Tetra Tech, Inc. (NASDAQ:TTEK) Q1 2023 Earnings Call Transcript

Tetra Tech, Inc. (NASDAQ:TTEK) Q1 2023 Earnings Call Transcript February 2, 2023

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 Jill Hudkins, President. 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, their appropriate GAAP financial reconciliations are posted in the Investors section of Tetra Tech’s website. At this time, I’d like to inform you that all participants are in a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation.

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

Dan Batrack: Great. Thank you very much, Darryl. And good morning, and welcome to our fiscal year 2023 first quarter’s earnings conference call. We had an excellent first quarter and start to our 2023 fiscal year, setting new records for net revenue, our operating income and earnings per share. In the quarter, our EBITDA margin exceeded 14% for the first time in our history. Backlog, the best indicator of future growth for us, achieved an all-time high of $3.81 billion, up 11% from last year. And just as the first quarter closed, we announced the acquisition of Amyx, bringing 500 high-end security cleared staff to our US federal IT practice. And more recent, back just 10 days ago, we completed our acquisition of the RPS Group that adds 5,000 staff and provides new growth opportunities, especially in international water and energy consulting business.

I’ll begin today’s presentation with an overview of our first quarter results and the business outlook, while Steve Burdick, our Chief Financial Officer, will provide additional details of our financial performance and capital allocation. Jill Hudkins, our President will also provide additional insight into our strategic growth opportunities that we see together with RPS. We had a very strong first quarter, setting new records for net revenue, operating income, adjusted earnings per share and backlog. Our net revenue was $737 million in the quarter, up 8% from the prior year, a new all-time high for any quarter in the company’s history. We also had a record 14% adjusted EBITDA margin, which is 90 basis points increase from the prior year. As a result of this increased margin, we generated an operating income of $97 million for the company, up 17% year-over-year.

Earnings per share from operations were a record $1.34 for the quarter. First time we’ve ever ceded $1.30, up 20% from last year on an equivalent tax basis. And in fact, we were well over $2 on a GAAP basis of earnings per share in the quarter. I’d now like to provide an overview of our performance by our end customer. In the first quarter, our growth was driven by strong performance across all four of our key client sectors. Our US Commercial net revenue was the fastest-growing sector in the company with net revenue up 22% year-over-year and comprised about a quarter of our overall business. The commercial growth was driven by strong performance in high-performance buildings, environmental restoration and a very fast-growing area in renewable energy services.

Work for our US Federal clients was up 10% year-over-year and represented 28% of our net revenue in the quarter. The increase in our US Federal work was driven by a very broad-based increases across all of our key government clients, but it was especially driven by civilian agencies for the US Federal government such as the Environmental Protection Agency, US State Department and the US Agency for International Development. Our state and local revenues for municipal, water, infrastructure and planning services grew at a 10% rate year-over-year this quarter with continued strong demand for our best-in-class water supply and watershed management solutions. This 10% growth builds on our seven consecutive years of double-digit growth in the state and local markets here in the United States.

Our International net revenue was up 13% year-on-year on a constant currency basis, driven by growth in water, environmental and sustainable infrastructure work, primarily in the countries of Canada, Australia and the United Kingdom. I’d now like to present our performance by our two segments. Our GSG and our CIG segments, both grew in the first quarter as a result of broad-based demand for our high-end services. I’ll start with the GSG segment or the Government Services Group segment, which was up 8% and year-over-year with the growth in water and environmental programs. Our GSG segment delivered a record 17.1% margin, up 240 basis points from last year. This record margin was a result of really three different things. First, continued business shift in our mix to higher-margin services.

Second, favorable project close-outs and really project performance. And third, higher utilization in the quarter. We had especially strong utilization for US Federal work and our disaster recovery services for responding to Hurricane Ian, which impacted Florida really just coming into the quarter during the month of October and extending through November and December. Without the extraordinary margin contributions from these project close-outs and episodic disaster work, we really would have seen about a 15% margin in the GSG segment for the quarter and it’s probably more representative of an ongoing margin for that particular segment. The CIG segment grew by 9% year-on-year and delivered a 13.1% margin in the quarter, up 60 basis points from last year in line with our expectations.

