Q3 2023 Tetra Tech Inc Earnings Call

Good morning, and thank you for joining the Tetra Tech earnings call. As a reminder, Tetra Tech is also a simulcast of this presentation with slides in the investors section of its website at Tetra Tech dotcom.

This call is being recorded at the request of Tetra Tech and this broadcast is copyrighted property of Tetra Tech.

Any rebroadcast of this information in whole or part without prior written permission of Tetra Tech is prohibited.

With us today from management are Dan Backtrack, Chairman and Chief Executive Officer, Steve Burdick, Chief Financial Officer, and Jill Hudkins President.

They will provide a brief overview of the results and then we'll 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.

<unk> 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.

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.

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 up the conference for questions and answers after the presentation with that I would like to turn the call over to Dan Patrick. Please go ahead Mr. Patrick.

Well, thank you very much Donna.

And good morning, and welcome to our fiscal year 2023 third quarter earnings Conference call.

We had an excellent third quarter.

<unk> our growth strategies, while rapidly integrating the Rps group, who just joined US at the end of January of this year.

Rps has been an excellent addition, and their strategic fit.

Client focus and financial performance have all exceeded our very high expectations here.

Together, we now have 27000 staff working worldwide and over 100000 projects for 'twenty 2000 different clients.

With about $5 billion a year in annual revenue, which is up over 30% year over year were recognized as leaders in water and environment with number one rankings by the engineering news record for well over a decade.

We see three major catalysts that will drive our growth in the future first we're just beginning to realize revenue synergies with the Rps group today.

Today, we are bidding on hundreds of millions of dollars of new programs that are leveraging the benefits of our collective client base and the high end capabilities of our workforce.

Second in the United States, we see the pace of funding from the <unk> and the IRB stimulus programs, just beginning to increase as major contract vehicles or put it being put into place by our government clients.

And third we see spending commitments increasing for climate change related programs and water supply watershed management and renewable energy, especially in the geographies of the United States, the United Kingdom and Australia.

Yeah.

Our growth catalysts and the margin expansion will continue to be underpinned by leveraging our Tetra Tech Delta technologies that we're utilizing all across our enterprise.

Using tools such as generative AI enabled fusion map platforms that we have here at Tetra Tech.

Biding risk mitigation for thousands of miles of rail systems.

We're rapidly assessing tens of thousands of buildings and infrastructure and we're evaluating large scale climate related impacts to lakes estuaries and coastal regions, all across North America, Europe and Australia.

Deployment of our Tetra Tech Delta technologies continue to support significantly higher profit margins on increased revenues without having to add the traditional associated increases in head count.

Given the strength of our performance and our outlook, we're increasing our guidance for both net revenue and earnings per share for fiscal year 2023.

Of course, I'll look forward to giving you specifics on that increased guidance and our outlook as we move into fiscal year 2024, but I'll give our 2024, our outlook and guidance on the next call that we have.

But I'll begin with an overview of our performance.

And our customers followed by Steve Burdick, Our Chief Financial Officer, who will provide a more detailed review of our financials and our capital allocation.

Jill Hudkins, our president who is joining me today will then provide further insight into key emerging growth markets.

Then address and provide an update on our earnings guidance for both the fourth quarter and increased guidance for all of fiscal year 2023.

The collective Tetra Tech operations, including the first full quarter of the Rps group being with the Corporation had strong performance exceeding our already very high expectations and.

In the quarter, our revenue increased 36% year over year from 890 million to $1 billion to $1 billion.

Our EBITDA income increased 33% from last year, reaching a record high of $119 million in the quarter.

And finally, even with record revenues up in the quarter, our backlog increased to a new high of $4 three $9 billion.

Up 25% from last year.

Yeah.

Yeah.

Tetra Tech's business without the contribution of Rps had double digit growth rates across the board for revenue net revenue operating income EBITDA and earnings per share.

Each of these metrics were all time third quarter highs for Tetra Tech's legacy business I thought it was very important to highlight this and show how the performance of the underlying corporation or the legacy operation was progressing and that the great advances that we've had in our financial metrics were not simply attributable to Rps in fact, the underlying business.

<unk> is performing at record pace.

The revenue without Rps was $989 million or almost $1 billion up 11% year over year.

The legacy Tetra Tech's net revenue increased by 12% year over year operating income and EBITDA grew even faster than revenue with being up 17% and 16%.

I respectfully.

And that revenue did generate without rps's contributions of earnings per share that was up 19% from the prior year.

Yeah.

I'd now like to provide an overview of our performance by each of our key end customers or customer groups.

