Prepared remarks
Good morning, and thank you for joining the Tetra Tech earnings call. As a reminder, Tetra Tech is simulcasting this presentation with slides in the Investors section of its webcast 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; Steven 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. With that, I would now like to turn the call over to Roger Argus. Please go ahead, Mr. Argus.
Thank you, Latania. Good morning, and welcome to our fiscal year 2026 third quarter earnings conference call. We had a strong third quarter with growth primarily driven by our U.S. federal and international end markets, both of which increased at double-digit rates. We received significant new orders during the quarter, including commercial orders for data centers and sediment restoration projects, driving our backlog up by more than $200 million in the quarter. Our performance resulted in our increasing guidance for fiscal 2026. For the call today, I will begin with an overview of our third quarter's performance and the client markets that are driving our growth. Steven Burdick, our Chief Financial Officer, will provide additional detail on our financial performance and capital allocation. We delivered a strong third quarter with positive performance across key financial metrics. Net revenue was $1.1 billion for the quarter, exceeding the upper end of our guidance and supported by strong demand for our leading-with-science approach to water, environment and sustainable infrastructure. Earnings per share of $0.42 also exceeded the upper end of our guidance. We generated cash flow of $229 million from operations in the quarter and $467 million year-to-date, which is an all-time high for the first three quarters of a year. Importantly, our backlog was up for the second consecutive quarter, increasing sequentially by 5% to just under $4.5 billion. Overall, the quarter was in line with our expectations and the increased backlog provides us with good visibility into the fourth quarter and the end of the fiscal year. Both of our business segments performed well in the third quarter. The Government Services Group, or GSG, grew by 7% in the third quarter on a year-over-year basis and generated a strong margin of 17.5%. Demand remains solid for both our U.S. federal and state and local government markets, especially in water, environment and defense. The Commercial/International Group, or CIG, also performed well, with revenue up 9% from the prior year and an associated margin of 15.1%. CIG's growth was from a diversified mix of clients across water, power and energy, and mining markets worldwide. I would now like to provide an overview of our net revenue by customer. Our international work was up 12% on a year-over-year basis and represented 47% of our business. Revenue growth was driven by water programs in the U.K., Ireland and the Netherlands, an increase in infrastructure work in Canada, and growth in mining and digital automation revenues in Australia. In the U.S., our U.S. federal work was up 12% from last year and represented 20% of our business. This growth was driven by our work for the U.S. federal government in infrastructure, planning and environment for defense and civilian clients. Our U.S. commercial business was up 1% compared to last year and represented 20% of our business. Revenues for energy and transmission-related services continue to increase, accompanied by stronger mining and minerals project activity. However, these gains were partially offset by the decline in renewable energy work, including the cancellation of remaining offshore wind programs along the Atlantic Coast. Our U.S. state and local business grew by 5% this quarter. We continue to see strong growth and longer-term orders in municipal water, including new projects for PFAS treatment, digital systems modernization, water reuse and desalination. We had a strong quarter for new orders and our backlog was up $208 million, increasing by 5% sequentially from the prior quarter. As we stated before, we take a conservative approach to backlog. We include only work that is contracted, funded and authorized. This gives us high-quality visibility into future performance and increases our confidence in our project pipeline. Our backlog growth was supported by several important wins across priority markets. In the United States, we added just under $300 million in contract capacity from the Army Corps of Engineers Mobile and Norfolk districts, where we have worked for decades. The Mobile district includes the critical U.S. Gulf Coast regions as well as supporting international programs in Central and South America. The Norfolk district is a central hub for supporting the world's largest naval base, innovation in coastal resiliency, and the critical East Coast shipping channels. We also added new state and local programs, including being awarded the lead designer role for the largest dedicated municipal PFOS treatment system in the United States located in Dayton, Ohio. This quarter, we were pleased to see that our U.S. commercial orders were also very strong. Commercial orders were led by digital automation for data centers, power and transmission services, and sediment restoration programs. I will now turn the call over to Steven Burdick, our Chief Financial Officer, to discuss our financial results and capital allocation in more detail. Steven?
