Tetra Tech - Earnings Call - Q2 2025

Executive Summary

• Q2 FY25 net revenue and adjusted EPS exceeded consensus and company guidance: Net revenue $1.104B vs S&P Global consensus ~$1.042B*, and adjusted EPS $0.33 vs ~$0.31*; GAAP EPS was $0.02 due to a $92.4M non‑cash goodwill impairment tied to USAID program terminations.
• TTEK raised FY25 guidance: net revenue to $4.400–$4.765B (from $4.365–$4.765B) and adjusted EPS to $1.42–$1.52 (from $1.37–$1.52). Q3 net revenue guided to $1.10–$1.20B and EPS to $0.35–$0.40.
• Resilience despite abrupt USAID/DOS impact: backlog adjusted to $4.31B total after ~$1.1B de‑obligation, with core backlog ex‑USAID/State at $4.09B and book‑to‑bill of ~1.1x (ex‑USAID/State).
• Capital allocation and liquidity strengthened: $150M buyback in Q2; new $500M authorization ($673M total available); quarterly dividend raised to $0.065; and a new $1.5B credit facility ($600M revolver; $250M 3‑yr TL; $250M 5‑yr TL) with covenants (max leverage 3.5x; min interest coverage 3.0x).

What Went Well and What Went Wrong

• What Went Well
  • Broad-based demand offset USAID/DOS headwinds; state & local net revenue grew 44% YoY (about half disaster response, balance ongoing municipal water up 19% YoY); U.S. federal ex‑USAID/State up 16% YoY; GSG revenue +12% YoY to $521M with 13.8% margin despite non‑reimbursable closeout costs.
  • CIG margin 13.2%; U.S. commercial up 5% YoY; UK/Irish water programs double‑digit growth; strong DoD/USACE pipeline with >$30B federal contract capacity and multiple recent wins supporting growth visibility.
  • Digital systems/AI strategy advancing: signed definitive agreement to acquire SAGE Group (800 automation experts) to expand AI‑enabled digital automation; management targets a $500M digital systems practice by 2030.
• What Went Wrong
  • USAID/DOS terminations triggered a $92.4M non‑cash goodwill impairment and backlog de‑obligation of ~$1.1B; GAAP EPS reduced to $0.02 in Q2.
  • International growth mixed; Australia infrastructure work down >10% (election‑driven pausing), and clients paused some international commercial decisions awaiting tariff clarity.
  • USAID closeout created non‑reimbursable costs and temporary utilization pressure in the affected group; management held staff during the transition to redeploy, modestly weighing margins in the short term.

Transcript

Operator (participant)

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 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; 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.

Dan Batrack (Chairman and CEO)

Thank you very much, Christine. Good morning, and welcome to our second quarter of fiscal year 2025's 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 of recorded results of this happening, I'm not sure I could have told you, but it certainly wouldn't have been good. 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 of 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. 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. It was particularly a very strong quarter for the company. I know I personally and the 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.

Now, 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, will provide an update on water and environmental markets, primarily in the government sector. 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. 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. GSG generated a 13.8% margin in the quarter. 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 had not 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.

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 U.K. 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 US Army Corps of Engineers. Our state and local revenues grew 44% year over year. Now, of 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 US commercial net revenues were up 5% year over year, driven by growth in our environmental, energy, and transmission-related work. 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 Australia revenues has been attributed to a major election that took place just less than a week ago. On May 3rd, 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, is 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 deobligation of approximately $1.1 billion in USAID and the Department of State projects that took place in the quarter. 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. 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 $1.1 for the quarter, driven by orders all across our global operations.

I'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, or both contract capacity and backlog. 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 U.K. 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 strategy. Steve.

Steve Burdick (CFO)

Hey, thanks, Dan. I'd like to now provide an update for the first half of the 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. 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 two times our top-line growth. Now, in the first half of the year, our GAAP results include one-time non-recurring charges. So I 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 eight years and to improve our annual EBITDA margins by an average of 50 basis points each year over that same eight-year period.

