Tetra Tech Q3 2023 Earnings Call Transcript

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Provided by Quartr
August 10, 2023

Key Takeaways

  • Q3 financials: Net revenue rose 36% year-over-year to $1.21 B, EBITDA climbed 33% to $119 M, and backlog reached a record $4.39 B, up 25% year-over-year.
  • Rapid RPS integration is exceeding expectations, driving early revenue synergies and enabling bids on over $1 B in new programs leveraging the combined client base.
  • U.S. IIJA and IRA stimulus funding is beginning to flow into water, environmental, and renewable energy programs, with climate-related spending accelerating growth catalysts.
  • Tetra Tech Delta technologies and generative AI platforms are boosting project margins by 2–5% and have generated over $25 M in non-labor revenue with gross margins above 30%.
  • Fiscal 2023 guidance was raised, with annual net revenue now forecast at $3.66–$3.71 B and EPS at $5.23–$5.28, underscoring confidence in strong year-end results.
AI Generated. May Contain Errors.
Earnings Conference Call
Tetra Tech Q3 2023
00:00 / 00:00

There are 7 speakers on the call.

Operator

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 Investors section of its website at tetra tech.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.

Operator

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.

Operator

In addition, since management will be presenting some non GAAP financial measures as references, the appropriate GAAP till reconciliations are posted in the Investors section of Tetra Tech's website. At this time, I would like to inform you that all participants are in a listen only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. With that, I would like to turn the call over to Dan Batrack. Please go ahead, Mr.

Operator

Batrack.

Speaker 1

Well, thank you very much, Donna, and good morning, and welcome to our fiscal year 2023 3rd quarter earnings conference call. We had an excellent Q3. 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.

Speaker 1

With about $5,000,000,000 a year in annual revenue, which is up over 30% year over year, we're recognized as leaders in water and environment with number 1 rankings by the engineering news record for well over a decade. We see 3 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 100 of 1,000,000 of dollars in new programs that are leveraging the benefits of our collective client base and the high end capabilities of our workforce. 2nd, 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.

Speaker 1

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 platform that we have here at Tetra Tech, we're providing risk mitigation for of the year. We're rapidly assessing tens of thousands of buildings and infrastructure, and we're evaluating large scale climate related impacts of the 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.

Speaker 1

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. 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 Hudkins, our President, who's joining me today will then provide further insight into key emerging growth markets.

Speaker 1

I'll then address and provide an update on our earnings guidance for both the Q4 and increased guidance for all of fiscal year 2023. The collective Tetra Tech operations, including the 1st 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 $890,000,000 to $1,210,000,000 Our EBITDA income increased 33% from last year, reaching a record high of $119,000,000 in the quarter. And finally, even with record revenues up in the quarter, our backlog increased to a new high of $4,390,000,000 of 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, of Tetra Tech's legacy business.

Speaker 1

And I thought it was very important to highlight this and show how the performance of the underlying corporation or the legacy operation that 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 $989,000,000 or almost $1,000,000,000 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% 16%, respectfully.

Speaker 1

And that revenue did generate without RPS' contributions of earnings per share that was up 19% from the prior year. I'd now 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.

Speaker 1

S. Environmental Protection Agency, of 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.

Speaker 1

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, of the Investor Relations section.

Speaker 1

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. 1st 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.

Speaker 1

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 Brazilian infrastructure. Really one of the strongest metrics and performance areas of the corporation in the quarter was our backlog. Our backlog was up 25% year on year on strong very broad based orders increasing by $874,000,000 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 its backlog, It's contracted funded and authorized work by our clients. We can go perform this work today. In the 3rd quarter, we won of $547,000,000 in commercial projects and task orders, including orders for renewable energy and environmental restoration programs.