Thanks, Roger. As Roger said, I'd like to provide an update on our reported year-to-date fiscal 2026 GAAP results, working capital, cash flows and capital allocation. As Roger discussed, our market-leading focus on front-end technical design and engineering for water and environmental projects is carrying higher margins across all of our end markets. Even as reported revenue was down from last year due primarily to a decrease in USA customer revenue and the revenues from one-time disasters last year, our operating income increased significantly and adjusted EBITDA on net revenue for the first nine months has increased by about 80 basis points year-over-year. These results further support our long-term strategic goal of improving EBITDA margins by about 50 basis points annually. More often over the last year, I've been asked by our shareholders and others what our margins look like on a net service revenue, or NSR, basis, which would be similar to how others in the industry report their margins. I've looked at that question and can tell you that our EBITDA margin would be about 240 basis points higher this year to date on an NSR basis. As a result of our ability to enhance profit margins and further manage our working capital, we were able to increase EPS and come in well above our previous guidance range for the third quarter. Regarding our working capital, cash flows generated from operations for the first nine months of the year were a historical record of $467 million, which represents a significant 31% improvement over fiscal 2025. Consistent with each of the last 21 years, our operating cash flows have continued to exceed net income. Our focus on working capital and cash flows has resulted in our DSO reflecting an industry-leading standard of 56 days, which is similar to last year and an improvement compared to Q2 of this year. This lower DSO metric provides significant insight into our core business as it reflects outstanding work that our project managers lead relative to higher-quality projects and highly satisfied clients across our end markets and geographies. Our net debt target is about 1 to 2x, and our actual net debt to EBITDA was at a leverage of 0.88x, which is lower than our leverage ratio one year ago when it stood at 0.96x. As we continue to execute on high-quality 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. Those higher shareholder returns are reflected in an improving return on capital employed, which now stands at over 20%. With that perspective, I now present our capital allocation strategy and overview. We have a very strong balance sheet; our operating cash flow was $567 million for the trailing 12-month period. We can invest in organic and acquisitive growth priorities to take advantage of key business opportunities such as technology and automation, which continues to provide us a dominant position in those markets. Year-to-date, we have closed acquisitions of technical leaders focused on defense, such as Habit in the U.S. and Providence in Australia. 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 the fourth quarter. This is our 45th consecutive quarterly dividend with annual double-digit increases in the amounts paid. Based on our lower leverage, we have continued our stock buyback program this year. In the third quarter, we increased our buyback to $100 million. For the first nine months of 2026, we bought back a total of $200 million. We do have $398 million available from our stock buyback plan that was approved by our Board of Directors as part of our capital allocation strategy. I'm pleased to share these strong year-to-date results for fiscal 2026, which has enabled us to increase shareholder value as we can pay increasing dividends, increase our stock buybacks, engage in accretive acquisitions, all while deleveraging our balance sheet. I want to thank you for your support, and I will now hand the call back over to Roger to discuss our global opportunities in water for 2026 and beyond.
Thank you, Steven. Across our key regions, our clients are increasing their investment in water-related priorities that align directly with Tetra Tech's core strengths. These priorities leverage Tetra Tech's expertise in high-end water treatment, water quality management, hydropower infrastructure, digital systems and cybersecurity. In the U.S., where we work with over 500 municipal clients, we are seeing clients continue to plan for modernization and expansion of their facilities while proactively integrating rate increases, bonds and commercial funding sources. We also see new programs in the U.S. to expand hydropower to meet increased demand, such as the Lake Chalon program, which we announced last week. In the U.K. and Ireland, large regulated investment cycles are supporting growth across our key markets in water quality, leakage management and desalination. The U.K.'s AMP cycle includes approximately GBP 105 billion of water sector investment through the year 2030. Across the U.K., Ireland and the Netherlands, we hold over GBP 2 billion in contract capacity to provide differentiated solutions such as our smart sewer systems and our water leak detection system. In Canada, federal infrastructure and hydropower investments are supporting demand for our water, environment and infrastructure services. We expect hydropower investments to continue to expand to address increased demand for clean and reliable energy. One of our key clients, Hydro-Quebec, plans to add 11 gigawatts in new capacity, driving new opportunities for us in hydropower, modernization, transmission and water treatment. In Australia, water agencies are accelerating deployment of digital automation and cybersecurity to improve operations and prepare for AI-enabled optimization. Market forecasts estimate more than $17 billion of digital water investments in Australia over the next decade. We have provided additional water automation services used today by utilities such as the Water Corporation in Western Australia and for South Australia Water’s system modernization. I'd now like to present our guidance for the fourth quarter and the entire 2026 fiscal year. Our guidance is as follows. For the fourth quarter, net revenue guidance is from $1.12 billion to $1.17 billion. Adjusted earnings per share guidance is from $0.45 to $0.48. For the full fiscal year of 2026, our net revenue guidance is from $4.315 billion to $4.365 billion, and our increased adjusted earnings per share guidance is from $1.56 to $1.59. The right side of this slide presents the FY 2026 net revenue growth, which is up 8% year-over-year at the midpoint with an associated margin expansion of 70 basis points year-over-year at the midpoint. You can read the FY 2026 assumptions on our slide, but I'll highlight a few: intangible amortization of $34 million, depreciation of $23 million, interest expense of $30 million, an effective tax rate of 27.3%, and this guidance does not include contributions from future acquisitions. In summary, we had a strong third quarter as demonstrated by our financial metrics in revenue, margin, cash generation and backlog. Demand for Tetra Tech's differentiated leading-with-science services continues to drive sustained growth for us in water-related work globally. Our focus on water is also bringing us new opportunities in hydropower, digital automation, data centers, mining and resilient infrastructure. Strong cash flows support our strategy to deploy our cash to grow organically and through acquisition while also returning cash to our shareholders. With our outperformance in the third quarter, we have raised our guidance for the full fiscal year 2026. I think we'll now take your questions.
