Tetra Tech, Inc.

Good morning, and thank you for joining the Tetra Tech earnings call. By now, you should have received a copy of the press release. If you have not, please contact the company's corporate office at 626-351-4664. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the investor section of its website at www.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, and Steve Burdick, Chief Financial Officer. They will provide a brief overview of the results and will open up the call for questions. I'd like to direct your attention to the safe harbor statement in today's presentation. Today's discussion contains forward-looking statements about future growth 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 takes 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'd like to inform you that all participants are in a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. With that, I would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Thank you very much, Laura, and good morning. And welcome to our fourth quarter and fiscal year 2021 earnings conference call. We had an excellent fourth quarter, completing an exceptionally strong 2021 fiscal year. And as we enter fiscal year 2022, we've never been in better alignment with our clients' priorities than we are today. Globally, and here in the United States, the priorities of water, environment, sustainable infrastructure, and renewable energy are creating new projects and additional funding commitments from our clients. Climate change is driving our communities to invest in resiliency and governments to make longer-term commitments for the reduction of carbon emissions. In areas impacted by climate change, we're seeing increased emphasis on adaptation, while we also are supporting those affected by unprecedented disasters. These global and local trends are directly aligned with our leading with science approach and have resulted in strong growth across all of our client sectors and generated new orders that resulted in an all-time high backlog for us. As shown on our webcast, if you're following along, are the results of our fourth quarter in fiscal year 2021. We hit all-time highs across the board with full-year revenue of $3.21 billion and operating income of $275 million, up 13% from last year. We delivered a $3.79 in adjusted EPS, up 16% from last year, and $4.26 of earnings per share on a gap basis, which is up 35% from last year. And we also generated $304 million in cash, or more than $5.50 of cash per share in fiscal year 2021. The strong performance of our company across our global operations is a demonstration of the strength of our business and the capability of our 21,000 associates, who are technically differentiated, highly client-focused, and fiscally disciplined. I'll now begin with an overview of our performance and customers, followed by Steve Burdick, our Chief Financial Officer, who will provide more detailed review of our financials and capital allocation. I'll then address our customer outlook and our earnings guidance for fiscal year 2022. We had a strong fourth quarter, ending the year with record net revenue, operating income, and earnings per share. Our net revenue increased 20% year over year to $709 million for the quarter. Our fourth quarter operating income of $79 million generated an earnings per share of $1.05, up 15% from last year. This represents the highest quarterly EPS in the company's history, and the first time we've exceeded a dollar EPS in any quarter in the company's history. And our backlog, our best forward-looking indicator, was also the highest in the history of the company, growing to $3.48 billion, up 7% both year-on-year and sequentially. I'd now like to provide an overview of our performance by our end customer. In the fourth quarter, revenue for all of our client sectors increased compared to last year. We saw continued strength in our state and local revenues, which were up organically 30% from the fourth quarter of last year. Even excluding the extraordinary contributions of our disaster response work, this is the sixth consecutive year of double-digit growth for our state and local business. Work for our U.S. federal clients was 28% of our revenue in the quarter and was up 11% from the same quarter last year. This growth was driven by an increase in climate change-related services and advanced analytics for our clients. Our U.S. commercial revenue was 22% of our business, up 8% from last year. Our environmental permitting, regulatory driven programs, and renewable energy services all contributed to our growth in this sector. And finally, our fastest growing client sector was international, where our revenue was up 35% from last year. Our international revenues did benefit from the addition of our new high performance buildings group in the United Kingdom, Hoor Lee, who joined us in the fourth quarter of fiscal year 2021. The rest of our international work grew at a strong 24% year-on-year pace with the expansion of broad-based sustainable infrastructure programs in Canada, Australia, and the United Kingdom. And I'd like to present our performance by segment. In the fourth quarter, both of our segments grew at double-digit rates year over year. The Government Services Group, or GSG segment, was up 13% compared to last year to $372 million, while maintaining a strong 14% margin on operating income. This performance was driven by our high-end data analytics and design services for water and environmental programs augmented by our disaster response and recovery work all across the country. The Commercial International Group, or CIG, grew by 30% year-over-year and delivered a 12.4% margin, up 50 basis points from last year. CIG's fourth quarter results were driven by growth in our international operations and a strengthening commercial market here in the United States. Our backlog was up 7%. both year-on-year and sequentially, on strong broad-based orders, resulting in a new all-time high of $3,480,000,000 of contracted, funded, and authorized work from our clients. In the fourth quarter, we won new programs and task orders for differentiated water, environmental, and renewable energy services, building momentum for us in fiscal year 22, both in the U.S. and the international markets. We also expanded our contract capacity by over $8 billion for key USAID, US Army Corps of Engineers, and NOAA programs that provide the contract vehicles for us to support the US government's climate change priorities. We won task orders with both the United States and international government agencies for water, environment, and climate change adaptation programs. In the fourth quarter, we had strong commercial orders of over $400 million. to provide renewable energy, environmental restoration, and sustainable infrastructure services. This was an extraordinarily well-balanced quarter for orders from both our government and from our commercial clients. And at this point, I'd now like to turn the presentation over to Steve Burdick to present the details of our financials from the quarter and where we finished the year. So, Steve?