The group that grew the fastest was the work that we're doing for U S. Federal clients, which was up 30% from last year, driven by broad based growth in water and environmental programs, especially for civilian agencies, such as the U S Environmental Protection Agency.

Noah Federal Aviation administration, and USAID and the state Department.

Our state and local revenues were up 16% from last year, excluding contributions from extraordinary disaster response related programs.

State and local growth was driven by our digital water municipal infrastructure work across major metropolitan regions, all across the United States.

Our U S commercial net revenues were up 22% from last year.

This growth was driven by work supporting renewable energy programs environmental assessments and continued to be driven by high performance Green buildings work.

International which saw the largest growth primarily driven by Rps was up 68% year on year etcetera.

Tetra Tech and Rps group's revenue synergies are just beginning to contribute to our combined growth in renewable energy sustainable infrastructure and water programs in the United Kingdom, Ireland, Norway and all across Australia.

Okay.

Now I'd like to present, our performance by our segment.

First segment, our government services group or PSG segment grew 16% from last year, while also increasing its margin to 14% in the quarter up 60 basis points from last year.

Gst's growth was.

Very broad based driven by increases in environmental services and digital water programs for both our state and local and federal clients.

The commercial international group or <unk> segment grew by 55% year over year.

Now the <unk> growth was driven with the addition of Rps, where most of its revenue actually resides as well as increased revenue from the legacy business and programs for renewable energy high performance building activities and Brazilian infrastructure.

Okay.

Yeah.

Really one of the strongest metrics and performance areas of the corporation in the quarter was our backlog our backlog was up 25% year on year on strong very broad based orders increasing by $874 million from the same quarter last year and ending the quarter at another all time high.

A $4.386 billion and the weight Tetra Tech defines as backlog, it's contracted funded and authorized work by our clients. We can go perform this work to date.

In the third quarter, we won $547 million and commercial projects and task orders, including orders for renewable energy and environmental restoration programs.

We were also awarded significant additional U S federal contract capacity in the quarter, including which Gill Hopkins will speak about in a bit and a few more moments, including a new $200 million IHA, a focused army corps of engineers contract and I would like to note, while its a $200 million based contract.

With multiple awards of the contracting period. We successfully competed for and were awarded the first task order issued under this contract by the Army Corps of engineers.

In addition to the work that were awarded in here in the United States, We were awarded over $100 million in new contract capacity for major water programs in the United Kingdom, All led by our United Kingdom based Rps operations, they've just been a great addition to the company.

At this point now I would like to turn the presentation over to Steve Burdick, Our Chief Financial Officer to go over some of the details of our financials in the quarter so steep.

Thank you Dan So as you just heard from Dan we had an excellent excellent quarter with results coming in better than anticipated.

Those improvements also extend to our cash flows and capital allocation related matters.

So cash flows generated from operations was strong totaling $133 million up 35% over last year.

And including certain outlays for Rps transaction costs as we included in the reconciliation cash from operations was $135 million.

In addition, we paid down $158 million of debt in the quarter.

Our focus on working capital and cash flows as resulted in our DSO, maintaining an industry, leading standard and all time record low for Tetra Tech up 58 days.

This is a sustainable improvement from prior years and the slower DSO continues the trend that reflects the outstanding work that our project managers lead relative to higher quality projects and highly satisfied clients and a broad portfolio across all of our end markets and all of our geographies.

Regarding our dividend program, we paid out $14 million in dividends in the quarter.

And I want to announce that our board of directors approved our quarterly dividend of 26 per share.

For this quarter. This was our 37th consecutive quarterly dividend and our ninth consecutive year of double digit year over year increases for dividends paid.

Now as Dan talked about are our recent closing of the Rps acquisition, which was just over six months ago has.

Has been going quite well in regards to integrating the people and projects of Tetra Tech and Rps together now.

I'd like to update you on our financial plan and current status for the integration of Rps, which is a significant opportunity over the long term for Tetra Tech.

So when looking out over the next three years, we expect to increase our actual EBITDA margin.

Under 5% in fiscal 'twenty, two for Rps by almost three times to over 13% by fiscal 2025.

This will be accomplished in a similar manner as what we had done with our two previous public company acquisitions coffee in 2016 and W. Y G in 2019.

And by focusing on high end differentiated services and revenues, while integrating the business onto our ERP system.

Form Andrew corporate systems for greater cost synergies, we would increase the margins for those businesses from about breakeven.

Prior to joining Tetra tech to the current Tetra tech double digit levels.

So now relative to Rps, we've realized significant cost synergies in the first six months.

