Tetra Tech, Inc.

Good morning and thank you for joining the Tetra Tech earnings call. As a reminder, Tetra Tech is also simulcasting this presentation with slides in the investor section of its website at tetratech.com. This call is being recorded at the request of Tetra Tech and this broadcast is the copyrighted property of Tetra Tech. Any rebroadcast of this information in whole or part without the prior written permission of Tetra Tech is prohibited. With us today from management are Dan Batrack, Chairman and Chief Executive Officer, Steve Burdick, Chief Financial Officer, 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. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in Tetra Tech's periodic reports filed with the SEC. Except as required by law, Tetra Tech undertakes no obligation to update its forward-looking statements. In addition, since management will be presenting some non-GAAP financial measures as references, the appropriate GAAP financial reconciliations are posted in the investor section of Tetra Tech's website. At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the company, we will open 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.

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. We're advancing our growth strategy while rapidly integrating the RPS group, who just joined us at the end of January of this year. RPS has been an excellent addition in their strategic fit. Client focus and financial performance have all exceeded our very high expectations here. Together, we now have 27,000 staff working worldwide on over 100,000 projects for 22,000 different clients. With about $5 billion a year in annual revenue, which is up over 30% year over year, we're 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, we're bidding on hundreds of millions of dollars in 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 IIJA and the IRA stimulus programs just beginning to increase as major contract vehicles are being put into place by our government clients. And third, we see spending commitments increasing for climate change-related programs in water supply, watershed management, and renewable energy, especially in the geographies of the United States, the United Kingdom, and Australia. 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, we're providing 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 headcount. 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 look forward to giving you specifics on that increased guidance and outlook as we move into fiscal year 2024. But I'll give our 2024 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 Hutkins, our president, who's joining me today, will then provide further insight into key emerging growth markets. I'll 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. In the quarter, our revenue increased 36% year over year, from 890 million to $1.21 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 $4.39 billion, up 25% from last year. 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. And 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 singly attributable to RPS. In fact, the underlying business is performing at record pace. The revenue without RPS was $989 million, or almost a billion dollars, 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% respectfully. And that revenue did generate, without RPS's contributions, a earnings per share that was up 19% from the prior year.

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

The group that grew the fastest was the work that we're doing for our 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, NOAA, Federal Aviation Administration, and USAID in 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 and 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 continue 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. 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.

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

First segment, our government services group, or GSG segment, grew 16% from last year, while also increasing its margin to 14% in the quarter, up 60 basis points from last year. GSG'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 CIG segment, grew by 55% year-over-year. Now, the CIG 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 resilient infrastructure. Really one of the strongest metrics and performance areas of the corporation and 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. of $4,386,000,000. And the way Tetra Tech defines this backlog, it's contracted, funded, and authorized work by our clients. We can go perform this work today. In the third quarter, we won $547 million in commercial projects and task orders, including orders for renewable energy and environmental restoration programs. We were also awarded significant additional US federal contract capacity in the quarter, including, which Jill will speak about in a few more moments, including a new $200 million IIJA-focused Army Corps of Engineers contract. And I would like to note, while it's a $200 million base contract with multiple awards over 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 we were awarded 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'd 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, Steve?

Hey, thank you, Dan. So, as you just heard from Dan, we had an 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 has resulted in our DSO maintaining an industry-leading standard and all-time record low for Tetra Tech of 58 days. This is a sustainable improvement from prior years, and this lower DSO continues the trend that reflects the outstanding work that our project managers lead relative to higher-quality projects. and highly satisfied clients in our broad portfolio across all of our end markets and 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 cents per share for this quarter. This is 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, our recent closing of the RPS acquisition, which was just over six months ago, has been going quite well in regards to integrating the people and projects of Tetra Tech and RPS together. And 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 from under 5% in fiscal 22 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 WYG in 2019. And by focusing on high-end differentiated services and revenues, While integrating the business onto our ERP system platform and our corporate systems for greater cost synergies, we'd increase the margins for those businesses from about break-even 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 ERP system, as well as office space consolidations. These actions will result in additional one-time integration costs in the fourth quarter that will provide increased long-term operating and financial benefits to the ongoing business. 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 deliver our balance sheet. Although we were More highly levered at the close of the RPS acquisition with a temporary net debt leverage ratio above the high end of our target range. We have exceeded our initial projections on reducing our leverage. We ended the third quarter at about a 1.6 net leverage multiple, and we would expect to further delever the balance sheet to a factor of about 1.4 times by the end of this year. And so by increasing the EBITDA 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 24 and approximately 85 cents 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. So as we... 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'm pleased to provide and share these Q3 results with you. Thank you for your support, and I will now hand the call over to Jill to discuss just a few of our many strategic business opportunities that we have in our core market areas. Jill?

