform that work in Q3 and Q4. We think about $200 million of the $220 million, which can be complete this year and relatively even revenues to roughly $100 million in each quarter. Now, work in Ukraine, as you follow any of the news headlines is highly variable. And that certainly could go down or it could go up depending on political will and commitments and other items. But we expect that to be incurred or spent by the government and authorized to us on relatively even amount between Q3 and Q4. I would say a small amount of that, though, is associated with our demobilization on all of the rest of the USAID contracts, where we’ve received termination for convenience notices, which is we’re just not continuing these. Those costs are reimbursable at the project level for project costs that are incurred. And so, a small part of that will be demobilizing here through the rest of this year. And that’s everything from repatriating staff to the U.S. and closing down field offices and transferring a government owned property back to the appropriate owners. So that’s how we see that progressing between now and the end of the year.

I appreciate that. Thank you, Dan.

Thank you, Sangita.

Our next question comes from the line of Sabahat Khan with RBC. Please proceed with your question.

Great. Thanks and good afternoon. I think, Dan, to your comments early at the beginning during the preamble around this as being sort of a dynamic and sort of the evolution was quite interesting relative to what we may have thought a year ago. Maybe if you can just talk about your discussions with some of your larger government partners, public sector partners and their visibility as it thinks about the back half of this year into 2026, their level of confidence, just visibility, have things sort of stabilized? The headlines seem to have stabilized, but just curious what your customers seeing on a ground level as it relates to the projects ahead and the funding that they have. Thanks.

Well, I’ll start with the federal government since that’s where most of the variability, maybe you can call it volatility, has been centered around. I would say there was a lot of uncertainty even till today, but what we tend to look at is not what they say, but what they do. That’s one of our items here is don’t listen to what they say, watch what they do. And watching what the U.S. administration has done to support the U.S. military’s readiness, I think, Leslie Shoemaker’s comment that we’ve added about $5 billion of new contract capacity with defense, U.S. Department of Defense. And most of that has actually been since the inauguration, and certainly it’s been since the election. So, we actually take a look at the contracts that have been put in place, the geographies, which happened to be coincidental with the priorities of the administration globally. I would say that in many respects, we feel better about the funding streams and the clarity within DoD in the U.S., and even the Corps of Engineers. And, I think, the slide in the presented materials gives a good example. And sometimes the government announces successes and wins we have even before we do. We wait until we finish signing it. But don’t be surprised if you see quite a bit more coming out with the new awards to the company. And so, what we’re hearing from our clients are, they’re going to commit to funding, not going to be hollow vehicles. I would say historically, we often saw Department of Defense have very large contract capacities, but they only use a portion of it with respect to actually task orders. We’re being told that they’re going to spend what they contract for, which provides additional confidence. That feels pretty good. Our largest – interestingly enough, our largest civilian agency client is the Federal Aviation Administration or FAA. And Secretary Duffy has said that modernizing in a safe way the air traffic control system is the top priority period. And I’ll tell you, there’s few that are better situated than us in that area. And I’ll tell you, it’s not just because we’ve been a long-time incumbent and we’ve been there, which is true. But, we’ve been working on the cutting edge, including rolling out some of the new space-based communication systems. I know some of you might recognize that as Starlink, but we’ve already been doing that. And I know many say that they’re talking to the administration and they’re talking to Secretary Duffy. We’re actually working for them. And there’s a big difference between wanting to get in and being in. And so, we feel pretty positive there. One area that’s been pleasantly surprising is the U.S. EPA. I think early on they talked about 65% reduction. I think most recently they talked about 50% reduction. But the work that we have in the contracts have been essentially unaffected, which has been a pretty pleasant surprise. I believe that’s because we are the contract holder of many, or most of the start contracts, which are emergency response activities, which includes things like responding to East Palestine train derailment. So that has been put as one priority. They want to make sure that the response capability at the federal level is there to protect the citizens of the country in the event of these unique events. So maybe we’re in the right spot not to be impacted and to be in the right part of the 50% that’s going to remain. So, I covered a few areas since you’d asked about the public sector or the government. That’s what we’re seeing at the federal level. And I kind of covered on the earlier question what we’re seeing at the state and local things look very strong. Our three big focuses, Florida, Texas, California, large funds. And, I thought, Leslie did a good job in her presentation of some of the new cutting edge programs that we’re putting in place like potable reuse, so take water that’s from the wastewater treatment plants, recover it, and use that as a new drinking water supply, which is we are doing the great majority of it with the largest desalination designer in the United States, which is the technology that’s primarily used for water reuse. And I’ll tell you, it looks very positive in those areas.

