Executive Summary / Key Takeaways

• Tetra Tech demonstrates remarkable resilience and strategic agility, delivering record financial performance and raising full-year guidance despite the abrupt cancellation of a significant portion of its USAID contracts, historically its largest client by revenue.
• The company's core investment thesis is underpinned by its market leadership in high-end water, environment, and sustainable infrastructure consulting, driven by secular tailwinds and a differentiated "Leading with Science" approach leveraging advanced digital technologies.
• Strategic initiatives, including targeted acquisitions in digital automation and international markets, coupled with a focus on higher-margin consulting services, are expanding profitability and diversifying the business mix.
• A robust balance sheet, strong cash flow generation, consistent double-digit dividend increases, and a newly authorized $500 million share repurchase program highlight a disciplined capital allocation strategy aimed at enhancing shareholder value.
• While risks such as ongoing legal contingencies and potential volatility in remaining international development work persist, Tetra Tech's broad client base, geographic diversity, and technological edge position it favorably against competitors in key growth markets like digital water and high-performance buildings.

A Foundation Built on Science and Adaptation

For nearly six decades, Tetra Tech, Inc. has carved out a leadership position in the complex world of consulting and engineering services. Founded on a commitment to applying scientific principles to solve intricate challenges, the company has evolved from its roots in water and environmental management into a global force focused on sustainable infrastructure. This enduring focus, encapsulated by its "Leading with Science" ethos, has allowed Tetra Tech to navigate numerous economic cycles and political transitions, demonstrating a consistent ability to adapt where others might falter.

The company's strategic evolution has been deliberate. Recognizing the increasing importance of technology and data, Tetra Tech initiated its Digital Systems practice around 2019, a move significantly bolstered by subsequent acquisitions, including Convergence Controls Engineering (CCE) in fiscal 2024 and the recently announced agreement to acquire SAGE Group in fiscal 2025. This expansion into digital automation and systems integration, particularly for water utilities and industrial clients, represents a forward-looking pivot. Similarly, the High-Performance Buildings practice, now exceeding $0.5 billion in size, reflects a strategic response to the growing demand for specialized design services in areas like data centers and advanced manufacturing.

This strategic positioning is critical within a competitive landscape populated by large, diversified firms like Jacobs Solutions (J), AECOM (ACM), and Fluor Corporation (FLR), as well as more niche players and indirect competitors offering specialized software or analytics. While competitors like AECOM and Jacobs possess greater scale and broader portfolios, often leading to larger market share capture in certain segments, Tetra Tech differentiates itself through its deep technical expertise, integrated digital solutions, and a strong focus on sustainability outcomes. Against firms like Fluor, which may compete on price in commoditized engineering and construction services, Tetra Tech emphasizes the value of its high-end consulting and design, which can lead to lower lifecycle costs and more resilient infrastructure for clients.

Tetra Tech's competitive moat is significantly reinforced by its technological differentiation. The company's proprietary Subscription Software Solutions (3S) service line, including tools like CSOC for water system optimization, FusionMap and OceansMap for coastal/flood risk management and disaster response, and WaterNet for leak detection, provides tangible, quantifiable benefits. For instance, CSOC has been credited with saving cities over $1 billion in capital costs by optimizing existing infrastructure. These tools leverage advanced analytics, AI, and machine learning to offer clients enhanced efficiency, faster data processing (e.g., 15-20% greater efficiency in data processing speeds for environmental projects compared to less specialized tools), and improved decision-making capabilities. While some competitors offer digital tools, Tetra Tech's integrated approach, combining deep domain expertise with proprietary technology, allows it to deliver solutions that are not easily replicated. The company's R&D efforts, reflected in a 15% year-over-year increase in R&D investment in 2024, are focused on further enhancing these capabilities, targeting improvements like a 30% reduction in material waste and 20% faster processing in next-generation tools. For investors, this technological edge translates into a stronger competitive position, potential for higher-margin work, and a more resilient business model less susceptible to commoditization.