Thank you, Steve. We have all been eagerly awaiting the flow of money from once in a generation U.S. federal stimulus programs that were passed in 2021 and 2022. IIJA funding is beginning to flow to federal agencies and established programs. IRA incentives are driving new project development in offshore wind. And the Chips for America funding process was rolled out just earlier this summer. This decade-long federal funding will be well distributed across Tetra Tech's core markets of water, environment, 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 the Kentucky LOC program, the first task order awarded under the $200 million IIJA Army Corps of Engineers contract that Dan just mentioned. The IIJA also provides significant federal funding to support state water projects that mitigate the impacts of PFAS in drinking water supplies. Dayton Water selected Tetra Tech to provide high-end consulting to support their PFAS management program, which received IIJA funding through the state of Ohio. The Inflation 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 the early development of a two gigawatt floating offshore wind program that will benefit from incentives provided in 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. Tetra Tech has provided innovative water solutions 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 a water industry leader, Tetra Tech is at the forefront of addressing emerging contaminants in water for our clients. I'll give you just a few examples of our key programs in PFAS, microplastics, and pharmaceuticals. Tetra Tech has performed more than $100 million in PFAS investigation work for U.S. military facilities. Tetra Tech has also designed some of the country's highest profile municipal water treatment plants, including the largest ion exchange PFAS water treatment facility in the country. Our $50 million microplastic project is supporting USAID's flagship program, Clean Cities, Blue Ocean, in advancing global ocean plastics management And our multi-year work with the U.S. EPA has provided microplastic risk assessments for 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 remove. For 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, Jill.

I'd like to provide a guidance for both our fourth quarter and for updated guidance for all of fiscal year 2023. In fact, for our increased guidance for the entire fiscal year of 2023. I'll begin with our consolidated outlook or guidance for the fourth quarter. This 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, you'll 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 are 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 $1,015,000,000 in the quarter with an associated earnings per share of $1.43 to $1.48. For the entire fiscal year of 2023, we have updated and increased both the projection 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 $3.71 billion with an associated earnings per share of $5.23 to $5.28. If you're following along on the slide presentation, you can see the assumptions. I'll highlight a few of these. Our guidance for the year does include intangible amortization of $15 million or 21 cents that's incorporated already into the annual guidance. It does include 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 with 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, as I've 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 and 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, was quite amazing. And we're sure we're rapidly leveraging our combined client base and our expanded services to offer more services and to actually have new opportunities for contracting capacity and 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 entire client base, our future looks brighter than ever before. So as a result of our strong year-to-date performance and record high backlog, as I just shared with you, we're pleased to have increased our guidance for both net revenue and our earnings per share. And with that, Operator, Donna, I would 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 one on your telephone keypad at this time. A confirmation tone will indicate that your line is in the question queue. Please be aware that there will be a 30-second pause in our webcast to allow for buffering. And please remember to mute the audio on your computer if you are not using that platform as well. Again, that is star 1 to register a question at this time. Today's first question is going to be coming from Sean Eastman of KeyBank 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 for EPS. I didn't hear anything extraordinary or episodic called out. So perhaps just some high-level thoughts on really what's driving the momentum here in the quarter.