Questions and answers
Thank you. At this time, the question-and-answer session will begin now. The first question comes from Rene Gagliardo with William Blair.
This is Rene on for Tim Miner. I just have one question about the backlog. We saw the backlog was up year-over-year for the first time in several quarters and up sequentially now for two quarters in a row. Can you talk about two of the primary drivers behind that backlog growth? We've seen some announcements recently, particularly on the commercial and federal side, and we're hoping to get a little more detail about where you're seeing momentum.
Thanks, Rene. I'm very encouraged by our continued backlog growth. As you mentioned, the 5% sequential growth was our second quarter in a row with growing backlog. For us, backlog includes only contracted, funded and authorized work, which means our project teams can begin work on these projects. We highlighted recent press releases such as the PFOS treatment system in Dayton, digital automation in Los Angeles and also a $27 million award from the FAA for airspace modernization. The backlog has grown across all of our end markets. A few specific areas of interest include commercial orders for data centers, where the scope of work we provide is expanding — we started with engineering and commissioning type work, expanded into feasibility studies, and now are doing work related to power and water supply associated with the development of new data centers. In the commercial sector, we were also encouraged by new work late in the quarter for sediment remediation programs. Many of the orders we received in the quarter are initial funding for longer-term, multiyear programs, which gives us confidence in future contributions and supports our backlog growth.
Next question comes from Sabahat Khan with RBC Capital.
Great. Thanks. There were a lot of moving pieces here between last year and early this year around Department of State work getting shifted, diligence impacts, and procurement headwinds across the U.S. government. Can you talk through the operating backdrop — the ability of the government and other U.S. agencies, even private sector customers, to bring work to the market in this environment? Maybe a bit of background on where we are today versus this time last year.
Thanks, Sabahat. Good question. Starting with the U.S. federal government, last year we went through the longest shutdown in history. The government has approved a budget, which they are operating under now, so some headwinds early in the year were due to that shutdown. Even with the budget in place, we continue to see challenges in the U.S. federal government placing orders and awarding work. This is due to a constrained contracting office staff pool and a significant reduction in force in contracting staff, which created bottlenecks in issuing task orders and getting work out to contractors. That remains an issue, and we haven't seen substantial change in the flow of work. We still received work and achieved backlog growth but the flow is constrained. On the commercial side, clients do not face the same contracting constraints, but uncertainty in the marketplace — whether around regulatory enforcement or compliance requirements — causes some clients to be cautious in awarding new programs. Despite these headwinds, we've seen strong awards in the commercial sector recently, which is encouraging. Geopolitical issues, such as the war in the Middle East, have caused supply chain pressures related to fuel and other inputs, which adds overall pressure to the market.
Great. Then on the medium-term outlook, you've previously been committed to the fiscal 2030 targets. Given where the year has evolved, can you comment directionally on fiscal '27? Are you expecting a return to a run-rate growth level in fiscal '27?
It's early to comment on fiscal '27. We are encouraged by the backlog growth we experienced in Q3 and are focused on Q4 to continue that trend and build a stable base of work that will carry into the new fiscal year.
One quick one on Department of State and USAID work. Some flow-through has occurred this year. Is that something that could continue into next year? If there is a steady-state amount that continues, does it become part of the base business? How should we model or view that business going forward?
Thanks. USAID as an entity does not exist in the same structure as before; the Department of State does and will continue as a client of ours. While we experienced a year-over-year decline associated with prior USAID work, we see work with the Department of State continuing and remaining a client. There is political uncertainty around some work we did with USAID, particularly Ukraine-related programs, so it's hard to give a clear view into the future. It has been continuing for us and will continue at some level, but we remain conservative in forecasting contributions from the remaining Department of State-related work.
The next question comes from Sangita Jain with KeyBanc Capital.
If I can continue on the Department of State question: Given that the Department of State is a customer of yours and you have several other federal agencies as customers, do you expect to start holding this into regular government services revenue and not even discuss it as episodic? Is that possible?
Eventually, yes.
What are the things you're waiting on before you decide to do that?
One factor is that the predominance of USAID-related work completed in Q4 of fiscal '25, so we are waiting for that to fully sunset. We have maintained a conservative approach to forecasting contribution from remaining Department of State work. Over time, we are hopeful the work will stabilize and our confidence will increase, and then it will be considered a normal part of our business.