Resilience in the Face of Headwinds: Performance and Financial Health

Tetra Tech's strategic foundation and technological advantages were put to a significant test in the second quarter of fiscal year 2025. The abrupt cancellation of a substantial portion of its USAID contracts, which had represented its largest client by revenue, presented an unprecedented challenge. As Chairman and CEO Dan Batrack noted, "Never have we seen our largest client by revenue essentially disappear within just one quarter." However, the company's performance demonstrated remarkable resilience.

For the six months ended March 30, 2025, Tetra Tech reported total revenue of $2.74 billion, an increase of 10.6% year-over-year. Revenue, net of subcontractor costs (a key non-GAAP metric highlighting employee-driven work), rose 11.3% to $2.30 billion. Despite the USAID impact, the Government Services Group (GSG) segment saw revenue increase 20.6% to $1.41 billion (net revenue up 23.4% to $1.12 billion), driven by strong growth in U.S. state and local disaster response and ongoing federal work outside of USAID. The Commercial/International Services Group (CIG) segment's revenue grew 2.0% to $1.37 billion (net revenue up 1.8% to $1.18 billion), supported by U.S. commercial environmental services and UK water programs, although partially offset by lower infrastructure activity in Australia.

Profitability metrics underscore the company's ability to maintain and even expand margins despite the revenue mix shift caused by the loss of lower-margin USAID work. Adjusted operating income for the first half of fiscal 2025 increased 16.8% year-over-year to $267.2 million. The GSG segment's operating margin based on net revenue was 13.8% in the first half of fiscal 2025 (down slightly from 14.0% in the prior year, reflecting the higher mix of international development work, which operates at a lower margin), while the CIG segment's operating margin improved to 13.1% (up from 12.7%), driven by a focus on high-end consulting and improved project execution. Management indicated that the core business margin profile is now higher post-USAID and that future margin growth should be slightly faster than the previously targeted 50 basis points annually.

Cash flow generation remains a core strength, historically exceeding net income. While cash flows from operating activities decreased in the first half of fiscal 2025 to $7.2 million, this was primarily due to the timing of cash collections on USAID programs and a $57 million payment related to a legal contingency settlement. The company's Days Sales Outstanding (DSO) stood at 67 days at March 30, 2025, but management noted that subsequent collections from USAID improved this to approximately 57 days, significantly better than the industry average of over 80 days. This efficient working capital management is a testament to strong project execution and client satisfaction.

The balance sheet remains robust. At March 30, 2025, total assets were $4.18 billion. Net debt was $650 million at the end of fiscal 2024, resulting in a net debt on EBITDA leverage of 1.0x, well within the company's target range of 1x to 2x. At March 30, 2025, the Consolidated Leverage Ratio was 1.63x and the Consolidated Interest Coverage Ratio was 15.81x, indicating strong compliance with debt covenants. The company's liquidity is further bolstered by $179.4 million in cash and cash equivalents and access to $299.3 million of available credit under its revolving facility at March 30, 2025. A new $1.5 billion credit facility entered into in May 2025 provides enhanced liquidity and more favorable terms through 2030.

Strategic Momentum and Future Outlook

Tetra Tech's strategic initiatives are designed to capitalize on enduring global trends and expand its market leadership. Acquisitions like Carron + Walsh in Europe and the planned acquisition of SAGE Group in Australia are key components of this strategy, adding technical expertise, geographic reach, and capabilities in high-growth areas like digital automation. The digital systems practice, specifically, is projected to become a $500 million annual revenue business by 2030, leveraging the company's deep ties in water and high-performance buildings.

The company's outlook reflects confidence in its ability to continue delivering growth and expanding margins. For the third quarter of fiscal 2025, Tetra Tech guided for net revenue between $1.1 billion and $1.2 billion and adjusted EPS between $0.35 and $0.40. The updated full-year fiscal 2025 guidance projects net revenue in the range of $4.4 billion to $4.765 billion and adjusted EPS between $1.42 and $1.52. The midpoint of this guidance implies 6% net revenue growth and 17% adjusted EPS growth year-over-year, demonstrating strong profitability expansion. Key assumptions supporting this guidance include approximately $35 million in intangible amortization, a 27.5% effective tax rate, $24 million in depreciation, and $34 million to $38 million in interest expense. This guidance excludes the contribution from the SAGE Group acquisition, which is expected to close later in the year.