This is the fifth consecutive quarter with a year-on-year margin expansions for the CIG segment. The margin expansion in the first quarter was driven by strong utilization in high-performance buildings, environmental programs and renewable energy services across our global operations. Backlog at the end of the quarter was up 11% year-on-year, resulting in an all-time high ending value of $3.81 billion for the company. In the first quarter, we won many new programs and task orders with both our commercial and government clients here in the United States and internationally. We leveraged our $25 billion value in contract capacity with the US federal government, and our existing master service agreements, to generate almost $1 billion in new orders just in the quarter.

We were also awarded new programs such as the $42 million in additional contract capacity by USA for Energy Transformation Services in Moldova, and a new $95 million contract with the United States Navy to support their environmental restoration needs. This broad-based backlog provides us with excellent visibility, through the remainder of fiscal year 2023. Now, just 10 days ago on January 23, we closed the acquisition of the RPS Group, and we’re rapidly moving forward on shared opportunities, collaboration, and actually aligning their systems with ours. And I’m very pleased to welcome everyone at the RPS Group to Tetra Tech. The RPS Group brings to Tetra Tech over 5,000 staff that are highly aligned with our approach to projects and high-end consulting services in key geographic regions that we’ve been targeting for future growth for some time.

RPS doubles our staff in the United Kingdom and Australia broadening our services and client relationships in both of these regions. RPS also extends our operations by adding 1,200 employees in Europe, across the countries of Norway, Netherlands and the Republic of Ireland giving us for the first time, a significant presence in that region. When we actually combine Tetra Tech and the RPS Group, we now have an organization collectively with 27,000 employees, working from 550 offices worldwide, servicing 22,000 clients and we collectively deliver 100,000 projects a year with an annualized revenue of approximately $4.5 billion. Together, Tetra Tech and RPS, this team is leading the science and driving growth by addressing our clients increasing needs for water, environment and sustainable infrastructure services.

At this point, I’d like to turn the presentation over to our Chief Financial Officer, Steve Burdick, to go through more details of our financial performance in the quarter. Steve?

Steve Burdick: Thank you, Dan. So I’d like to now review the financial results for the first quarter of fiscal 2023. Overall, as Dan mentioned, we had record revenue and earnings and the strong performance from our operations is marked by quarterly revenue of $895 million and net revenue amounting to $737 million, which is a quarterly record for us. Now when adjusting for the FX change from last fiscal year, revenue was up 7% and net revenue was up 12% over the last year on a constant currency basis. We experienced a strong revenue growth from all the end markets, including US commercial, international, federal government, and our state and local clients. Our profitability for the first quarter was also very strong. Our adjusted EBITDA came in at $103 million, which was up 16% over last year, and our EBITDA margin increased 90 basis points to 14%.

This improvement came from both segments as you heard from Dan about three-quarters of this increase, was driven by our growth in the GSG segment, and an improvement in GSG’s operating margin, which was up 240 basis points over last year and about one-quarter of the increase was in operating income coming out of CIG where the margins were up 60 basis points over last year. Now, our GAAP EPS came in at $2.18. This was an increase of 74% from last year. As noted in our reconciliation summary as provided in the appendix to this presentation, we entered into a hedge for the purpose of locking in the RPS price in US dollars at the time we signed the agreement back in September. Now for the first quarter of fiscal 2023, we had an FX hedge gain of $68 million that contributed $0.94 to the GAAP EPS.

We entered into this hedge when the British pound was trading at a 30-year load to the US dollar. And ultimately at the time the acquisition closed in late January just 10 days ago, the cumulative effect or the cumulative gain on our FX hedge amounted to about $110 million and this effectively reduced our purchase price by almost 15% and will save over $6 million of interest expense per year going forward. In addition to the hedge gain, we incurred costs related to the RPS acquisition for bridge debt financing fee of about $2.7 million recorded in our net interest and for legal fees of about $3.8 million recorded in operating income. Now excluding these acquisition gains and losses, our quarterly EPS came in at an all-time record high of $1.34.

This was an increase of 13% compared to the adjusted EPS last year. I also want to point out that our tax rate in the quarter was 25% versus 19% a year ago. And the tax rate differential had an impact on our EPS and that — if we were at the similar lower tax rate our EPS would have been even higher by another 20%. Cash flows generated from operations for the first quarter totaled $25 million. Historically, the first quarter is seasonally our lowest period relative to cash generated from operations. Our focus on working capital and cash flows has resulted in our DSO maintaining the leading industry standard of 61 days. This is a sustainable improvement from prior years and this lower DSO trend continues to reflect the outstanding work that our project managers lead relative to higher-quality projects and highly satisfied clients in our broad portfolio across really all of our end markets and geographies.