You know, as you all probably know, about one 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 due 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 have continued to exceed our fiscal net income by more than 100%. Including the USAID-related receivables, our consolidated DSO stood at 67 days.

As I noted, 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 one 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.

As we continue to execute on high-quality operating results with strong cash flows and a healthy working capital, we've been able to pay out higher dividends, increase the stock buybacks, and invest in strategic acquisitions to provide higher returns for all of our shareholders, all while delivering our balance sheet. 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 improved the balance sheet as we closed and funded on a new credit facility with our very supportive bank group, such that over the next five years through 2030, we have access to more liquidity, about $1.5 billion, at more favorable terms and conditions.

As we have revised our capital structure over the last two 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 basis points to 3.63%, and this in an environment of higher uncertainty. 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 a significant amount of liquidity available to invest in both organic and inquisitive priorities. 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 amount paid. Based on the lower leverage, which we did fall below one time at the end of 2024, we did reinstitute our stock buyback program. 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. 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.

Leslie Shoemaker (CIO)

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. We work for the Corps to upgrade our inland waterway systems, the engineering of the locks and dams that support the US 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. 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. In Ireland, we are supporting the water utility in their program to fully re-engineer 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 Karen and Walsh, a leader in program management services for utilities and government agencies. Welcoming them aboard will really extend our ability to provide more program management services. With that, I'd now like to turn the presentation over to Joseph.

Joseph Fong (High Performance Buildings Lead)

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 designs, 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 supply 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 building's work. With our hyperscale clients raising expending forecasts for data centers and related infrastructure, we anticipate continued growth in this end market for our water, energy, and high-performance building services.

For 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 colocation data center clients in the U.S., United Kingdom, and Australia, we are anticipating 20-25% 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 broadens our expertise to address the needs of clients across water, manufacturing, and defense.

Sage joins 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 teams 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 a strategy that we initiated in 2019 to expand in the areas of digital systems and automation. Since that time, the evolution of instrumentation technologies and, more recently, the advent of generative AI has made digital systems even more integral to the operations 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 four 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 will have significantly expanded expertise, shared proprietary technologies, 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 is 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.

Dan Batrack (Chairman and CEO)

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 range is from $1.1 billion-$1.2 billion of net revenue, with an associated adjusted EPS of a range of $0.35-$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-$4.765 billion, with an associated adjusted earnings per share of $1.42-$1.52. The midpoints of this annual guidance show a 6% net revenue growth with an adjusted earnings per share of 17%. This is all inclusive of USAID and others that have been adjusted downward during the year.

Some of the assumptions, if you're following along the webcast, do include about a $35 million intangible amortization cost during the year, which would actually be included. That includes $8 million in both Q3 and Q4, effective tax rate at 27.5%, depreciation of $24 million, interest expense of $34-$38 million, and 267 million diluted shares outstanding. 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 will be joining Tetra Tech. Not only does it give us more resources, bring us new clients, but it adds a big new geography for us with their presence in Australia. Steve covered, I thought, quite well, and it has 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. I will 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. All of this together just puts us in a great position to continue to grow our business and support our clients worldwide.

Christine, I'd like to open the call up for questions.

Operator (participant)

The question and answer session will begin now. Please be aware that there will be a 30-second pause in our webcast to allow for buffering. At this time, audio participants are invited to submit their questions. Please remember to mute the audio function on your computer before you speak. If you are using a speakerphone, please pick up the handset before pressing any numbers. If you would like to ask a question, press star one on your Touchtone phone. Thank you. Our first question comes from the line of Tim Mulrooney with William Blair. Please proceed with your question.

Tim Mulrooney (Group Head of Global Services)

Good morning, everybody. You had a really strong quarter in state and local, even excluding the disaster response. 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 munibonds and user fees. 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?

Dan Batrack (Chairman and CEO)

Thanks for that question, Tim. It's a really good question. I actually received the flip side of that same question about three or four years ago when the IIJA was put in place and when some of the ARPA funding was put in place for additional funding at the state and local level. 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? My comment was, I see those are going to be overflow to other areas, but not see a material increase.