Great. And then just kind of on the – sort of the – kind of fiscal 2023 targets, obviously, a bit of a surprise USAID announcement kind of this year. As you kind of look ahead to sort of the next kind of 3, 4, 5 years and kind of tying in your commentary about the margins a bit early, how are you sort of feeling just about the medium-term outlook? Do you feel like you’re sort of USAID aside still on track for kind of the medium-term targets that you laid out? Thank you.

Yeah, I think we are. I think we are. The one area that I feel really good about is also some of our geographic diversification. If you – the last two acquisitions have brought in an entity in Ireland, Carron + Walsh, of course bringing in SAGE, which is located in Australia. But both of those have fungible expertise, particularly SAGE. So the expertise with respect to automation and the programming, the use of IoT, the use of robotics, it’s not confined to geography, it’s easily transportable to work that we’re doing all across Canada, the U.S. and Europe. So, I think, in the middle-term growing our commercial work which carries even higher margins, adding additional geographic reach in places like Ireland that have very large infrastructure that are multiyear, if not multi-decade programs, for sure, looks favorable for us through the middle-term. Of course, the one comment I’ve made around the office here, some have asked, how clear is next week? How clear is 2 weeks from now? And I said, well, I’d like to see pretty clear in a week or two. But in some respects, I can see even clearer in 5 years from now, because some of the short-term variability and some of the short-term volatility goes up and down, but the primary tailwinds that are driving Tetra Tech are not changing. Coastal flooding, coastal protection, water supplies, where they don’t exist because of drought conditions, brackish water because of over drafting or over pumping of water supplies in places like Florida and low lying areas. None of these are actually going away. If anything, they’re being exacerbated. And where are they going to be next week, next month or the next midterm? There’s some variability. But if you actually look out a bit longer, the tailwinds and the drivers of our business aren’t changing at all. If anything, they’re just becoming even more important.

Great. Thanks for that. Just maybe one last one, maybe more for Steve. You laid out a little bit of your capital allocation philosophy and sounds like it’s been a little bit of all of the above on return of capital on M&A. Maybe you can just talk about, is there a sort of a rank order that you prefer at this point between share buybacks versus M&A? Or is there enough capital to sort of pursue M&A while doing some elevated return of capital? Thanks.

Yeah. I think we have the ability to do all of the above as we’ve been able to show. I know, for the last when we – after we acquired RPS, we put our stock buyback program on hold until we got our net leverage down below one and we did that on time as we forecasted. So, I think, our goals are to continue our double-digit increase in our cash dividends to shareholders. We want to grow and invest in organic growth in the areas that especially what Joseph and Leslie and Dan have talked about today. We want to complement that organic growth with acquisitions that are important to us. And, I think, with the liquidity we have available, we have the ability to continue our stock buyback program. And as our net leverage, if it goes back below one, we’ll have even more liquidity to ramp that buyback program up.

Great. Thanks very much.

Sure.

Our next question comes from the line of Ryan Connors with Northcoast Research. Please proceed with your question.

Good morning.

Good morning, Ryan.

So, congratulations on proving out that you still got a very attractive business, despite all the doom and gloom. I wanted to explore the USAID thing from the standpoint of capabilities and assets. So, in terms of utilization, any metrics you can share around utilization? Presumably, there were some folks working heavily with USAID who are now maybe underutilized, yet that doesn’t appear to be showing up in the margins, at least not in the second quarter. So, anything you can share for us about kind of the utilization rates of those people?