Well, hey. Thank you, Dan. So, now I'd like to now review the GAAP financial results for the fourth quarter as well as our financial condition for fiscal year 2021. You know, overall, as Dan noted earlier, we had record results in Q4 and record fiscal year results, revenue, operating income, EPS, and backlog. The fiscal 2021 fourth quarter revenue was $892 million. The net revenue amounted to $709 million, which exceeded the upper end of our guidance range of $650 million to $750 million. Our revenue was up 18% over last year and net revenue was up 20% over last year, with double-digit growth across international, federal, and state and local end markets. Similarly, our operating profit and earnings per share improved. GAAP EPS came in at $1.52 in the fourth quarter, which was an increase of 85% over last year. In addition, Adjusted earnings per share of $1.05 came in better than the top end of our Q4 guidance range of $0.95 to $1.00. This is an improvement over the fourth quarter of last year by 15%. The higher EPS was due to an improvement in operating income, which came in at $82 million for the quarter, up 23% over last year. And adjusted income was $79 million, up 15% over last year. As Dan noted earlier, the improved operating margin in the fourth quarter was really driven by a 30% growth in CIG, and the resulting CIG margin of 12.4% was an improvement of 50 basis points over the last year. The difference between our GAAP EPS of $1.52 and adjusted EPS of $1.05 was primarily due to a non-recurring tax benefit. A reconciliation is available in this release, but to point out, the tax benefit results from the release of the tax net operating loss reserve from our WYG acquisition in the fourth quarter of 2019. And because we turned the company around from perennial losses with tax losses to double-digit profitability, there's no longer an accounting requirement to not recognize that future tax benefit. And that future tax benefit, as such, will provide future positive cash flows for the company. We also remain focused on generating positive operating cash flows in excess of our net income. Cash flows generated from operations for the fourth quarter totaled $78 million. For fiscal 2021, we have generated $304 million in cash flow from operations, which is ahead of last year by 16%. Our focus on working capital and cash flows has resulted in our DSO decreasing to 63 days as of the fourth quarter. This is an improvement of five days from last year at this time. Our net debt amounts to $46 million, and our net debt on EBITDA was at a leverage of 0.2 times. This is with a cash position of more than $167 million and thus an improvement in net debt of $88 million compared to last year. Our long-term capital allocation strategy calls for a balance of investing in the growth of our business, managing the balance sheet, and providing returns to our shareholders. For the year, cash from operations generated $304 million, which is equal to about $5.57 per share. This has allowed us to invest in five acquisitions over that time to advance our long-term strategy. And during the fourth quarter, we continue to provide significant returns for our shareholders through dividends and share buybacks. So regarding our dividend program, during the past quarter we paid out $10.8 million in dividends, and I want to announce that our Board of Directors approved our 30th consecutive dividend, which will be paid in the month of December at a rate of 20 cents per share which is an 18% increase over last year. Furthermore, we utilized $15 million in the fourth quarter on our stock buyback program. With the addition of the recently announced $400 million program, we had a total of $548 million remaining in our approved stock buyback programs. All told, for fiscal 2021, we returned more than $100 million to our shareholders through dividends and share buybacks. And in fiscal 2021, our strong cash flow allowed us to successfully complete these strategic acquisitions, continue to return capital to our shareholders, while still deleveraging to 0.2 times. And our strong balance sheet and available liquidity of over $900 million positions us to continue to invest in these technical capabilities and strategic growth areas, both organically and through acquisitions. I'm really pleased to share these financial results for the fourth quarter and the fiscal year with you all. Thank you for your support, and I'll turn the call back over to Dan.