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 a decline at that time. 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 the state revolving fund out of EPA. 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 the water infrastructure funding mechanism. We have not seen that, any signs of any type of reduction or pressure at this time.

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. In places like California that were very large, where there are deficits in the general fund, we've seen very large bonds pass that will carry this through a multi-year period. I don't know. At this point, I don't see any near-term pressure in our state and local projects that we have. A lot of these are multi-year projects that we get funded either semi-annually or annually. While it may not be in our backlog, we expect the next phases to move forward because these are multiple-year programs. One quarter of a water supply system or one quarter of a wastewater treatment plant isn't very valuable.

Even if there was an impact, these are typically very late-cycle indicators with respect to our state and local. No impact now. I don't really see it coming in the near future. If for some reason things change, I expect it would be a few-year delay before we'd see it in our funding.

Tim Mulrooney (Group Head of Global Services)

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. That's helpful color. Thanks. One more from me. I recently saw Lee Zeldin's list of top priorities for environmental deregulation at the EPA, which was released in March. Curious if you've had a chance to review those 31 proposed actions as well and what the company's doing internally to prepare for those potential changes. I'm thinking about this both from a risk standpoint, but also an opportunity standpoint. Thank you.

Dan Batrack (Chairman and CEO)

Yeah. Zeldin, the EPA administrator with this administration, has come out just recently with a number of proposed changes to the EPA's regulatory regimes. I would say those are proposals. We're watching them very carefully to see how they progress and how they finally end up. What is interesting, most of the work we do, and I don't know why I approximated it, something like 90% of the work we do on the environmental side is actually driven by state and local regulations and work that we do to meet those compliance requirements. I'd say the other 10% that we do that is actually driven by federal government regulations are mostly on superfund sites that I would say are outside the proposed regulations that have been proposed by Administrator Zeldin. One thing I have found interesting is there are emerging contaminants that have received a lot of attention.

Of course, PFAS, these forever chemicals, is probably one of the more covered topics. Administrator Zeldin was on the commissions and the groups that actually reviewed putting these regulatory actions in place. He spoke at a number of different forums here over the past month about it's important to regulate these. It's important to remove them from the drinking water supply and protect the human health of the country. It's going to be moving forward with the regulations that have been put in place, but is looking for not the water delivery or the utilities to pay the bills for this to remove, but actually to have the responsible parties who actually impacted the water supplies. He actually called out even the federal government as being one of the largest contributors to PFAS in the environment, which then works its way to the drinking water supply.

Now, we've worked for the federal government since our very founding, getting close to 60 years ago now. The Department of Defense is the location where it comes from. It's from firefighting. It's from other chemical uses, discharges. We have an enormous amount of contract capacity. I expect some of these things that will go forward with EPA's enforcement and investigations will be led by the Department of Defense. I think we're really well positioned there. I don't know. There are a lot of federal regulations that are being proposed and discussed. We don't see them having a direct impact on the contracted work we have other than some positive outcomes with respect to investigation and cleaning up some of these persistent chemicals that have become priorities these days. Good questions. We're watching it very closely to see how they change.

As it relates directly to the work we're contracted for, we don't see much of an impact. Thank you, Tim.

Operator (participant)

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

Sangita Jain (Analyst)

Yeah. Good morning. Thank you for taking my question. If I can just on the core margin progression, how do you think that works out once it just settles on the USAID cancellations and productivity normalizes? I know you've given us a 50 basis point annual target at the end of the day, but just wondering how you think about it now.

Dan Batrack (Chairman and CEO)

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 USAID work was gone? I don't know if that was prophetic or not. My initial comment was, our margins are going up. 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. That's with aid. Now, I think that the baseline of our overall margin profile without aid is now higher. 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. I think that we did not 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. Without USAID in there, I think that the margins should grow slightly faster than the 50 basis points. I think we have a new higher baseline, and I think we have a faster growth rate with respect to margin growth over the five years that we called out on investor day. 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 14th.