Yeah. It’s very insightful. Utilization has gone down in that group. But, I will say that in the quarter, you wouldn’t have seen it on an aggregate basis, because we staffed up a lot of people for the fires out here in LA responding to the disasters. So, yes, we had a reduction in what I call the AID staff. What we look to find is the project going to be a lot of this was put on hold. So, the progression went, we were working full tilt until the inauguration. Very quickly, we received stop work orders where we minimized cost, but we kept pretty much everybody on board, because we expected things to be turned back on, and then it went to termination for convenience. So, yes, their utilization did drop. You wouldn’t have seen it on an aggregate basis, because of the offsets that were very high 100%, frankly, people working 100-hour a week. So that offset it. We did incur costs. We did hold folks until they went to termination for convenience, and we ourselves held people longer while we did the search and evaluation. Could we place them at other locations? And those are areas where it’s not reimbursable by the client where we made the decision to hold on to people for longer periods while we were looking, while we determined if other projects were going to get put back on. And so that really refers to my comment, probably my inarticulate comment that margins actually could have and I expect to be better if we had moved quicker. But this is kind of a certainly hope a Black Swan event where you have something that’s quite abrupt to turn off. But, I expect that as we move through this termination for convenience utilization will go back up across the board. So even as the fires come off with these very large high utilizations, you’ll see the rest of the business utilization up. So, it’ll look like we kind of sailed right through this without any change, but just under the surface, aid went down, fires went up, and you’ll see that flip back over here in the coming quarters.

Got it. Okay. That really helps explain it. Thank you. And then my second question was just around the backlog. Given the nature of the business, the backlog is obviously something that investors tend to focus on. It kind of gives a line of sight to things. Obviously, there’s a hole there from USAID proportionate to its size, but yet you’ve won some really nice wins as well. How long do you think it would take? Are we talking quarters, a year or more or a couple of years to get back to kind of pre-DOGE backlog, so to speak?

Yeah. That’s really interesting. We spent some time looking at that here. And our visibility with respect to the book of business we have ex-USA Department of State is actually about the same or slightly up. So, if you take a look at what if you take USAID out, you saw that our backlog is just right about $4.1 billion, $4.09 billion. But if you take a look at the midpoint of our revenue, our net revenue without USAID, it’s about $4 billion. So we have about a year’s worth of visibility or contracted authorized work. With our overall contract capacity going up, I think we’re going to – I would hope to see that our visibility will begin to stretch out more than a year. When it has been more than a year, which it has been on an aggregate basis, it’s because of the multi-year funding that we had within USAID. So if you look at it and say, you had more visibility than a year before, and now you’re down to a year, I would observe that actually if you took USAID out, we were about 11 months, 11.5 months, so we’re actually up. So, there may be an appearance of a hole, because the backlog that came down was disproportionate to the revenue, but that’s because it was multiyear funding. If you actually take that out and look at the underlying business, there’s actually not a hole. And we have funding that’s at a similar level or even slightly up from where it had been before. And with respect to converting the contracts that we’ve won, I think those are going to take place if what we’re hearing from our clients, as I shared earlier, and the question was what are you actually hearing on the front line with your public clients. If they start funding these, we could actually see that backlog grow much quicker and being see that, I don’t know if I call it uncharted territory, but favorable territory with respect to more visibility, with respect to backlog as a percentage of revenue.

Got it. Okay. That’s very helpful, Dan. Thanks for your time.

Okay. Thank you, Ryan.

Our next question comes from the line of Andrew Wittmann with Baird. Please proceed with your question.

Great. Thanks for taking my questions this morning, guys. I guess I just wanted to confirm some of the moving parts here and then talk a little bit about kind of the outlook here. So, by my calculations in the second quarter is about [$180 million] [ph] on USAID, about $50 million in net revenue on disaster. And then you said you’ve got $220 million for USAID in the back half of the year spread between the two quarters. So, I guess, inside of this, it sounds like a lot of the USAID work that’s been continuing here, if not all of it, is Ukraine. And that is still an ongoing situation. And we know what you’ve got in your backlog, because you only put what’s funded in your backlog. But does this contract, like, expire? Is it out of option years or task orders? I guess I’m asking, because I think I believe your guidance says that these numbers that I just articulated here are what’s in the guidance, and there’s nothing else in the guidance. But the Ukraine is ongoing. This is obviously a USAID contract that’s gotten special dispensation to keep getting funded. So I was just wondering, if there’s like a new contract that needs to be awarded and so it’s out to competitive bid, which would mean it’s less likely for you. I think, Dan, you can see where I’m going with this, but I was just hoping you could comment on that.