Great. Thank you very much, Steve. I'd like to spend a few minutes discussing our outlook and the three major market drivers that we see today. First, the U.S. Biden administration has increasingly focused federal agencies on programs that are directly aligned with what we do. Second, the U.S. Congress passed, with bipartisan support, the landmark $1.2 trillion infrastructure bill that was signed by the President just three days ago. And third, internationally, there's an increase in climate change awareness that is resulting in new programs and budget commitments in the economies that we're working in. These three micro... These three market drivers are all directly in line with the work that we do for our clients. This is January 2021. The Biden administration has set the priorities of the federal government across the multiple federal agencies that are our clients. Their prioritization of climate change, water and environment, and international development is increasingly focusing resources on the type of work that we do. U.S. federal work for us is distributed across three primary sectors. First, civilian agencies, Department of Defense, and the third is international development. For these agencies, we are their high-end consultants. We currently have over $20 billion in contract capacity with the U.S. federal government that we use to support over 100 different federal agencies and departments with their highest priority programs. We work with the United States Environmental Protection Agency to assess climate change impacts on water quality all across the United States. We support the Department of Defense in analyzing and mitigating the impacts of emerging contaminants, such as PFAS, and provide resilient design for their facilities. And for USAID, we work on some of their highest profile programs in ocean and coral reef protection, sustainability and forest management, and clean energy development. On November 15th, 2021, President Biden signed into law the Infrastructure Investment in Jobs Act, or also known as IIJA, committing an investment of $1.2 trillion here in the United States. The act includes $550 billion in new commitments and sets out clear funding designated to the administration's priorities of water, renewable energy, environmental restoration, and ports and waterways. These priorities are directly aligned with what we do and the funding will flow through federal, state, and local programs and the contracts that we're working on now. For example, we're a leading consultant for the Army Corps of Engineers in dam design and waterway restoration. We provide our state and local clients with our number one ranked services in watershed management, water supply, and desalination design. And we provide permitting, design, and high-voltage engineering for renewable energy programs that include hydropower, wind, and solar. This landmark infrastructure act will provide new opportunities for us to work with our clients to advance the science and resilient design across the markets we serve. As we enter fiscal year 2022, there's also an increase in climate change commitments in the major countries that we're working in. This increased awareness is resulting in additional funding for climate adaptation, including coastal protection, water supply, and clean energy. Across Canada, the United Kingdom, and Australia, we're seeing an increase in project activity, investments in resilient infrastructure, and a demand for high-end solutions. By leveraging our leading with science approach, we provide our clients with the high-end expertise to address their programs anywhere in the world. I'd now like to present our outlook for fiscal year 22 across all four of our client sectors. And I'll start with the U.S. federal sector. The U.S. federal should continue to grow in the high single digits with alignment to the administration's priorities. We assume, however, that material increases associated with the new Infrastructure Act will not begin or actually hit our contracts until late fiscal year 22. or early fiscal year 2023, and therefore, we have not included any contribution from this bill in our guidance. State and local should continue to grow at a double-digit pace for us, between 10 and 15 percent, with expected continued strong growth in this sector as additional projects are initiated by our clients with their increased budgets and the remaining stimulus funding that came from fiscal year 2021. This growth rate does exclude $50 million in 2021 revenues associated with extraordinary disaster response activities that we performed. U.S. commercial is expected to be about 20% of our business and grow at a 5% to 10% rate. Growth will be supported by a continued focus on environmental restoration, much of which is driven by regulatory requirements or directives, as well as our rapidly growing renewable energy consulting and engineering practice. And for international, our international work is expected to be about a third of our business, evenly split between government and commercial work. Our international work is expected to grow at a 10% to 15% rate as we increase our support for sustainable infrastructure and climate change services in the key geographies of the United Kingdom, Australia, and Canada. Now, while I just covered the growth rates on revenue from our key client sectors, we're also going to see in fiscal year 2022 our operating margins continue to expand. As you can see on our webcast, since 2017 we've expanded our operating margins by 180 basis points and 40 basis points just from fiscal year 2020 to 2021. We do anticipate an additional 40 basis points expansion to result in an 11.2 operating margin for the year of fiscal year 2022. I will say that this is going to be contributed both from a margin expansion relatively even between our GSG segment and our CIG segment. So it's not just one of them that will be promoting and expanding the margin within the company. We see it relatively contributed evenly from a continued margin expansion from both segments. I'd now like to present our guidance for the first quarter and for all of fiscal year 2022. Our guidance is as follows, and I will start with the first quarter for 2022. Our net revenue provides a guidance range of $630 million to $680 million with an associated diluted earnings per share of $0.98 to $1.03. For the entire year, our net revenue guidance is for a range of $2.6 billion to $2.8 billion with an associated earnings per share of $4 to $4.20. As has been our practice in the past, these guidance do include the intangible amortization. We expect that to be about $0.14 per share during fiscal year 2022. Effective tax rate in the first quarter, which is a bit different than the remainder of the year, 17%, with the remaining three quarters at 25%. We do have 54.5 million shares outstanding, and this does, as has been our practice in the past, does not include contributions from acquisitions that may take place during the year. In summary, we had an excellent fourth quarter and an entirety of fiscal year 2021, setting new records across the board for Tetra Tech's performance. As we enter fiscal year 2022, our high-end water, environment, Renewable energy services are directly aligned with global priorities of all of our clients. Our all-time high backlog of $3.48 billion provides us with both excellent visibility and momentum as we're moving into this new fiscal year. And Laura, with that, I'd like to open up the call for questions.

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 ask. If you're using a speakerphone, please pick up the handset before pressing any numbers. If you would like to ask a question, please press star 1 on your touchstone phone. One moment while we poll for questions. Our first question comes from the line of Sam England with Barenburg. You may proceed with your question.