And we expect to further realize additional cost synergies through both the transition of the Rps business onto our RPM onto our ERP system as well as office space consolidations.

These actions will result in additional one time integration costs in the fourth quarter, but we will provide increased long term operating and financial benefits to the ongoing business.

So so far to date compared to our original projections, we are seeing improved margin opportunities based on our joint integration efforts with the Rps leadership team and increasing levels of revenue synergies.

And through these improved Rps profit margins and cash flows along with Tetra Tech's strong positive cash flows from operations, we expect to continue to Delever our balance sheet.

Although we were more highly levered at the close of the Rps acquisition with the temporary net debt leverage ratio above the high end of our target range.

Have exceeded our initial projections on reducing our leverage.

The third quarter at about a one time $1 six net leverage multiple.

And we would expect to further delever the balance sheet to effect of about one four times by the end of this year.

And so by increasing the EBITA margins, while decreasing the interest expense on lower net debt, we would expect to be cash accretive, adding approximately 50 cents of EPS in fiscal 'twenty four and approximately 85.

In fiscal.

2025.

And these estimates are based on our existing capital structure, but we continue to consider alternative financing arrangements for the long term benefit of the company.

Since we are.

Continue to expect that the addition of Rps will result in double digit EPS accretion by 2025, which is what we had previously stated at the time of our acquisition.

I am pleased to provide an share. These Q3 results with you. Thank you for your support and I will now hand, the call over to Joe to discuss just a few of our many strategic business opportunities that we have in our core market areas. Joe. Thank you Steve.

We have all been eagerly awaiting.

Money from once in a generation U S. Federal stimulus program that were passed in 2021 and 2022.

I'd say a funding is beginning to flow to federal agencies and established programs.

Yes.

IRI incentives are driving new project development and offshore wind.

And the chip for America funding process is all about just earlier this summer.

This decade long federal funding will be well distributed across Tetra tech core market of water environment, and sustainable infrastructure and renewable energy.

I'm excited to share a few examples of recent Tetra tech wins that demonstrate early indications of this federal funding ramp up.

Tetra Tech's successful track record delivering industry, leading navigation and water control structures for the U S. Army Corps of engineers resulted in Tetra Tech being awarded a Kentucky Lock program. That's first task order awarded under the $200 million IAA Army Corps of.

Derek contract that Dan just mentioned.

The other day.

Also provide significant federal funding to support state water project that mitigate the impacts of pathos and drinking water supplies Dayton water selected Tetra Tech to provide high end consulting to support therapy, Bob Management program.

<unk> II funding to the state of Ohio.

The in place and reduction act is providing both funding and tax incentives for renewable energy.

Tetra Tech's number one ranking in wind power and our global expertise in.

Floating offshore wind permitting scored a major project award off the coast of California.

Tetra Tech will support early development of a two gigawatt floating offshore wind program that will benefit from incentives provided and the inflation reduction Act.

Another nearly $400 billion of programs that we see developing is the identification and treatment of emerging contaminants in our water supplies.

<unk> has provided innovative water solution since the company's founding in 1966.

Tetra Tech has been ranked number one in water by engineering news record for 20 years and number one in water treatment for a full decade.

As the water industry leader Tetra Tech is at the forefront of addressing emerging contaminants and water for our clients.

I'll give you just a few examples of our key programs and key Fob.

Plastics and pharmaceuticals.

Tetra Tech has performed more than $100 million in Paphos investigation work for U S military facilities.

Tetra Tech is also designed some of the country's highest profile municipal water treatment plant, including the largest iron exchange piece off water treatment facility in the country.

Our $50 million micro plastic project is supporting USAID flagship program clean cities Blue Ocean, and advancing global Ocean plastics management.

And our multiyear work with the U S. EPA has provided micro plastic risk assessments and the largest estuary in the U S. The Chesapeake Bay watershed.

Another emerging issue is the presence of pharmaceutical residuals in water, which are very challenging to renew.

Oceanside, California, Tetra Tech recently completed delivery of an advanced water treatment facility addressing pharmaceuticals, and multiple other emerging contaminants.

Here at Tetra Tech, we are working with every one of our clients to anticipate needed water system upgrades and to address future regulations.

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

Great. Thank you very much Joe.

I'd like to provide a.

Guidance for both our fourth quarter and for our updated guidance for all of fiscal year 2023 in fact for our increased guidance for the entire fiscal year of 2023 I'll.

I'll begin with our consolidated.