Yeah, absolutely. I’m quite familiar with all those moving pieces. I’ll help clarify a couple of items. In the quarter, it was about $130 million of USAID and Department of State work, not $180 million. So about $130 million. Your $50 million is almost right on for disasters, and that’s really kind of split between the work we’re doing still supporting Hurricane Milton and Helene in the Southeast and then the fires in West. So you’ve got that exactly right. Now, the $200 million or technically $220 million, we have in backlog, is contracted for. So it’s not only contracted. These are only a small part of the contract ceilings we have in place. In fact, we made an announcement back in the fall of when that the $200 million is under. It’s called the SPARC contract for USA, and it’s for the continuation of what we had done the previous few years, supporting the energy infrastructure in Ukraine. And that contract is – the contract capacity is about just under $450 million. And so, this $220 million is a small part of that. So do we have to go out and win something? No. That $450 million energy contract for Ukraine through USAID, is it a multiple award? No. It’s a single award. There’s only one contract holder, us. And with respect to could they actually say, I’m going to double that number with a stroke of a pen or an email? Definitely. Now, I’ll also – as I mentioned earlier, I don’t know if things are highly volatile there. Could they also send a stroke of a pen and email and put it the other way and say, you’re done. Now then we go through demobilization. It still wouldn’t go to zero. You still have to then repatriate handover all the equipment and all the rest of the items. So, the amount that we have in our guidance for second half of the year with respect to AID has already been contracted, and the task order is already issued. Now, normally, I would say, in fact, I will say, it’s very difficult to undo a task order that’s already been given when you got equipment that’s in the air heading there. But, these are unprecedented times. Anything can happen. I’ve seen airplanes being requested to do a U-turn right in the middle of the Atlantic. So I don’t want to take something that’s unusual and say that’s not possible. Anything’s possible when you just went through losing a billion plus in one quarter, I won’t take anything off the table. But the one thing I’ll say is, when you take which was, it’s been 10% of our total revenue of the company, and Ukraine drove that up to 15% of the entire revenue for the company, and it goes essentially to zero. And forget a quarter because the inauguration wasn’t until the end of January. So in 60 days and still perform this type of quarter. I’m not saying that all comers come, but we’re well prepared and flexible to move quickly with this. And to go back to your question again, no, we don’t need to win a new contract; no, we don’t have to have any new task orders issued to us; yes, it’s authorized. But with a caveat, these things can change because of the location and the different variability of things happening in Ukraine.

Yeah. So, basically, your guidance approach hasn’t really changed. Last quarter, you laid out is saying, like, this is kind of what we thought the downside could be, and you’re still just modeling exactly what you have and not assuming anything else in your guide. And we know the backlog is always what’s contracted and funded, but your guidance sometimes can take a little bit different approach here, you only have what’s contracted. So, I appreciate the way you’re approaching this volatile area. I guess, and then just my follow-up and final question then is just on the backlog and not Department of State, which you’ve quantified very well through all these things. But on the federal civilian side, was any of the 1.1 that came out attributed to other areas of federal civilian, or was that all USAID and State Department stuff?

To be precise, there was some others, but it was measured. I think, in aggregate, everything else we tracked this pretty close, right, but we tracked it really close. It was like less than $10 million. And I think we had like $1 million or $2 million out of EPA. We had a million out of – we had $2 million, I think, out of FEMA. I think we had like a couple of hundred thousand out of National Science Foundation. Well, I don’t know, I shouldn’t say 10, I’m probably 5. So, yes, there were a few other really small pieces, but it was 99.9% USAID, State Department.