Hi, guys. Thanks for taking the questions. The first one I had, could you talk a bit about what you're seeing in terms of wage inflation at the moment and also staff attrition?

It's obviously a common topic amongst the professional services space at the moment and doesn't seem to be impacting your margins at all at the moment.

That's a good question, Sam. To date, we've really seen little to no impact on wage inflation. We do recognize that it has impacted portions of the economy and that issues with respect to finding workers and increased salaries has been an issue in some sectors, but it's really not affected our business. Generally, we find our individuals are paid well, and the decisions that they come join Tetra Tech with respect to wage inflation, we do pay what I would consider at-market wages. Much of the individuals who may be more focused on wage salaries are the people who've just entered the market. Quite often they're associated with our early projects that are cost plus or time and materials. So in the event we do see it in the future, which I would reiterate we've not seen it to date, but we would be able to pass it on through our rates or our cost reimbursable nature of the contract vehicles that we have. With respect to attrition or turnover, we've also not seen that at this point. I think I've shared on previous calls The overall turnover rate for Tetra Tech on an annual basis has actually dropped a little bit since the advent of the pandemic, roughly in March of 2020. We've seen it go down. We were sort of in the high nines collectively as a company. We've seen that drop to about 9%. And we've not seen that increase as mobility has increased with sort of the reopening of some of these economies and other restrictions. So we've really not seen that be an issue for us at this time. But we are, for sure, watching it carefully. And the one thing that we have here at Tetra Tech that we think makes employees find Tetra Tech as a great location and destination for a lifelong career is the most interesting work that we have that allows them to work not in a matrix or not just be a number, but actually make a difference with the type of work that they perform for our clients. and that have impact on the environment and the world, particularly with climate change becoming such a prevalent topic. So we've actually not had much turnover and, in fact, have attracted some of the best talent in the industry have joined us here where there has been a little bit higher turnover.

Okay, great. Thanks. Then the next one I had, I was just wondering if there was anything arising from COP26 this month that you think could be a benefit to you in the longer term, particularly thinking about the international side of the business?

Well, I do think that there is opportunity there. We're going to look to see how the commitment of increased funding. I did have one slide that was one of the drivers for us. We have seen Canada, as I noted in the webcast presentation, increased by over $5 billion commitment to climate change finances. United Kingdom had doubled that number at more than $11 billion. And Australia actually committed just from the government $20 billion, doubled that number again. that is actually going to be focused on mobilizing private investments that are anticipated at an additional $80 billion. And so I think that collectively, the $20 billion as an initial investment to trigger a collective aggregate in Australia of a $100 billion investment over the next decade. So we have seen these commitments for the numbers. We do believe, similar to the infrastructure bill here in the United States, it's not a light switch. The commitment doesn't turn to those dollars and projects being initiated within a day, a week, or a month. But we do think we're going to see continued build, continued prioritization. And we're really encouraged. It was not just the United States and the largest economies committing to this. It's really a global commitment. And so we think this portends very well for our future and the work that we can contribute to our clients in the future.

Okay, great. Thanks. Now, maybe just one more. I just wondered on the margin side, you know, another sort of strong improvement scene. Are you sort of rethinking the longer term margin opportunity for the business, given the way in which technology is improving the margin profile of the business? Or, you know, are you still sort of set to the targets you've talked about in the past?

Well, that's a great question. We I hope that as we progress through the year, we'll actually identify new targets that we'll establish out two or three years from now. We have targeted a 13% operating income margin. I think if you add back some of the items that are typical for many reporting, which is adding back stock-based comp, adding back amortization, you'll see that we're very close to the 13% now. And, in fact, we are reevaluating that. And it's no question that as we build a little bit more scale with some of the data analytics work we have, some of the subscription programs that we have, some of the software that we've deployed to our clients, we do think that number will go up. And I do look forward to sharing that with you and our other shareholders here in the coming quarters. But we do think there's higher ground, more expansion and margin available for us, and I'd like to quantify that for you here as we move through the year.

Great. Thanks very much. I'll hand it over there.

Great. Thank you, Sam.

Our next question comes from the line of Mark Riddick with Sidoti. You may proceed with your question.

Hi, good morning. I was wondering if we could start a bit on one of the call-ups that you made mention of performing well was around a high-performance building. And I know we've talked in the past about that opportunity, and particularly in the U.K. I just wanted to touch a little bit on maybe what your initial views are there as far as what you've seen so far and what that opportunity set may provide going forward.