Outlook or guidance for the fourth quarter as consolidated guidance is both for the legacy Tetra Tech operation and for the contributions of Rps, if you're following along on our Investor Slide deck Youll actually see for your use we've broken down the contributions from both the legacy operations and Rps.

But the numbers I'll be providing our consolidated guidance for net revenue and earnings per share for both the fourth quarter and for the full year.

For the fourth quarter our.

Consolidated net revenue guidance is for a range of $965 million to $1 billion and $15 million.

In the quarter with an associated earnings per share of $1 43 to $8 48.

For the entire fiscal year of 2023, we have updated and increased the both the projections and guidance for net revenue and earnings per share as follows.

Our new updated net revenue guidance is for a range of $3 66 billion to $3 seven 1 billion.

With an associated earnings per share of $5 23 to $5 in 2008 the.

Following along on the slide presentation, you can see the assumptions I will highlight a few of these.

Our guidance for the year does include intangible amortization of $15 million or 21 that's.

That's incorporated already into the annual guidance.

That does conclude the effective tax rate in the fourth quarter of 27% $54 million.

Average diluted shares outstanding this does exclude any contributions from future acquisitions that we would make between now and the end of the fiscal year. It also excludes specifically the transaction integration expenses associated with just Rps and it does exclude the rps only intangible amortization associated.

But just that single acquisition.

In summary.

We're seeing strong demand for our differentiated leading with science approach in water environment and sustainable infrastructure in the third quarter and so on.

Already commented on Steve's highlighted we did set new records really all of our key financial metrics revenue net revenue operating income EBITDA earnings per share and of course, we feel very proud.

Proud of and we think it's a great metric looking forward with ending the quarter with an all time high backlog.

The rapid integration of Rps is actually exceeding our expectations, we had very high expectations and so to exceed that.

Quite amazing and we're sure we're rapidly leveraging our combined client base and our expanded services to offer more services into actually have new opportunities for contracting capacity in new work than we had before.

And with funding just beginning to be released from the U S stimulus programs and increased climate change commitments across our client tier client base, our future looks brighter than ever before.

So as a result of our strong year to date performance and record high backlog.

I just shared with you. We are pleased to have increased our guidance for both net revenue and our earnings per share.

And with that operator Donna.

Ask you to open up the call for questions.

Thank you the floor is now open for questions. If you would like to ask a question. Please press Star Zero, Sorry Star one on your telephone keypad at this time.

Formation tone will indicate that your line is in the question queue. Please be aware that there will be a 32nd pause on our webcast to allow for buffering.

And if you'd please remember to mute the audio on your computer if youre using that platform as well again that is star one to register a question at this time.

Today's first question is going to be coming from Sean Eastman of Keybanc capital markets. Please go ahead.

Hi team nice update here.

So I thought a good place to start would be.

Quite a material beat versus the quarterly guidance range range for EPS I didn't hear anything extraordinary or episodic called out.

So perhaps just some high level thoughts on on really what's what's driving the momentum here in the quarter.

No that's a great question Shaun and good morning.

You didn't hear a specific area of beat.

With respect to any single unusual contributor whether or not a quarter ago in the second quarter. We had an extraordinarily unexpected contribution for work from USAID in Ukraine that was not the case so the work.

This was not driven by a beep, specifically in USAID or Ukraine or any other one location. We've historically had significant contributions in the individual quarters from disaster response, because of fire floods Hurricanes I actually did receive a few calls and questions that.

As our performance is going to be up markedly because of the fires in Canada, no that was not a market opportunity we were.

We certainly observed here in the U S.

The smoke and ash from it from up north, but it was not actually a project driver for us.

Was in some ways I've had some around here say it was a.

An unexciting quarter, because it was really very broad base I would actually characterize it as an exciting quarter and that we saw high performance across the board in all of our end markets and I was really pleased to see we have done well in our state and local business and if you want to say is there are a few areas that were a little bit better, but I will tell you that.

Much much.

Much stand out compared to others, but I was glad to see our state and local work actually pick up on its year to year growth. That's been growing historically was up at 15% to 20% last few quarters. We've seen it at 10 to 12 US I was really glad to see it back up at 16 are sort of above a mid mid teen.

So that was I guess I would say that was.

Nice, but certainly not big standout between anything else.

Of course, 30% growth in our government work what drives 30% growth.

Really across the board, we talked about three major segments. We talk about defense, we talk about civilian agencies. When we talk about aid they were all up.

<unk> was up slightly more as part of that mix Thats why we called it out but really we were up across the board in all three areas.

And of course, the international I did want to call out not only the Rps contribution, but the underlying business that we had a tetra tech internationally in the UK, Canada, and Australia was up as we called out in our slide.