Okay. That’s helpful perspective. Thank you for clarifying that. I appreciate it. Have a good day.

Great. Thank you very much, Andy.

Our next question comes from the line of Michael Dudas with Vertical Research Partners. Please proceed with your question.

Good morning, everybody. Dan, thanks for taking me in here.

Yeah, of course.

So maybe a shift to your international work. Can you give a sense, you talked – you called out slow growth in Australia. It seems like UK is recovering both election-oriented, I guess, you think about the lag times and such. Maybe how would you look at just 1% or 2% growth you had this quarter? How that looks second half of the year? And as maybe you look a little bit further, how the given some of the shifts in what you’re doing in the UK. And maybe some of the high HPV work, is there opportunity for acceleration of international exposure and some growth out of that over the next few quarters?

That’s another really good question. The one thing I’ll say we’ve seen is the uncertainty. So, I’ve talked on this call a fair amount about variability and changes in funding and priorities within the U.S. federal government’s budgets that we work for. But, I guess, I’ll have to join the club and use the word tariffs or international clarity. There is both work. There is impact mostly on our international commercial, which falls within our CIT and our international revenues, where I think some of our clients are the work that we have has been continuing, which you can see is sort of flat. But as far as initiation of new activities with respect to, in some instances, buildings, but certainly other items such as siding and permitting and other items has been slowed down. Just looking for clarity, are they going to have a tariff change? Are they going to go forward? And what I’ve heard from our clients are, I thought this was interesting. They’re not going to say that the tariffs or the expenses in and of themselves aren’t material, of course they are. But all they want is clarity. If the number is 30%, it’s 30%. If the number is 10%, it’s 10%. If the number is, I don’t know, about 150%. But if the number is 150%, it’s 150%. And we will then proceed accordingly with those ground rules. And then that’s not a problem. We’ll move forward. And that’s fine for us too, because what we’ve said, and I’ve said this before, in periods of recessionary environment, some of our businesses actually do quite a bit better, because instead of generating 500 gigawatts of power across a big area, maybe I’m going to decrease my wind farm and generate 30 gigawatts. So go back and redesign it. And then things have changed and input prices are higher. So I would say that the growth rates on international are probably one of the areas that we have some questions on, and I think it’s partially dependent on clarity what’s happening on international trade and items associated with that. Now it hasn’t caused our revenues to go down. I think the more long-term programs that we have in Australia, Canada, and the UK, like Ministry of Defense and Department of Defense in Australia unaffected. So, those areas are going through nice growth, long-term programs, long visibility, but things that move quick. And, I think, we’re going to see it in U.S. commercial and international commercial, because those are the clients that can turn the switch the quickest. Those are the ones that, this isn’t working for me, we’re not going to proceed. Or this is working for me, let’s go right now. So that’s where we probably have the greatest variability. And I think that’s why we’re seeing a more tempered growth rate in the international right now.

I’m sorry you had to use the T word in this conference call, but thanks for your thoughts, Dan.

Yeah. Thanks, Michael. I would say for the most part, Tetra Tech is unrelated to that word, but some of our clients might have a little play on that. Thank you very much, Michael.

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

Thank you very much, Christine, and thank you all for joining the call today. I very much appreciate your support through these periods. I hope we were able to answer some of your questions regarding the impacts of USAID, State Department and others in the federal government. There’s no doubt I am very cognizant of the questions that people had and what’s the impact going to be. And I hope we were able to be really clear on the impact to our underlying business, its growth rates, its margin, separation of backlog. We really did try as a management team to be extra candid and transparent on that front. And if for some reason there’s some specific item that you’d like more clarity on, please call over here to our IR and bring Steve and I or anyone else in as appropriate, because we really want to be as transparent as possible, because we have a great business. And, I think, the biggest issue that’s impacted us this past quarter is a misunderstanding of what the impact to Tetra Tech is from some of these changes. And, I’m looking forward to presenting our results in the third quarter, I’ll talk to you in 90 days, and I hope you’ll all be safe and prosperous between now and our next conversation. Thank you very much.