Well, it is interesting that it's one of the areas that our high-performance buildings practice now with the addition of Orly in the U.K., which adds just under 1,000 staff. We have... probably a larger number than that here in the United States, primarily focused on the east and west coast, and a similar number in Australia. So we think we have a great geographic presence to support our clients globally, wherever they are. We have noted that in 2021, and even late 2020, because of the pandemic and a reevaluation of office space, we saw a slowdown in that business. So it was really interesting that that was an impact with respect to no investment in buildings. Internally, we saw the growth rates really go up the second half of this year, year on year, but it was primarily because of very depressed comparables from the prior year with the pullback. So we did see numbers that are in the mid-teens and growth. I'm much more interested to see how that will progress as we move into early 22, where the comparables are more pre-pandemic representative. I do think the growth rates can be in the double-digit rate And a lot of it has moved from just new construction to renovation and a reconfiguration of the buildings to allow more distancing, to allow industrial hygiene, to allow wellness buildings, and to move to net zero, both from existing buildings and for new construction. I will say that collectively the margins are higher than our average commercial activity. And so I think it's going to be one of the strongest contributors that we have. It is interesting. These are items that have been driven by our commercial clients as priorities for their tenants and for the buildings they own. But we've seen an additional tailwind begin to emerge with regulatory drivers. So as part of moving to lower emissions from buildings, and I think I've mentioned this before, approximately 30% of the greenhouse gas emissions are associated with physical building structures globally. So this is an absolutely cornerstone area that needs to be addressed globally. to combat increased global warming and greenhouse gas emissions. So we are seeing that grow, and with regulatory drivers now contributing to what was driven by clients' personal preferences, we think this is going to be a big driver. And with respect to the UK, I think some of the regulatory mandates that are emerging now may put it at the forefront of any of the regional jurisdiction requirements in the world. So I think it's great timing. for Horley to join us. They are a forefront, a gold-plated, top-end consulting engineer that fits very well with Tetra Tech, and I expect great things from them to contribute to Tetra Tech and actually help elevate our leading position with high-performance buildings designs.

Thank you. That's great. That's a great update for us. And then the last thing for me before turning it over, I wanted to just touch a little bit on the utilization opportunities going forward. I think we've made mention in the past, or you've made mention in the past, of the ability to use some staff across maybe, you know, across borders or certain areas of service. And I was wondering, and I would imagine that certainly is something that is also a draw for folks to join and stay with the company. But I was wondering if you could talk a little bit about, maybe what those opportunities look like, especially now that there's maybe a little more visibility following the signing of the act.

Thank you. That's a great question, Mark. One thing that if you'd ask what are some of the areas I've been extraordinarily pleased with or been really happy with within the company has been our use of the virtual and electronic platforms that we put in place over the past decade. So when the pandemic did come, we did get the opportunity to test how great or not great it was going to work And the ability to move individuals working from home instead of the office was just an extension of what we've been able to do internationally. So, for instance, the high-performance buildings is a great example. Each of our geographic centers have different specialties. Some are the best at fire protection in the world. Some are the best at lighting and low voltage. Some are the best at communication systems. Other are with respect to mechanical systems. And so to take these expertise that we have in different areas and to move them and allow them to work electronically, regardless of where they are in the world, on a project to provide our clients the best world-class outcome has been very helpful, not just for the best product, but when things got slow in the commercial sector, we were able to move these individuals and work on our federal work, which picked up, or state and local. So the fungibility of many of the technical disciplines we have has given us great flexibility to respond to where we have surges in work. So if, for instance, the federal government picked up significantly, but we saw a little bit more of a slower recovery in commercial, we can move those individuals across. And you can see it in our margin. So we don't have stranded technical assets or labor base. And I will say, and I'll reiterate this, that the workforce that we have today, we're running at about a 70% utilization which is a calculation all in. That counts myself, that counts Steve Burdick, our CFO, and every individual in this company is included in this. Some refer to it as, do you include your SG&A? We include our SG&A and everything else in between is around 70. We have about a 10 to 15% surge capacity with respect to utilization that we could take to address increased revenue with the existing workforce that we have today. So if for some reason the infrastructure bill that was passed is accelerated and hits the market quicker. We really don't have any issue with respect to responding and taking on this work with having a problem adding additional staff. We don't need it. So it's a combination of increased utilization and the use of technology that we've employed in our business can handle a 10% to 15% surge. And that's without adding any additional overhead. So much of that would just drop to the bottom line or a margin expansion. So that's what we see both with utilization opportunity, how we would do it, and how we could actually handle additional opportunities in the market.

That's really helpful. Thank you.

Thank you very much, Mark.

Our next question comes from the line of Noel Diltz with CFO. You may proceed with your question.

Hi, guys, and congrats on the next quarter. Thanks a lot. Sure thing. I was hoping to just dig in a little bit more on the margin profile of GSG and CIG as we look forward. Dan, I know you mentioned that you see anticipate pretty even improvement across both sectors. And I guess that surprised me maybe a little bit just because CIG seems to have been somewhat more impacted by the pandemic. So maybe you could dig in a little bit more into how you're looking at the kind of margin profile looking forward for each segment. And then you touched on this a little bit with utilization, but Are there any costs that we should be aware of that you see coming back into the business, like travel, et cetera, with the pandemic kind of beginning to ease a bit? Thanks.