It was up upper single digits that was 7%, but if you've taken into effect.

Some of the.

Sure headwinds we had in some of the international development in places like the U K.

And Australia that was a little bit slower in their international development work the real the numbers that was up on infrastructure and commercial work internationally was well into the double digits.

So.

I wish I could say there was one particular area that was up but it was really.

Performance across the board, although we can still do better I'm not going to say we hit on every single cylinder as I've mentioned some of our international development work out of the UK and Australia could have been stronger with respect to revenue. Although we've had some really nice orders as far as forward looking project assignments come out of Australia.

I don't think that it's something that.

I would indicate that we're going to be stopped there for long so.

I guess, that's kind of a long winded way of.

Things look pretty good here across the board in the quarter Sean.

That's great Dan Thats, I think Thats, what everybody wants to hear and then.

And then if I just do some calculations.

Sort of pull out the foreign exchange headwind.

This year pull out the episodic work this year and the adjustment for last year and look at sort of underlying organic growth. It seems we're trending in roughly the mid teens in terms of organic net revenue growth.

And it seems as though you are suggesting.

New order momentum as it is accelerating.

So.

What should we extrapolate from that Dan I mean does it does it feel like this this kind of pace of growth can be sustained.

Well I feel really good about where we're at now.

I guess, how about I talked about revenue growth, which was the beat on revenue and earnings per share.

Driven by any one area also say, it's true on backlog because that really is the best.

The best indicator on where we're going to be on our growth coming up.

I'll also say that there was no single big order that drove that increase of the 25% year over year or over 100 million sequentially now if you take the mid point.

Of our guidance for the fourth quarter. So I will talk about organic growth and what we've included in our guidance you'll see we're in the mid teens, so youre right.

With respect to what we've posted up to this point sort of mid teens organic growth.

Growth on a revenue and slightly better than that on our earnings.

We have included that guidance for the fourth quarter and I just provided so yes. It will continue through here.

I would say.

Directionally things look very strong, but going into 2024, and I think <unk> provided some good insight into a few areas that are going to contribute.

But I do want to stay away from specific numbers on fiscal year 2024, and I know, it's only 90 days away and I'll provide that specifics on the next call, but I would say, we don't see anything from a.

Economic outlook from the markets. We're in are from our clients or in any of these geographies that.

Looks like there's a material change as we're moving forward.

Okay, I'm going to sneak one more in just relative to the Rps business sort of.

Two quarters, it's been in the mix two quarters, you have kind of walked up the outlook.

Indicated it's tracking ahead of plan now two quarters in a row, perhaps what in particular.

Would you communicate to investors is.

<unk>.

Driving the better than expected results out of the gate here from Rps.

I attributed well first of all they have excellent workforce. They are experts in the areas that they serve primarily in the U K, Australia, Ireland then.

Norway with reasonable presence also in.

In Holland.

In the Netherlands.

But I would say, it's really the culture. The culture within Rps is very closely aligned to what we have of Tetra Tech theyre not commodity providers, they're not final detailed designers that are doing shop drawings. They really are provided high level value front end.

<unk> services that are very much in alignment with Tetra Tech and I would say that.

Having now had them with us four to six months, so a couple of quarters.

I'm amazed that.

The high level I thought Tetra Tech was very early in the overall lifecycle.

Process, if you want to talk about our vertical from identifying a project and be an advocate and doing the conceptual alternative review Rps actually comes in even before Tetra Tech some of the advisory work that they do regarding.

Advocacy with work for department of public works different political.

Parties on how they would prioritize their infrastructure and renewable energy and climate change work is actually is very complementary. It I didn't think you could go much earlier in the lifecycle than us, but rps certainly.

Does bring some of that in their advisory work, particularly in Australia.

It opens up a whole new set of clients and project opportunities and where I think it could go in and this is aspirational on my part I don't want to put it.

Specific data on a calendar at this moment, but I have spoken in the past that Rps historically had had margins higher than that of Tetra Tech.

<unk> had numbers up high teens approaching 20%.

And I think that.

Given the given the alignment with their Tetra Tech colleagues I think culturally we're very similar I think that the the priority on being best in class being a technical leader and that it's about.

Quality not quantity has aligned very well with us and that's why you've seen I think I have seen very little or no disruption on the workforce with respect to those that are client facing and project phasing.

I've seen there.

<unk> going up I've seen their backlog going up.

And to a certain degree.

I think some of the Rps folks have show let me let me stand next to Tetra Tech call. We can show Tetra Tech how to do it at even a higher level, which.