Got it. On U.S. commercial, international commercial has been strong the last couple of quarters. Can you comment on what's happening in the U.S., given the slowdown in renewables and going into next year?
There is still a renewables practice in the U.S., though the offshore wind practice has diminished. Our power and energy practice in the U.S. is growing. Data center work continues to grow and we're receiving orders around sediment restoration, which includes front-end work associated with potential long-term implementation. Data centers for us are relatively small — around $60 million for the year — but we're seeing an expanded scope of services from clients and are encouraged by that demand.
The next question comes from Ryan Connors with Northcoast.
I wondered if we could dive a little deeper into the state and local business. One takeaway from the industrial side of the water industry this earnings season has been a bit of a downshift. How are you seeing that market evolve? Any shift in the cadence of projects, types of projects, or composition of funding? How is that market evolving?
Good question. Last quarter we noted that the federal government had proposed some budgets that could include cuts for co-funding that supports state and municipal water programs, so we expressed caution. Final budgets are not complete. One version when Congress returned funded state revolving funds at the same level or slightly more. We've been cautious and watching closely, but our municipal water treatment business was still up double digits year-over-year in Q3, so we haven't seen an impact there. Clients are looking at other funding sources; they have the population to serve, so they find ways to fund projects through rate increases, bonds, or legal settlements. Where we have seen impact is in flood protection, where federal co-funding has been reduced; that is a smaller part of our state and local business, but more than 20 states have filed suits over withheld federal flood protection funding. Municipal water treatment, which is the predominant part of our state and local work, remains strong.
Got it. Thanks. Second question: concerns around AI disrupting business models have weighed on the stock. How are you viewing AI as it relates to your industry? What risks and opportunities does it create for Tetra Tech?
Tetra Tech is a front-end applied science, technical and engineering firm. We provide front-end work that requires deep, site-specific knowledge — geology, site conditions, regulatory frameworks, community priorities — and we use that knowledge and technical expertise to develop bespoke, custom solutions for clients. We view AI as an enabler for our technical experts. We are not a downstream commodity design company doing routine, repetitive design work that could be displaced. AI is a tool that allows our experts to evaluate more alternatives, assess larger data sets, and develop better solutions, which supports higher-quality outcomes for clients. We've always used the latest technology to support clients and differentiate ourselves. In water, where challenges are complex, clients need our technical expertise enabled by AI and other digital tools to address problems and satisfy project requirements. We see AI as an enabler that will help us provide better solutions, grow market share, and expand margins on fixed-price projects.
The next question comes from Andrew Wittmann with Baird.
One of my questions has been asked and answered, but maybe one for Steven. At Investor Day you outlined a view of improving margins by around 50 basis points per year, and this year you're doing better than that. The guide shows EBITDA margin up 70 basis points. How should we think about that relative to fiscal '27? Could some benefits be pull-forward such that next year is less? How should we think about margin outlook?
Good question. We implemented a plan to improve margins, and historically we've improved margins by about 50 basis points per year on average. Some years are more, some less. From fiscal '23 to '24 we increased by about 70 basis points, from '24 to '25 we increased by about 80 basis points, and this year we're about 70 basis points. Everything we're doing to improve margins is working. For next year, we think 50 basis points is a reasonable expectation, but it could be a little less or a little more based on the usual variability. We'll provide better clarity when we give fiscal '27 guidance.
Fair enough. Quick one: did you mention how much Ukraine/AID work is in the fourth quarter guide? Q3 came a bit above expectations — can you comment on Q4 contribution?
Q3 was about $66 million in total related to that work, and Q4 is probably in that range.
Roger, regarding the mining end markets: commodity prices for copper and gold have been strong, and commodities like uranium have been notable. Do you think we're at the beginning of a mining cycle that could benefit Tetra Tech more materially? How do you see that business today and into the next year?
We have a strong global mining practice and work with large multinational mining clients. The work we see is driven in part by commodity prices and demand for rare earth elements. We have projects across exploration, research, new mine development, remediation and long-term tailings management. We're watching the market closely and staying close to clients. We have the technical capabilities to ramp if larger projects come to market, and we're encouraged, but I would not predict commodity prices or assert that a larger cycle has begun.
This will conclude the Q&A session. I will now turn the conference back over to Roger Argus to conclude.
Thank you, Latania. In closing, I'd like to thank you for your questions and interest in Tetra Tech. Recent awards and future opportunities continue to demonstrate the strength of our business and the enduring alignment of our differentiated water services with the priorities of our clients worldwide. I look forward to speaking with you again next quarter. Thank you, and goodbye.
Ladies and gentlemen, this concludes our conference call for today. Thank you all for participating, and have a nice day. All parties may disconnect now.