Okay, great. I'll address both of those. First is margin. There's no doubt I originally would have, and I have over the past two years, expected that the CIG margin was going to expand or grow disproportionately to the government services. And, in fact, that is what we have seen over these past couple years. But I would say that with the additional use of technology in our government services group, and that's been for digital water for a state and local looking to move to digital platforms, remote monitoring and operation of plants for municipal clients is actually allowed for margin expansion. Our federal IT practice, which I've spoken of in past calls, that we expect to grow from its current rate at about $300 million a year run rate up to about 500 over the next couple of years. is carrying a much higher margin, and just the use of technology, and I would say these software applications for solving some of the engineering and consulting challenges and projects that we have has actually allowed for additional expansion. So I thought that if you went back a year or two, I thought that our government services was going to be good. I think I said we were at 12% to 13%. We've gone a year ago because of the use of data and technology to 12.5 to 13.5, and I expect that that will go 13 to 14. I saw our CIG continues to expand. Part of that's driven by mix. We have shed and closed down what I would call business that had moved to more commodity rates. We have used technology. So for this next year, I still think there will be spotty recovery. I do think that some of the commercial work will lag the recovery with our state and local and government clients. And yet I still expect the margins will expand. From what I came into 2021 was 11% to 12%. I think we'll add another 50 basis points to that to 11.5% to 12.5% range. So those are the reasons. I got utilization and mix is affecting our CIGs. And on the government side, it's use of technology and additional advanced analytics. And as far as costs go, do I expect additional costs? I'm not so concerned about travel and entertainment, these types of items, but I do think actually the quarter we're in right now may be one of the first quarters that we see an impact with respect to additional vacation time. And I know folks have been bottled up and have had been restricted on going outside and traveling. We do see that I think there'll be a bit more travel and a little bit more vacations and holiday time in the U.S. from Thanksgiving all the way through New Year's. I think it's relatively de minimis. I think it's very temporal. So I do think people will get to visit and spend time with family and take a little time off that we hadn't seen. But I think it's just very temporal. I don't see a resurgence of an indirect cost that will affect our rates at all. But I will mention in Q1, if you see a slightly increased vacation time, that's not a surprise. In fact, we're planning for that already, and it's been embedded in our guidance.

Okay. That makes a lot of sense. Second question, just obviously you saw a nice acceleration in U.S. commercial in the quarter. You touched on what you're seeing in some of the high-performance buildings, but could you expand a bit on industrial water and what you're seeing there in terms of activity and how you're thinking about the consulting around PFAS at this point? Thanks.

That's a good question. I'll start with PFAS first since it's extremely topical these days. And I think that PFAS, while it's been questions that I've fielded on these calls over the past year or two, it's become a bit more prominent with respect to being in the news. The current administration and the EPA has actually come out with a timeline to initiate all of the steps necessary to create a drinking water standard or an MCL for PFAS. It is interesting. We've seen our commercial clients now move to complete investigations and assessments of areas where there may have been discharges of water or any products that had contained PFAS. So we have seen an increase in investigation and assessment. We've seen evaluation of changing some of the product usage to remove anything that would have components or derivatives of PFAS or PFOA or any of these other regulated chemicals. So we have seen on that portion what I would say is a precursor to a regulatory enforcement or regulatory-driven requirement. So we have seen that. As far as purely industrial water, I would say it has been static. We've seen some of the discretionary work pick up, but a lot of the work that we do under our industrial water programs are regulatory driven with respect to meeting discharge requirements, meeting pretreatment thresholds that have to be in place. So we've really seen that stable through the pandemic because there were regulatory drivers. I do say on PFAS though, and I know it's moving away a little bit from the commercial side, As PFAS moves forward, it's going to have and moves to a regulatory standard, which we expect probably in 2023, based on the timelines that came out from the EPA, that all of the municipal water utilities will have to meet the PFAS standard. And so that doesn't happen overnight. So the work that will have to begin driving those evaluations will start soon. And in fact, we've put in place in Orange County, California, one of the largest PFAS treatment systems that exists in the entire country already in anticipation of this regulation in the future. So we're actually seeing it from being something that's coming to it's beginning to be here now.

Thanks so much.

Thank you, Noah.

Our next question comes from the line of Sean Eastman with KeyBank Capital Markets. You may proceed with your question.

Hi team, thanks for taking my questions. I just wanted to come back to the IIJA. I'm just curious, if you look at the core water funding line items that Tetra Tech plays in, what type of percentage increases are you seeing in this legislation? I'm just curious if you can provide any context for this bill.