That's a great question, Sean, and good morning. You didn't hear a specific area of beat. uh with respect to any single unusual contributor whether or not a quarter ago in the second quarter we had an extraordinary unexpected contribution for work from usaid in ukraine that was not the case so the work this was not driven by a beat specifically in usaid or ukraine or any other one location we've historically had significant contributions in individual quarters from disaster response because of fire floods I actually did receive a few calls and questions that, is our performance going to be up markedly because of the fires in Canada? No, that was not a market opportunity. 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. It 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 in that we saw high performance across the board in all of our end markets. And I was really pleased to see we've done well in our state and local business. If you want to say, is there a few areas that We're a little bit better, but I'll tell you, not much standout compared to others, but I was glad to see our state and local work actually pick up on its year-to-year growth. It's been growing historically was up at 15% to 20%. Last few quarters, we've seen it at 10% to 12%. I was really glad to see it back up at 16%, sort of above mid-teen rates. I guess I would say that was nice, but certainly not a big standout between anything else. Of course, 30% growth in our government work. What drives 30% growth? That's really across the board. We talk about three major segments. We talk about defense. We talk about civilian agencies. We talk about aid. They were all up. Civilian Works was up slightly more as part of that mix. That's 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 at Tetra Tech internationally in the UK, Canada, and Australia was up, as we called out in our slide, it was up upper single digits, so it was 7%. But if you've taken to effect some of the short headwinds we had in some of the international development in places like the UK, and Australia that was a little bit slower in their international development work. The real 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 uh we can still do better i'm not going to say we hit on every single cylinder as i 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 so i don't think that it's something that would indicate that we're going to be stopped there for long so um 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. I think that's what everybody wants to hear. 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're suggesting new order momentum is accelerating. So what should we extrapolate from that, Dan? I mean, does it feel like this kind of pace of growth can be sustained?

Well... I feel really good about where we're at now. I guess I talked about revenue growth, which was the beat on revenue and earnings per share wasn't driven by any one area. I'll also say that's true on backlog, because that really is 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 midpoint of our guidance for the fourth quarter, as I will talk about organic growth and what we've included in our guidance, you'll see we're in the mid-teens, so you're right with respect to what we've posted up to this point, sort of mid-teens organic growth on our 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. Um, I would say, uh, directionally, uh, things look very strong, but I'm going into 2024 and I think Jill. Provided some good insight into a few areas that are going to contribute. Um, but I do want to stay away from specific numbers on fiscal year 2024. 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 or 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, you know, 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, you know, driving the better-than-expected results out of the gate here from RPS?

I attribute it – well, first of all, they have an excellent workforce. They're experts in the areas that they serve, primarily in the UK, Australia, of course, Ireland, and Norway, with a reasonable presence also in – in Holland, the Netherlands. But I would say it's really the culture. The culture within RPS is very closely aligned to what we have at Tetra Tech. They're not commodity providers. They're not final detail designers that are doing shop drawings. They really are providing high-level value front-end consulting services that are very much in alignment with Tetra Tech. And I would say that having now had them with us for just six months, so a couple quarters, I'm amazed that at the high level, I thought Tetra Tech was very early in the overall lifecycle process. I'm going to talk about a vertical from identifying a project and being 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 work for Department of Public Works, different political parties on how they would prioritize their infrastructure and renewable energies and climate change work actually is very complimentary. I didn't think you could go much earlier in the life cycle 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, and this is aspirational on my part, I don't want to put a specific date on the calendar at this moment, but I have spoken in the past that RPS historically had had margins higher than that of Tetra Tech. They've had numbers up high teens approaching 20%. And I think that given the alignment with their Tetra Tech colleagues, I think culturally we're very similar. I think that 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 I think I've seen very little or no disruption on the workforce with respect to those that are client-facing and project-facing. I've seen their performance going up. I've seen their backlog going up. And to a certain degree, I think some of the RPS folks have shown, let me stand next to the Tetra Tech colleague and show Tetra Tech how to do it at even a higher level, which I'm more than welcome here in the company.

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

Great. Thank you very much, Sean.

Thank you. The next question is coming from Andy Whitman 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 mentioned it at every conference call. But I feel like myself and I bet others would probably benefit from understanding this in a little bit more detail. So, Dan, can you talk a little bit more about is Tetra Tech Delta its own business or is 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. I don't know. To the extent that it's relevant, maybe just giving an example of a contract, a larger contract that we're really able to employ these solutions just to give us as investors and analysts a little bit better sense about kind of what this business is and what we can expect from it in the future.