Yes, they're going to be better, and they're going to be higher. That's what we still see at this point.

Sangita Jain (Analyst)

Great. Thank you, Dan. 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.

Dan Batrack (Chairman and CEO)

Yeah. It's interesting. We have about 220 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 of the 220 can be complete this year and relatively even revenues to roughly 100 in each quarter. Now, work in Ukraine, as if you follow any of the news headlines, is highly variable. That certainly could go down or it could go up depending on political will and commitments and other items. We expect that to be incurred or spent by the government and authorized to us on a 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. A small part of that we'll be demobilizing here through the rest of this year. That's everything from repatriating staff to the US and closing down field offices and transferring government-owned property back to the appropriate owners. That's how we see that progressing between now and the end of the year.

Sangita Jain (Analyst)

Appreciate that. Thank you, Dan.

Dan Batrack (Chairman and CEO)

Thank you, Sangita.

Operator (participant)

Our next question comes from the line of Seva Haqqan with RBC. Please proceed with your question.

Seva Haqqan (Analyst)

Okay. Great. Thanks. Good afternoon. I think, Dan, too, coming early at the beginning during the preamble around this just 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 you think 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 are seeing on a ground level as it relates to the projects ahead and the funding that they have. Thanks.

Dan Batrack (Chairman and CEO)

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. 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. 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. Most of that has actually been since the inauguration. Certainly, it's been since the election. We actually take a look at the contracts that have been put in place, the geographies, which happen 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. I think the slide in the presented materials gives a good example. Sometimes the government announces successes and wins we have even before we do. We wait until we finish signing it. Do not be surprised if you see quite a bit more coming out with new awards to the company. What we're hearing from our clients is they're going to commit to funding. It's 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. Interestingly enough, our largest civilian agency client is the Federal Aviation Administration or FAA. Secretary Duffy, head of, has said that modernizing in a safe way, the air traffic control system is the top priority. I'll tell you, there's few that are better situated than us in that area. I'll tell you, it's not just because we've been a long-time incumbent and we've been there, which is true. 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. We've already been doing that. I know many say that they're talking to the administration and they're talking to Secretary Duffy. We're actually working for them. There's a big difference between wanting to get in and being in.

We feel pretty positive there. One area that's been pleasantly surprising is US EPA. I think early on, they talked about 65% reduction. I think most recently, they talked about 50% reduction. The work that we have and 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. 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. 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.

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. 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. 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. Take water that's from the wastewater treatment plants, recover it, and use that as a new drinking water supply, which 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. I'll tell you, it looks very positive in those areas.

Seva Haqqan (Analyst)

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 three, four, five 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 the kind of the medium-term targets they've laid out? Thank you.

Dan Batrack (Chairman and CEO)

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. The last two acquisitions have brought in an entity in Ireland, Karen and Walsh, of course, bringing in Sage, which is located in Australia. Both of those have fungible expertise, particularly Sage. The expertise with respect to automation and the programming, the use of IoT, the use of robotics is not confined to geography. It is easily transportable to work that we are doing all across Canada, the U.S., and Europe. 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 multi-year, 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 two weeks from now?" I said, "I can see pretty clear in a week or two. In some respects, I can see even clearer in five years from now." Some of the short-term variability and some of the short-term volatility goes up and down. The primary tailwinds that are driving Tetra Tech are not changing. Coastal flooding, coastal protection, water supplies where they do not exist because of drought conditions, brackish water because of overdrafting or overpumping of water supplies in places like Florida and low-lying areas. None of these are actually going away. If anything, they are being exacerbated. Where are they going to be next week, next month, or the next midterm? There is some variability.

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.

Seva Haqqan (Analyst)

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 to capital and M&A. Maybe you can just talk about, is there 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.

Steve Burdick (CFO)

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 START buyback program on hold until we got our net leverage down below one. We did that on time as we forecasted. 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. I think with the liquidity we have available, we have the ability to continue our START buyback program.