You know, I would point you to page 13 of our, just as a reference to a slide, but on the U.S. Infrastructure Stimulus, or IIJA, we actually did call out some of the areas that we would see as a direct addressable market or areas that we would be focused on. Now, there's many portions that addresses everything from broadband to capital bridges and other structures, but some of the areas that we see water infrastructure resilience, 110 billion. I will say one that's caught our attention, that's new funding. So when you say, what's the incremental increase? Well, when you're going from zero to 47 billion for climate resiliency, I don't know how you put a percentage on that number. So it's an infinite number. And it's actually creating new projects and new priorities that just didn't even exist before. But we did outline here over $200 billion in of what we think are directly addressable new funding here in our presentation today. And again, anywhere from over $100 billion for water infrastructure resilience, power infrastructure, which a lot of it is for the grid, high-voltage engineering, and much of it is to determine the interconnects and the transmissions from renewable energy into the grid. And we're doing that work in-house. We have well over 500 high-voltage electrical engineers within Tetra Tech, And I'll tell you, we're one of just a very few organizations that have the capability to do that type of high-voltage engineering anywhere in North America. Environmental restorations, which is another word for Superfund sites, is being put an additional $20 billion. So it's an incremental increase, and we expect that to be very key for ourselves. And of course, ports and waterways, contaminated sediments at well over $10 billion. So I think These are the areas that we're focused on. The bill itself covers many different areas, but we do know what we're focused on, and that should keep us more than busy for an extended period of time. And the one item I do want to make sure that is known here with respect to Tetra Tech that I feel so positive about the bill that's passed is it's not a bill that is going to push the funds through in the next one to two or three years. This is a program that is going to stay at least the next five, and they say to 10 years. So this is actually a tailwind or funding that's going to be deployed over an extended period of time. So it's not let's just go fast and see what happens. It's actually funds that are going to be invested to take Tetra Tech forward in the country into the 21st century for infrastructure and become a global leader. And for that, You actually need the thought leaders, the high-end engineers and scientists to take the lead, and we think that we're very well positioned for that.

Okay, very helpful. And just in light of your very excited response there, it's interesting that your comments here on the call are, are more so around highlighting the flex you have in your current staffing rather than coming out and saying, you know, we're ramping staffing to get ready for this. So what exactly do you want to see before you start making those types of decisions, Dan?

Yeah, that's a great question. And, you know, our practice, my practice that I learned from my predecessor is who learned from his predecessor, which is really a hallmark of Tetra Tech's culture, is we staff to the work we have. We don't staff in advance and prepare for it. So we aren't going to add 10% staff in anticipation of work to come. What we do is we will make commitments with the staff that we have to address the projects that are in the marketplace, and we will add staff as projects come on. We can handle a significant amount of increase. So if you think about this, When I sit through the use of flexing or additional utilization plus technology, I believe the utilization can handle 10% and technology another 5%. So at $3 billion, that's $450 million. I'll just round up to $500. We could handle an additional $500 million of annual revenue with the workforce that we have today and the technologies that we've deployed throughout the organization. So we could take that. Now, of course, that means that you're running your car or running your organization at a higher RPM, so to speak. It doesn't like to be there forever. And so then what we would do is then we would add additional staff that would bring the utilization back to what I would call a more long-term sustainable level. So this is the practice that we've employed certainly through my tenure at the company and that we would expect to deploy in the future.

Okay, very helpful. I'm going to sneak one more in. So you have 40 basis points of margin expansion in the guidance for fiscal 22. How much of that is just utilization versus higher margin mix of business? And then as we look into the out years and consider the IIJA and some of these other international funding programs, Do you see the penetration of those higher-end advanced analytics and digital solutions accelerating around some of these funding programs? I mean, is there an opportunity to accelerate this kind of margin-accretive mix shift that you've been highlighting over the last several quarters?

Well, I think the answer is yes. And with respect to the expansion of – our 40 basis points for fiscal year 22, about half of it is from utilization or just more work and top line growth. And the other half is through mix and use of technology. The utilization only has a certain optimal amount that can contribute. So I believe that the movement, and I think it was an earlier question today, are there new high levels by which the margin can expand in the corporation? And the answer is clearly yes. And I think that's going to come from technology and mix change. And that affects both our commercial and our government side. So I would say where is the additional outpaced side of margin going to come from? It's going to come through our use of technology and business mix that we have performing that work. And that's the area that I expect will represent an even bigger upside in the future. Utilization will always be something that can contribute based on the amount of work we have in any given quarter compared to our workforce. But as far as structurally changing everything and moving it up, there's no doubt it's moving to the use of more analytics, more technology, and moving more and more to the high end.

Very helpful. I'll turn it over. Thanks a lot.

Thank you, Sean.

Our next question comes from the line of Andy Whitman with Baird. You may proceed with your question.

Hey, Dan. Thanks for taking my question. I had a question on the USAID business. And you previously talked about how this business, when nobody was traveling, did suffer some declines because of the pandemic. I was just wondering how back to work are your people in this business in particular and how much of the guidance, the revenue guidance increase or how much revenue up list is baked into the 22 guidance from USAID?