Our net debt amounts to $82 million and the net debt to EBITDA was at a leverage of 0.2 times with a total cash position of about $164 million. Now regarding our dividend program, we paid out $12 million in dividends in the first quarter. And I want to announce that our Board of Directors approved a $0.23 dividend to be paid this quarter, and this is our 35th consecutive quarterly dividend and our seventh consecutive year of double-digit year-over-year increases in the dividends paid. As we presented here today, the continued high-quality operating and financial results with improved EBITDA margins, positive cash flows and lower leverage has provided the opportunity for Tetra Tech to comfortably take on greater leverage through our banking relationships to fund the RPS acquisition, which I will speak to next.

So for those following the presentation, I’d like to present our financial plan for the integration of RPS, which is a significant opportunity for Tetra Tech. And when looking out over the next three years, we expect to; first, increase the actual EBITDA margins of RPS from the lower historical levels to be more in line with Tetra Tech generating margins well over 13%. This will be accomplished in a similar manner as what we had done for our two previous public company acquisitions both Coffey in 2016 and WYG in 2019. By focusing on high-end differentiated services and revenues, while integrating the business into our ERP platform and our corporate systems for greater cost synergies, we had increased the margins in those businesses from breakeven to the current Tetra Tech double-digit levels.

And secondly, through improved RPS profit margins and cash flows, along with Tetra Tech’s strong positive cash flows from operations, we expect to delever our balance sheet to a level to be more in line with our long-term net debt-to-EBITDA goal of one times to two times. And we would expect to have a net debt leverage of about 1.5 times by the end of this year. So as you can tell, I’m very pleased to share these quarterly results with you for the start of our fiscal 2023. I want to thank you for your support and I will now hand the call over to Jill to discuss just a few of the many business opportunities of bringing Tetra Tech and RPS together.

Jill Hudkins: Thank you, Steve. RPS is an excellent strategic fit for Tetra Tech, expanding both our global water and renewable energy opportunities. Tetra Tech has a leadership position in water, as demonstrated by our number one water ranking by engineering news record for 19 consecutive years. Tetra Tech is working worldwide to provide our clients with sustainable water supplies and innovative water treatment solutions. Our rapidly growing digital water practice is advancing water utilities programs by providing remote automation, monitoring and data analytics. The addition of RPS expands Tetra Tech’s addressable market by providing us with access to a £10 billion per year UK water market. RPS brings long-term relationships and consulting contracts with all of the major UK water agency clients.

These same clients utilize RPS Group’s Water net Pro software platform on a subscription basis, a cloud-based decision-making system that provides predictive analytics and visualization for water quality, hydraulics and asset management. The addition of RPS also advances Tetra Tech’s global energy strategy by giving Tetra Tech access to a £15 billion per year offshore wind market in the United Kingdom and Europe, significantly increasing Tetra Tech’s renewable energy opportunities. Tetra Tech holds top rankings with engineering news record in renewable energy for hydropower, wind power and solar power. Tetra Tech has long-term relationships with energy utilities, having provided high-end siting and permitting consulting for more than 1000 projects in the US.

For the US offshore wind market, Tetra Tech provided all of the front-end planning and permitting services for the only two operational projects, the Block Island Wind project and the Coastal Virginia Wind project. RPS also brings an impressive resume for offshore wind in the UK and Europe, having worked for over a decade on the development of the one, two and three wind projects, and providing specialized services in the areas of marine investigation and geophysical analytics. Together, we are ideally suited to support our clients in the expected 260 gigawatts of offshore wind development in the North Sea, representing a fivefold increase in current wind generation with offices in Ireland, the United Kingdom, Norway and the Netherlands, RPS is well positioned to put Tetra Tech on the map in the North Sea.

And now, I’d like to turn the presentation back to Dan.

Dan Batrack: Great. Thank you, very much, Jill. I’d now like to present our guidance for the second quarter and for all of fiscal year 2023. And I’d like to do that in two parts this morning. First, I’ll be presenting Tetra Tech’s guidance without RPS. And I’ll remind the collective group here they’ve been with us for just 10 days now. And second, I’d like to provide the outlook for the RPS Group’s financial contributions for both the second quarter and for all of the fiscal year of 2023 for the amount post-acquisition or post January 23. I’d like to begin with our guidance as follows for Tetra Tech excluding RPS. For the quarter, for the second quarter of 2023, our net revenue guidance is a range of $685 million to $735 million, with an associated earnings per share of $1.03 to $1.08.