More than welcome here in the company.

Fantastic I appreciate the insight as always I'll turn it over.

Great. Thank you very much.

Thank you. The next question is coming from Andy Wittman of Robert W. Baird. Please go ahead.

Oh, great. Good morning, and thank you for taking my question.

I wanted to talk about Tetra Tech Delta.

This is not a new thing at Tetra Tech.

In the last few years, you've you mentioned at every conference call.

But I feel like.

Myself, and I, but others would probably benefit from understanding in a little bit more detail. So Dan can you talk a.

A little bit more about it.

Delta its own business, whereas it intertwined with kind of existing contracts, maybe if you could talk about how its margin profile compares to the rest of the company or maybe even its growth rates.

<unk>.

To the extent that it's relevant maybe just giving an example of contracts larger contracts that are you really able to employ these solutions is to give us as investors and analysts.

A little bit better sense about kind of what this business is in what we can expect from it in the future.

No I will tell you Andy.

The Tetra Tech Delta.

As one of the areas that.

I am really excited about here at Tetra Tech.

Those that have worked with me over the years know that came out from the technical side of the house.

Tetra Tech has been a leader in modeling our research and development as a think tank is really its origins and to see the Tetra Tech Delta, which has started off as well.

Well, we've always had these models that we've used we used the tetra tech delta to encompass the collection of the tools that we use internally that differentiate us in the marketplace. We have tools that we've developed for the federal government that we've been paid hundreds of millions of dollars over the years to have the best in class Technical research that then can be deployed through the federal government.

Through state and locals that they give out on grants in fact become the underlying science and technology used by the world's scientists and engineers to perform their work and if you really dig deep enough youll find tetra tech at the origins of bunch of that work.

So the Tetra Tech Delta did start as far as our communicating publicly is the tools that are embedded in all of the work. We provide so we have all sorts of technology and tools, where we can do remotely and promote.

Sensing and remote assessments for.

Green buildings for heat loss heat transfer damage erosion on things such as Seawalls, they can actually be seen through <unk>.

<unk> cameras can then be identified and have sequential erosion rates and determine what type of operation and maintenance. Its allows us to do work that would normally take 100 people two years to do cannot take 10 people 10 days to do.

It costs less dollars to our client it actually is more comprehensive and allows preventative work or reconstruction or new technologies, such as Seawalls artificial islands are.

Diversion bypasses to be put in place. So all of that is exciting. It typically has moved our margins up on our projects where it's been used.

Anywhere between 2% to 500 basis points or 2% to 5%. So if we were making 10% before now we're making somewhere between 12% to 17% just by using the tools that we have about 200 different tools internally and if a client hires tetra tech they get access to every one of those 200 tools, whether or not theyre located in Perth, Australia.

Dallas, Texas or leaves England.

Now the part that's most exciting to me so I.

I'm kind of geeky that way I love using these tools I love, how it can actually make us better better cheaper faster for our clients.

I, particularly like it that we can come in and win a project on a competitive basis being selected technically number one, but being 30% cheaper than our competitor and yielding the best profits we have in the company.

And doing it for our clients. So that's the part that I like but the part that I am probably most excited about and I am still this is still a three or four levels beyond what I can.

Contemplate myself. Unfortunately, we have people in the company that are experts on this this generative AI that Tetra Tech is now employing and I'll go to our go to market size in dollars here on this we're actually putting this in place where we've we've been using it for a few years now.

It's actually measured in several millions of dollars I think that a combination of the Tetra Tech Delta, where our clients are using the tools without our input. There is some things that our clients can do without us having to sit there they don't need us to be there, we can actually give them or sell them or lease them and guess you'd called subscription, but we can do things that the clients can use it and we can come.

In and provide.

Customization that program is somewhere at revenues generated whereas revenue generated without tetra tech labor associated with it.

Is somewhere.

Probably $25 million and I think it's growing quite quickly I think that number has gone from five to 10. So doubled doubled again here this last year to well over 20 and the part that seems most promising to me is regenerative AI platform here at Tetra Tech, we refer to the collective generative AI.

Our water environmental.

Sustainable infrastructure is where we actually sell licenses and the clients can use it without a tetra tech person being there and this is actually for managing large asset basis, such as what's the and I referenced the thousands of miles of track for railroads can we actually through use of satellite other lidar systems actually give.

Vegetation encroachment.

Flood or water impairment of Av.

Our railway or a waterway or anything else that would be potentially damage door exposed or vulnerable because of this real time.

As we can officially call it near real time.

We have several thousands of licenses issued to our clients. Currently is currently being adopted by <unk>.