I'll tell you, Andy, the Tetra Tech Delta is one of the areas that I'm really excited about here at Tetra Tech. Those that have worked with me over the years know I came up from the technical side of the house. I think Tetra Tech has been a leader in modeling research and development as a think tank. It's really its origins. And to see the Tetra Tech Delta, which is started off as the, well, we've always had these models that we've used. We use 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, you'll find Tetra Tech at the origins of much of that work. So the Tetra Tech Delta did start as far as our communicating publicly as the tools that are embedded in all of the work we provide. So we have all sorts of technologies and tools where we can do remote sensing and remote assessments for green buildings for Heat loss, heat transfer, damage, erosion on things such as seawalls that can actually be seen through 3D cameras can then be identified and have sequential erosion rates and determine what type of operation and maintenance. It's allowed us to do work that would normally take 100 people two years to do, can now 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 or artificial islands or 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, but anywhere between 2 to 500 basis points, so 2 to 5%. So if we were making 10% before, now we're making somewhere between 12 to 17% just by using the tools. Now, 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 they're located in Perth, Australia, Dallas, Texas, or Leeds, England. Now, the part that's the most exciting to me, so I'm kind of geeky that way. I love using these tools. I love how it can actually make us 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 a competitor and yielding the best profits we have in the company. and doing it for our clients. So that's the part I like. But the part that I'm probably most excited about, and this is still three or four levels beyond what I can contemplate myself, but 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 market size and dollars here on this. We're actually putting this in place where 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's 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, I guess you'd call it subscription. But we can do things that the clients can use it, and we can come in and provide customization. That program is somewhere revenue is generated where it's, revenue generated without tetra tech labor associated with it is somewhere it's uh probably 25 million and i think it's growing quite quickly i think that number had gone from five to ten so it doubled it doubled again here this last year to well over 20 and the part that seems most promising to me is a generative ai platform here at tetra tech we refer to the collective generative ai for water, environmental, and 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 bases such as what's the – and I referenced this – 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 a railway or a waterway or anything else that would be potentially damaged or exposed or vulnerable because of this, real time, or as we officially call it, near real time. We have several thousands of licenses issued to our clients currently. It's currently being adopted by state DOTs here in the United States. The current number of licenses we have are measured somewhere between 2,000 to 3,000 of these, and this is only with one or two DOTs. If you really took a look internally, we have a goal of having 1 million users for our generative AI here over the next two or three years. Current size, it's probably included in that $25 million. I've been hesitant to daylight this. Oh, by the way, I'll come back to complete the financial portion. Maybe $25 million, but the incremental portion on the generative AI, the margins are north of 30%, and that's with reinvestment. The gross margins are up, as many SAS programs are, at 80%. We're seeing those that we have sufficient... subscription 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 it's something that we can track CAGR rates and 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 a software company. We're actually becoming the best at the application of the science and technology our domain experts bring 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 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 important 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 to the margins that were in the backlog before. Are you seeing any movement there, given the overall demand trends in the marketplace?

I would say yes. Yeah, we don't call out. It's interesting. You hear us. begrudgingly 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 GNA 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 I sort of separate out the discussion I just had on the delta and the generative AI work we're doing. So it is tending higher. 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 mixed. We are taking some of the lower work that we have in the company that might be considered being commoditized or actually having lower leverage, and we are moving more to the high end. And so we are finding through a combination of some pricing power ability in the marketplace and just moving to a higher end mix. And I think that includes some of the advisory work that we talked about with RPS and others. So there is higher margin embedded in the backlog we have. And it's typically our backlog would burn off in a year. I think we say 85% of next year's revenue is in the backlog we have. Another 15% would 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've just booked.

Thank you very much.

Thank you very much, Amy. Thank you. The next question is coming from Michael Dudas of Vertical Research Partners. Please go ahead.

Good morning, everyone. Morning, Michael. Hi, Dan. I'm still getting over the comment about RPS with higher margins in Tetra Tech. You're really challenging the Tetra Tech folks now, it seems. Or at least the aspirations, for sure.