Well, that's a really good question, Andy, because if you went back to the last quarterly call we had with you all collectively at the end of July, I expected that USAID would actually be one of the biggest drivers for our federal growth. And in fact, what we actually saw here this last quarter was our international development work was relatively flat. In fact, our federal work was primarily driven by, as I've mentioned in my prepared remarks, by the civilian in defense. Now, to come back to aid, what we did see at the end, at the very end of our fourth quarter, in fact, roughly early September, so with a couple weeks to go, we saw the U.S. and, by the way, Western countries exit Afghanistan. Tetra Tech was one of the largest international development support contractors for USAID and, in fact, other agencies. in Afghanistan, supporting infrastructure development, supply of water, flood protection, sanitation, reliable energy for renewable sources. We were working on all of those programs. And we watched that business or that support go from what in the previous 12 months was roughly a $50 million revenue contribution to the company, the net revenue being about half that, to pretty much a light switch within a few weeks. Everybody was gone. Now, we have continued with some work with respect to supporting refugees and other what I call ancillary items. But I think it's that item that actually caused us, as we moved into fiscal year 22, to move our federal growth projections. You saw that we had estimated a 10 to 15 percent federal growth for the fourth quarter and the beginning of 2022. You saw us pull that back a little bit. to 5 to 10, and it was really almost solely associated with this $50 million reduction in that single program. So if you really just took that aside, the rest of our federal business is really growing at a 10 to 15% rate. I do think that there was still continued impact on international development with respect to localized restrictions on travel because of the Delta variant and other COVID impacts. I've seen the most restrictive restrictions actions taken in Germany and Belgium here even just this week. We've seen another location. So that's continued to be sort of a little bit of a fit and start. We move forward and then we get a little slow down. So that hasn't opened up quite as quickly as we saw. But the single program in Afghanistan actually just from a collective numbers has caused what we expect USA to be sort of flattish in 2022. Now, I would say that if you just take X, Afghanistan is growing quite well, but when you put that in, it actually impacted that single guidance number we provided on our outlook for the U S federal government.

That's really helpful context. Thank you for that. Okay. Um, my second question, um, just has to do with, um, how you're thinking about the buyback. You are now in the enviable position of having your free cashflow yield of your stock. probably being below your marginal cost of debt. So EPS accretion isn't really what you're playing for anymore like that was in the past. But I was wondering how that phenomenon is being thought about at the board and your posture towards the buyback given this and just kind of your thoughts surrounding that.

Well, I do think – how do they refer to it sometimes as a problem, but it's a high-class problem, to have actually generated sufficient cash to be in essentially a net debt-free position and actually move to a cash on the balance sheet. I think Steve has outlined, and we've been very consistent, that we're committed to returning capital to our shareholders through buybacks and through buybacks of stock and dividends. We thought that between acquisitions, and dividends in the buyback that we had prior to this fiscal year, we could begin to move our leverage to an appropriate spot where a balance sheet is contributing to the company also. The good news is we continue to lower our DSO. We've generated more cash. You did see the first week of fiscal year 22, or October 4th, the week of October 4th, we did increase, the Board did support an additional $400 million of buyback authorization. Steve has said it's taken us well into the $500 million of availability for buyback. It is not for EPS secretion, but we do want to make sure we not only would more than offset any dilution that would exist for use of the stock, but the goal is to actually move the company to a leveraged position that will have the balance sheet contribute and have our balance sheet work every bit as hard as our engineers and scientists to make the company successful. So do look for us to deploy the buybacks at perhaps a bit more aggressive level. We didn't increase it just to have that capacity and just look at it. So we'll be able to share with you how we look at that at the end of Q1, because we'll have been through our first quarter with the increased capacity available. But really most importantly, we're looking for firms that are best in class, that add technologies and expertise, that will differentiate the company. It is by far the most important strategic imperative for the company. We're looking to get smarter, better, more inventive, and to provide solutions that have never existed before for our clients. So people that join us that can make us smarter and add us into new markets and help differentiate us even further than we already are is the absolute first priority for the use of our cash. We really, and Steve did talk, we're just under a billion dollars of access to capital without doing anything extraordinary. I would hope that we have all those opportunities and we can make use of all of that. But we're not looking to become bigger, as you've heard before. We're looking to be better. And so that's what's causing us to be selective as to who we have joined Tetra Tech.

Great.

Thanks a lot.

Have a good day, guys.

Great. Thank you very much, Andy.

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

Thank you very much, Laura. I really appreciate it. And thank you all for your insights and questions and interest in Tetra Tech and for joining us today. We're really excited here at Tetra Tech. And I think one comment was you heard the enthusiasm. I'll tell you the enthusiasm has come from the employees and the project managers here at Tetra Tech based on the work that we're doing that we're working on today. And so I really look forward to speaking to you at the end of this first quarter and sharing with you how we started fiscal year 22. So thanks for your support. Have a great safe rest of your day and weekend. Thank you.

Ladies and gentlemen, this concludes our conference for today. Thank you for all your participation. Have a great rest of your day. All parties may disconnect now.