If our net leverage goes back below one, we'll have even more liquidity to ramp that buyback program up.

Seva Haqqan (Analyst)

Great. Thanks very much.

Steve Burdick (CFO)

Sure.

Operator (participant)

Our next question comes from Brian Connors with Northcoast Research. Please proceed with your question.

Brian Connors (Managing Director)

Good morning.

Dan Batrack (Chairman and CEO)

Good morning, Brian.

Brian Connors (Managing Director)

Congratulations on proving out that you've 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. 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. Anything you can share for us about kind of the utilization rates of those people?

Dan Batrack (Chairman and CEO)

Yeah. That's very insightful. Utilization has gone down in that group. I will say that in the quarter, you would not 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. Yes, we had a reduction in what I call the aid staff while we looked to find, is a project going to be—a lot of this was put on hold. 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. It went to termination for convenience. Yes, their utilization did drop.

You would not have seen it on an aggregate basis because of the offsets of a very high 100%, frankly, people working 100-hour weeks. That offset it. We did incur costs. We did hold folks until they went to termination for convenience. We ourselves held people longer while we did the search and evaluation. Could we place them at other locations? Those are areas where it is 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. 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.

This is kind of a certainly, hope, a black swan event where you have something that's quite abrupt to turn off. I expect that as we move through these termination for convenience, utilization will go back up across the board. Even as the fires come off with these very large high utilizations, you'll see the rest of the business utilization up. It'll look like we kind of sailed right through this without any change. Just under the surface, aid went down, fires went up. You'll see that flip back over here in the coming quarters.

Brian Connors (Managing Director)

Got it. Okay. That helps explain it. Thank you. 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. 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-USAID backlog, so to speak?

Dan Batrack (Chairman and CEO)

Yeah. That's really interesting. We spent some time looking at that here. Our visibility with respect to the book of business we have, X, USAID Department of State is actually about the same or slightly up. 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. If you take a look at the midpoint of our revenue, our net revenue without USAID, it's about $4 billion. 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. 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 and a half months. We're actually up. There may be an appearance of a hole because the backlog that came down was disproportionate to the revenue. That's because it was multi-year funding. If you actually take that out and look at the underlying business, there's actually not a hole. We have funding that's at a similar level or even slightly up from where it had been before.

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 when 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 be able to see that, I don't know if I'd call it uncharted territory, but favorable territory with respect to more visibility with respect to backlog as a percentage of revenue.

Brian Connors (Managing Director)

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

Dan Batrack (Chairman and CEO)

Thank you, Brain.

Operator (participant)

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

Andrew Whitman (Analyst)

Great. Thanks for taking my questions this morning, guys. I guess I just want to confirm some of the moving parts here and then talk a little bit about kind of the outlook here. By my calculations in the second quarter, it was about $180 million on USAID, about $50 million in net revenue on disaster. You said you have $220 million for USAID in the back half of the year spread between the two quarters. I guess inside of this, it sounds like a lot of the USAID work that has been continuing here, if not all of it, is Ukraine. That is still an ongoing situation. We know what you have in your backlog because you only put what is funded in your backlog. Does this contract 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. The Ukraine is ongoing. This is obviously a USAID contract that's gotten special dispensation to keep getting funded. I was just wondering if there's a new contract that needs to be awarded, and 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.

Dan Batrack (Chairman and CEO)

Yeah. 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 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 the west. You've got that exactly right. Now, the $200 million or technically $220 million we have in backlog is contracted for. 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 is called the SPARC contract for USAID.

It is for the continuation of what we had done the previous few years supporting the energy infrastructure in Ukraine. That contract capacity is just under $450 million. This $220 million is a small part of that. With respect to 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 is a single award. There is only one contract holder, us. With respect to could they actually say, "I am going to double that number with a stroke of a pen or an email"? Definitely. Also, as I mentioned earlier, I do not know. 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 are done"? We would go through demobilization.