No, that's true. And I put myself in the bucket of the Tetra Tech folks. I'm wondering, I need to get up a little earlier in the morning. There you go. Excellent. I appreciate that.

A couple overall thoughts. Maybe to share some, you know, there's been, I've noticed, much better activity out of Canada. and seems like it kind of fits very well with the tools and the mid-market you say. Is there an opportunity for above-average booking and revenue growth across that market, especially in your water and, say, the renewable side?

Renewable has been very strong up there. I'd say the area that if you'd say Canada, our infrastructure and say it's a provincial infrastructure in some of the large cities has gone really well for us. We've seen more spending there. Of course, there's been a high focus. I don't want to make this a negative item, but there have been a lot of economic activity coming out of Canada, which means a lot of rail. 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 side. So that's been very busy for us. It is making use of some of the digital tools we talked about, including we have rail AI and a number of other programs like that. So water has been a big issue. You know, I think that when you, at least the last 30 days, you talk about Canada, you talk about fires and both British Columbia and 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 kind of go back to my earlier comment about broad-based. Is Canada doing well? Yeah, Canada's 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'll 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'm hoping to bring the expertise even more prominently here to the U.S., is our high-voltage engineering. I've talked about this before. TechJet has 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... Well, chastise me later saying that's really 480 and up. But that capability to have well over 500 high-voltage engineers that can work at a very specialized market where you have transmission from the renewable energy sources, every single one of them are in some off – off the beaten path location where you have to have local transmission to an interconnect to actually be used for the uh the ends and it'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 you can have green energy being used and reducing the 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. And for us, I'd put that under our Canadian expertise that differentiates us.

I appreciate those thoughts. And I guess my second question, my follow-up question would be, You talked about certainly broad-based strength amongst your segments and your geographics for the success so far in fiscal year 2023. As you kind of look ahead to the year end into 2024, do you see the pipeline of opportunities growing at a similar or better rate than what you've been booking in revenue and certainly leading to, I would say, a continued plus one book to bills as you look to 2024? And certainly in that pipeline, those margins you talked about in response to Andrew's question, are, you know, somewhat in that similar range as you're looking to book new business?

Well, I thought Jill highlighted the one that receives 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'm glad to see, and Jill highlighted that, on her slide. The one item that we've not talked about too much and we caution not to infer too early of a conversion from the bill being passed to converting it to revenue is actually 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 that she spoke regarding City of Dayton, the U.S. Corps of Engineers that both she and I mentioned, 200 million. They're using other vehicles. So I think when you ask the question, are there other things that could contribute to allow a book to bill at greater than one, even with the revenues increasing so high. I think new work actually coming out now in 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 it'll ramp, the revenue will ramp through 24. But what's going to come first is going to be, which we're seeing now is contract capacity or contracts. For us, others will actually dump that into their backlog. They'll do some factor and say 200 million. I think I'm going to get X amount of it and let me just count it. We don't do that. We only count it after you've given us a task order and you've funded it and you've authorized us to do the work. So for us, you'll watch it translate I want to say a little slower than others who will count something that doesn't exist. We'll 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 24. 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 change that we're doing for our commercial clients.

Excellent, Dan. Thanks for your thoughts.

Yeah, absolutely. Thank you, Michael.

Thank you. At this time, I'd like to turn the floor back over to Mr. Batrak for closing comments.

Well, thank you very much, Donna, for turning it back and for moderating the questions. Great questions. i uh 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 uh even as 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 uh for us we're in a u.s federal calendar starts on october 1st so it's only about six weeks away seven weeks away uh i'm really looking forward to a strong finish to this year and i'm really uh looking forward to providing our guidance for 2024 uh i think it'll be the among the last times you hear us talk about tetra tech legacy and rps I've not broken it up into these details because RPS is different than Tetra Tech. We are one in the same, but I think the performance of the, I guess I'll call it underlying or 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 24, I'm looking forward to, 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 quarter's investors call.

And I'll talk to you in next quarter, roughly in 90 days. I hope you have a great rest of the day and week. Bye.

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