State Dot's here in the United States. The current number of licenses, we have our measured somewhere between two to 3000 of these and this is only with one or two <unk>.

It really took a look internally we have a goal of having 1 million users for our degenerative AI here over the next two or three years.

Current size is probably included in that $25 million I've been hesitant to daylight. This.

By the way I'll come back to.

To complete the financial portion, maybe $25 million, but the incremental portion on the degenerative AI the margins are north of 30% and that's with reinvestment.

The gross margins are up as many SaaS programs are at 80%, we're seeing those that we have sufficient.

Subscription.

<unk> leverage on meaning that there's only a very small incremental cost for a customized AI system.

We actually have.

Operating margins at 50%.

And I think we're going to disclose this in more detail once it gets sufficient scale that is something that we can track.

CAGR rates annual recurring revenue renewal on subscriptions all of the other things that come with this model, but it is one of the most exciting it's not that we're becoming software.

Our software company were actually become the best at the application of the science and technology are domain experts spring that I think has no clear not only in the U S, but anywhere in the world and adding this technology is going to bring margin, it's going to bring revenue and it's going to be a disassociating the need to hire people just to make that happen.

That was a comprehensive discussion I appreciate that Dan.

Maybe a little bit more mundane question, but.

Nevertheless, I was just hoping you could talk about.

The margins inside of the backlog that you've put in here during the quarter and how they may compare.

The margins that were in the backlog before you see any movement there given the overall demand trends in the marketplace.

Obviously, yes, we don't call out.

Interesting, we you hear us.

We congratulate you talk about gross margins, so I'll actually talk about embedded.

Operating margins in it.

Because I've always thought gross margins is just a.

Pocket trick where people call.

Overhead G&A and then they don't count the cost so I actually like to go to operating margins. So.

It is typically 50 to 100 basis points higher.

And sort of separate out the discussion I just had on.

The Delta and the generative by AI work, we're doing so it is tending higher it is some of it's actually pricing power because some of the work that we're doing is very high demand very fast track that has to be done. So there is some pricing power, but the rest of it's kind of mix. We are taking some of the lower work that we have in the company that might be considered being <unk>.

<unk> or actually having lower leverage and we are moving more to the high end and so we are finding through a combination of some.

Some pricing.

Ability in the marketplace and just moving to higher end mix and I think have include some of the advisory work that we talked about with Rps and others.

There is higher margin embedded in the backlog we have.

And it's typically our backlog to burn off in a year I think we say 85%.

Next year's revenues and the backlog we have another 15% we'd go slightly beyond that so it's short term backlog.

And so that increase that we've talked about a 50 basis points increase year over year on our margin expansion would be reflected in that backlog that we just bought.

Thank you very much.

Thank you very much. Thank you the next.

Thank you. The next question is coming from Michael Dudas with vertical research partners. Please go ahead.

Good morning, everyone.

Good morning, Michael.

Yeah.

Still getting over the comment about Rps with higher margins with Tetra Tech you really challenging to Tetra tech folks out teams.

Okay.

For sure.

That is true and I put myself in the bucket of the Tetra Tech folks and I'm wondering I need to get I need to get up a little earlier in the morning.

Excellent I appreciate that.

Couple of quick overall thoughts maybe to share some.

There has been noticed but much better activity out of Canada.

And it seems like it kind of fits very well with with the tools and the mid market size or is there opportunity for above average booking and revenue growth across that market, especially in your water and say the renewable side.

With renewable has been very strong up there until theory that if you'd see Canada, our infrastructure and I'd say, it's a provincial infrastructure and some of the large cities has gone really well for us.

We've seen more spending there of course, there has been a high focus.

I want to make this on a negative item, but there have been.

A lot of economic.

Activity coming out of Canada, which means a lot of rail that there have been some derailments associated with floods and other items and we're glad to be working for some of the rail majors on infrastructure on that site. So that's been very busy for us. It is you're making use of some of the digital tools, we talked about including.

<unk>.

Rail AI and a number of other programs like that.

Peter has been a big issue.

I think the when you released the last 30 days you talked about Canada, you talked about fires in both the British Columbia in the east.

So those are areas that we're looking at for habitat work, we do for environmental restoration of course for protection of watershed. So.

I cannot go back to my earlier comment about broad based as Canada doing well, yes, Canada is doing very well.

But relative to other geographies, we have I would say that if this was two years ago three years ago I'd be glad to give even more accolades to Canada, but I will tell you. The other geographies are matching it across the board.