Management anticipates continued revenue growth in the U.S. state and local government sector, driven by critical water and environmental programs and ongoing disaster response work. The U.S. commercial business is also expected to see continued growth, particularly in environmental services and high-performance buildings. Internationally, growth is expected to continue on a constant currency basis, supported by planning and design activities in the UK and other core markets. The company's backlog, or Remaining Unsatisfied Performance Obligation (RUPO), stood at $4.3 billion at March 30, 2025, providing solid visibility, with $3.14 billion expected to be satisfied within the next 12 months. While the USAID cancellation reduced total backlog, management noted that the underlying business backlog, excluding USAID, is at a similar or slightly higher level than before, supported by over $30 billion in contract capacity across the U.S. federal government (primarily defense and civilian agencies).

Capital allocation priorities remain consistent: investing in organic growth, pursuing strategic acquisitions, returning capital through dividends, and executing share repurchases. The company's Board recently approved a 12% increase in the quarterly dividend and authorized an additional $500 million stock repurchase program, bringing the total available for buybacks to $673 million. This aggressive return of capital is supported by the company's strong cash flow generation and comfortable leverage position.

Risks and Considerations

Despite the demonstrated resilience and positive outlook, several risks warrant investor attention. The abrupt cancellation of USAID programs resulted in a $92.4 million non-cash goodwill impairment charge related to the Global Development Services (GDS) reporting unit. While the majority of USAID work has been terminated, the remaining $38.1 million of goodwill in GDS is primarily supported by work for UK and Australia foreign aid agencies, and a future reduction in their budgets could lead to additional impairment.

The legal contingency related to the Hunters Point Naval Shipyard environmental remediation services, which resulted in a $115 million charge and a $57 million cash payment in the first half of fiscal 2025, still carries some uncertainty. While a settlement agreement was reached with the U.S. government for $97 million (including the $57 million paid and $40 million expected within 12 months), ancillary claims from third-party private plaintiffs are ongoing and not resolved by this settlement. The company has initiated litigation with an insurance carrier for potential reimbursement, but recovery is not assured.

Market risks, including interest rate fluctuations and foreign currency translation, can impact financial results. While the company uses a mix of fixed and floating rate debt and attempts to match revenue and expenses in the same currency, significant shifts could still affect profitability. The nature of the company's contracts, particularly operations and maintenance contracts, often includes termination for convenience clauses, which can lead to reductions in the Remaining Unsatisfied Performance Obligation (RUPO) if clients exercise these options.

Finally, while acquisitions are a key growth driver, they inherently carry risks related to integration, achieving anticipated synergies, and potential impacts on financial performance if not successful.

Conclusion

Tetra Tech's performance in the first half of fiscal 2025, particularly the second quarter, serves as a powerful testament to its resilience and the strength of its diversified business model. Absorbing the sudden loss of its largest client while simultaneously delivering record revenue and raising full-year guidance underscores the effectiveness of its strategic focus on high-end consulting, technological differentiation, and broad market presence.

The investment thesis for Tetra Tech is compelling, centered on its leadership in markets driven by enduring secular trends like water scarcity, environmental protection, sustainable infrastructure, and digital transformation. The company's "Leading with Science" approach, amplified by proprietary digital tools and a commitment to innovation, creates a significant competitive moat. Supported by a strong balance sheet, robust cash flow, and a disciplined capital allocation strategy that balances investment in growth with returns to shareholders, Tetra Tech appears well-positioned to continue its trajectory of profitable growth and margin expansion, even as it navigates the inherent risks and dynamics of its operating environment. The ability to not only withstand but thrive amidst significant challenges highlights the underlying strength and adaptability that should appeal to discerning investors.