For the entire year of fiscal year 2023, we are increasing our net revenue guidance range to a level of $3 billion to $3.15 billion of net revenue, with an associated earnings per share guidance of $4.90 to $5.05. This guidance for Tetra Tech excluding RPS has the following assumptions. It assumes within this guidance we will take an expense of $0.21 per share, or $15 million for intangible amortizations, we’ll have an effective tax rate for the year of 26% for the remainder of the year. We have approximately 54 million diluted shares outstanding and this guidance does exclude any other contributions that would take place after the RPS acquisition. With respect to the contributions, the financial contributions for RPS for the second quarter, we have estimated that they will contribute approximately $100 million of net revenue to Tetra Tech, with an associated earnings per share of minus $0.10 in the second quarter.

For the entire fiscal year of 2023, the eight months that they will be with us in total, we expect that they will contribute approximately $400 million of net revenue and be neutral to our earnings per share on an adjusted basis, excluding transaction and integration costs. In summary, we had an excellent first quarter and just a fantastic start to fiscal year 2023 setting first quarter records and frankly any quarter records for net revenue income and earnings per share. Our backlog reached another all-time high comprised of services that are aligned with our long-term growth strategy that provide us excellent visibility for the remainder of 2023 and frankly even further into the future. As we begin the year, we’re seeing increased opportunities and demand for our Leading with Science approach and advanced analytics solutions reaffirming our strategy to focus on the high-end services in water, environmental programs and sustainable infrastructure.

And with that, Darryl, I would like to open the call up for questions.

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Q&A Session

Operator: The question-and-answer session will begin now. Our first questions come from the line of Noelle Dilts with Stifel. Please proceed with your question.

Noelle Dilts: Hi. Thanks everyone. So I was hoping that you could just expand a bit on your expectations around RPS margins for fiscal 2023. I think when RPS had — before the acquisition, had been talking about kind of getting to a double-digit EBITDA margin in the near term. So could you just, expand upon sort of how you’re thinking about the margin profile this year, and how the cost savings that you’ve laid out rollout over the next basically 2.5 years? Thanks.

Dan Batrack: Absolutely, Noelle. Thanks for the question. Steve, actually put together a slide that was included in his prepared remarks, that graphically depict our expanding margin expectations for the RPS Group. Now in 2022, which has been completed let’s call that the trailing 12 months, RPS Group was around 4%, just slightly over 4%. We expect that under Tetra Tech that number will double and we expect as an average for the year, that that will increase to approximately 8%. In fact, we’ll be exiting fiscal year 2023, at a run rate closer to 10%. But for the average, that they’ll contribute for 2023, it would be approximately 8% for the year, with it beginning at approximately 4% now, and expanding to a run rate at about 10% at the end of the year.

We expect in 2024, that number to move into a double-digit level approximately 11% and that level it will enter at about 11x at about 12 with an annual average right there in the middle, at about 11 and that would be for 2024. And then finally, in the following 12 months, we expect that to be up at Tetra Tech level, which would be a 13% plus. Now, in one respect, I would say that 2024 sounds like a long way away. But since, we’re on the US federal government calendar, that’s less than eight months away. So, it’s actually quite close. With respect to savings, I did make a comment on the adjustments with respect to our forecast for contributions from RPS to Tetra Tech. We do expect that on a cost synergies basis, moving to common platforms and aligning our systems, we will see — once fully implemented, we will have approximately a $25 million contribution from reduced cost or it will contribute to their EBITDA.

That is embedded in helping assist to get to the margins that I had just indicated. We expect that it will cost us about 10 — I’m sorry, it will cost us about $20 million, in order to achieve the $25 million in savings per year. We expect we’ll get about half of that cost synergies this year, in fiscal year 2023. So of the $25 million we’d expect, we get about $10 million, a year savings here in this current fiscal year. The cost for that will be about $15 million. So of our total $20 million that we’ll spend to achieve the $25 million, we’ll incur about half of that this fiscal year. That will leave about $5 million for fiscal year 2024. We expect the annual yield to be up to about $20 million, a year for 2024, and then beyond that 25 on an ongoing and future basis.

I know I ran through those numbers, pretty fast. So, there’s some questions on that I’d be happy to get into those details or have Steve, provide some of the underlying support.