The one area, that's coming out of Canada that has done, particularly strong and I am hoping to bring the expertise even more prominently here to the U S is our high voltage engineering I've talked about this before <unk> is well over 500 high voltage engineers, it's a very specialized technology. It's people that are typically 500 kv and up.

I know our electrical engineers will.

We will chastise me later, saying Thats really for <unk>, but.

But.

But that capability to have well over 500 of high voltage engineers that can work at a very.

Specialized market, where you have transmission from the renewable energy sources on every single one of them are in some off.

The beaten path location, where you have to have local transmission to an interconnect to actually be used for the <unk> and that's even more true with the offshore wind because most people don't have factories sitting out in the ocean. So you really do have to complete the transmission both onshore to the interconnect and then push it into the grid. So that you can have green energy being used and reducing <unk>.

Carbon footprint. So that work is really coming primarily out of Canada out of Ontario for US a fantastic group Great management team excellent technical leaders and that's something that could actually be an outperformer even above the strong performance across the board for us I'd put that under our Canadian <unk>.

Expertise that differentiates us.

I appreciate those thoughts.

I guess my second question.

My question would be.

You talked about certainly broad based strength amongst your segments and geographics for the success. So far in 2008 fiscal year 2023, as you kind of look ahead to the year and into 2024.

You see the pipeline of opportunities growing.

Similar or better rate than what you've been booking and revenue certainly lead to see continued growth plus one book to bills as you look to 2024 and certainly in that pipeline.

Those margins you've talked about in response to Andrew's question.

Somewhat in that similar range as Youre looking to book New business.

Well Jill Jill highlighted the one that's receives the most.

The most attention I would say broadly is what's the timing and the magnitude of the opportunities coming out of the U S stimulus programs.

And what I, what I am glad to see until highlighted that.

On her slide the one item that we've not.

Talked about too much of a caution not to infer too early of a conversion from the bill being passed to converting to revenue is actually key.

Key program wins, so I'm really glad to see that a key program win is a contract is being put in place and you saw programs as she spoke regarding city of date in the U S. Core of engineers that both she and I mentioned $200 million. They are using other vehicles. So I think when you. When you ask the question are there other things that could contribute to allow book.

To bill at greater than one even with the revenues increasing so high I think new work actually coming out now and going from contract capacity into orders or task orders, that's what's going to go into our backlog as we go into 2024 and I think of the ramp the revenue will ramp through 'twenty, four but what's going to come first.

Is going to be which we're seeing now as contract capacity or contracts.

For us others will actually dump that into their backlog they'll do some factor in say $200 million I think I'm going to get X amount of it and let me just counted we don't do that we only counted after you've given us a task order and you funded it and you've authorized us to do the work so for us you'll watch it translate.

To say, a little slower than others, who will account something that doesn't exist, we will count it when they've given us both the authorization and the funding so that will allow the translation to backlog to begin to pick up as we move into 'twenty four and yes, I do believe it carries higher margins overall, it's not just government, but also commercial work on the renewable energy and climate climb.

Change that we're doing for our commercial clients.

Excellent and thanks for your thoughts.

Yeah, absolutely. Thank you Michael.

Thank you at this time I would like to turn the floor back over to Mr. Patrick for closing comments.

Well hi.

Thank you very much Donna for turning it back in for a moderating the questions great questions.

I hope to have not only good performance in the coming quarters as we did here, but I hope to have individual high points that exceed everything else. So we really do have something that is an outlier that would be even or something to highlight and spend even more time on.

I know, we're getting close to the end of our fiscal year I know that our fiscal year 2024 is for US we are in the U S. Federal calendar starts on October one so it's only about six weeks away seven weeks away.

I am really looking forward to a strong finish to this year and I'm really looking forward to providing our guidance for 2024.

I think it'll be the among the last time, you'll hear us talk about Tetra Tech legacy and Rps.

I have not broken it up into these details because rps is different than Tetra Tech. We are one and the same but I think the performance of the.

I guess I'll call. It underlying our legacy company has been so strong and I want to track the contributions of Rps, we've provided that detail, but I will tell you within the company.

We are one company, we're working together, we have more collaboration more revenue synergies more opportunities together and I think as we move into 'twenty four I am looking forward to presenting to you all what we are doing together as one number one company one future and one excellent set of performance and with that thank you very.

Much for joining us for this quarters investors call and I'll talk to you in next quarter, roughly 90 days and hope you have a great rest of the day and week.

Alright.

Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect. Your lines of work off the webcast at this time and enjoy the rest of your day.

Okay.

[music].

At this time and enjoy the rest of your day.

Okay.