It still would not go to zero. You still have to then repatriate, hand over all the equipment and all the rest of the items. So the amount that we have in our guidance for the 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 is very difficult to undo a task order that has already been given when you have got equipment that is in the air heading there. But these are unprecedented times. Anything can happen. I have seen airplanes being requested to do a U-turn right in the middle of the Atlantic. I do not want to take something that is unusual and say that is not possible. Anything is possible when you just live through losing a billion plus in one quarter. I will not take anything off the table.

The one thing I'll say is when you take, which was it spent 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. Forget a quarter because the inauguration was not until the end of January. 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. 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.

Andrew Whitman (Analyst)

Yeah. So basically, your guidance approach hasn't really changed. Last quarter, you laid out saying, "This is kind of what we thought the downside could be." You're still just modeling exactly what you have and not assuming anything else in your guidance. 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. 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 billion that came out attributed to other areas of federal civilian, or was that all USAID State Department stuff?

Dan Batrack (Chairman and CEO)

To be precise, there were some others, but it was measured, I think, in aggregate. Everything else, we tracked this pretty close. In fact, we tracked it really close. It was less than $10 million. And I think we had a million or two out of EPA. We had a million out of, we had $2 million, I think, out of FEMA. I think we had a couple of hundred thousand out of National Science Foundation. I do not know. I should not say $10 million. I am probably $5 million. Yes, there were a few other really small pieces, but no, it was 99.9% USAID State Department.

Andrew Whitman (Analyst)

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

Dan Batrack (Chairman and CEO)

Great. Thank you very much, Andy.

Operator (participant)

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

Michael Dudas (CFA)

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

Dan Batrack (Chairman and CEO)

Yeah, of course.

Michael Dudas (CFA)

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

Dan Batrack (Chairman and CEO)

That's another really good question. The one thing I'll say we've seen is the uncertainty. 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. 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 CIG and our international revenues, where I think some of our clients or the work that we have has been continuing, which you can see is sort of flat. As far as initiation of new activities with respect to, in some instances, buildings, but certainly other items such as siting and permitting and other items, it has been slowed down. Just looking for clarity. Are they going to have a tariff change?

Are they going to go forward? 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. 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%. If the number is 150%, it's 150%. We will then proceed accordingly with those ground rules. That's not a problem. We'll move forward. That's fine for us too because what we've said, and I've said this before, in periods of recessionary environments, some of our businesses actually do quite a bit better because instead of generating 500 GW of power across a big area, maybe I'm going to decrease my wind farm and generate 30 gigawatts.

Go back and redesign it. Things have changed, and input prices are higher. I would say that the growth rates on international are probably one of the areas that we have some questions on. I think it is partially dependent on clarity of what is happening on international trade and items associated with that. It has not caused our revenues to go down. I think the more long-term programs that we have in Australia, Canada, and the U.K., like Ministry of Defense and Department of Defense in Australia, are unaffected. Those areas are going through nice growth, long-term programs, long visibility, but things that move quick. I think we are 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 is not working for me.

We're not going to proceed." Or, "This is working for me. Let's go right now." That is where we probably have the greatest variability. I think that is why we are seeing a more tempered growth rate in the international right now.

Michael Dudas (CFA)

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

Dan Batrack (Chairman and CEO)

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.

Operator (participant)

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

Dan Batrack (Chairman and CEO)

Thank you very much, Christine. 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 other areas in the federal government. There is no doubt I am very cognizant of the questions that people had and what is the impact going to be. 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.

If for some reason there is some specific item that you would like more clarity on, please call over here to our IR, and they will 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. I think the biggest issue that has impacted us this past quarter is a misunderstanding of what the impact to Tetra Tech is from some of these changes. I am looking forward to presenting our results in the third quarter. I will talk to you in 90 days. I hope you will all be safe and prosperous between now and our next conversation. Thank you very much.

Operator (participant)

Ladies and gentlemen, this concludes our conference for today. Thank you all for participating and have a nice day. All parties may disconnect now.