Speaker 1

We were also awarded significant additional U. S. Federal contract capacity in the quarter, including which Jill that Hudkins will speak about in a bit in a few more moments, including a new $200,000,000 IIJA focused Army Corps of Engineers contract. I would like to note, while it's a $200,000,000 base contract with multiple awards over the contracting period, we successfully competed for and were awarded the 1st task order issued under this contract by the Army Corps of Engineers. In addition to the work that we awarded here in the United States, we were awarded over $100,000,000 in new contract and we'll be conducting a few more questions.

Speaker 1

We'll be conducting a few more questions. We'll be conducting a few more questions. We'll be conducting a few more questions. 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?

Speaker 2

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 $133,000,000 up 35 percent over last year. And including certain outlays for RPS transaction costs as we included in the reconciliation, Cash from operations was $135,000,000 In addition, we paid down $158,000,000 of debt in the quarter.

Speaker 2

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 at 58 days. This is a sustainable improvement from prior years and The slower DSO continues the trend that reflects the outstanding work that our project managers lead relative to higher quality projects and highly satisfied clients in our broad portfolio across all of our end markets and all of our geographies. Regarding our dividend program, we paid out $14,000,000 in dividends in the quarter, and I want to announce that our Board of Directors approved our quarterly dividend of $0.26 per share for this quarter. This is our 37th consecutive quarterly dividend and our 9th 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 6 months ago, has been going quite well in regards to integrating the people and projects of Tetra Tech and RPS together.

Speaker 2

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 3 years, we expect to increase our actual EBITDA margin from under 5% in fiscal 2022 for RPS by almost 3 times to over 13% by fiscal 2025. This will be accomplished in a similar manner as what we had done with our 2 previous public company acquisitions, Coffey 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 breakeven prior to joining Tetra Tech to the current Tetra Tech double digit levels. So now relative to RPS, We've realized significant cost synergies in the 1st 6 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.

Speaker 2

These actions will result in additional one time integration costs in the Q4 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 delever our balance sheet. Although we were more highly levered at the close of the RPS of the 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.

Speaker 2

We ended the 3rd quarter at about a 1.6 net leverage multiple, And we would expect to further delever the balance sheet to a factor of about 1.4x 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 $0.50 of EPS in fiscal 2024 and approximately $0.85 in fiscal 2025. And these estimates are based on our existing capital structure, but we continue to consider alternative financing arrangements for the long term benefit of the company. 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.

Speaker 2

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?

Speaker 3

Thank you, Steve. We have all been eagerly awaiting of the flow of money from once in a generation U. S. Federal stimulus programs that were passed in 2021 2022. IIJA funding is beginning to flow to federal agencies and established programs.

Speaker 3

IRA incentives are driving new project development in offshore wind. And the CHIP for America funding process was rolled out just earlier this summer. This

Operator

of the year.

Speaker 3

Decade long federal funding will be well distributed across Tetra Tech's core markets of water, environment, of 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 Lock Program, of the first task order awarded under the $200,000,000 IIJA Army Corps of Engineers contract that Dan just mentioned.

Speaker 3

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 PFOS 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 1 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 their early development of a 2 gigawatt floating offshore wind program that will benefit from incentives provided in the Inflation Reduction Act.

Speaker 3

Another nearly $400,000,000,000 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 1 in water by Engineering News Record for 20 years and number 1 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 PFOS, microplastics and Pharmaceuticals.

Speaker 3

Tetra Tech has performed more than $100,000,000 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 $50,000,000 microplastic project is supporting USAID's flagship program, Clean Cities Blue Ocean in advancing global ocean plastics management.

Speaker 3

And our multi year work with the U. S. EPA has provided microplastic risk 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.

Speaker 3

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 and to anticipate needed water system upgrades and to address future regulations. And now I'd like to turn the presentation back to Dan.

Speaker 1

Great. Thank you very much, Joe. I'd like to provide a guidance for both our of Q4 and for our updated guidance for all of fiscal year 2023, in fact, for our increased guidance for the entire fiscal year of 2023. I'll begin with our consolidated outlook or guidance for the Q4. This consolidated guidance is both for the legacy Tetra Tech operation and for the contributions of RPS.

Speaker 1

If you're following along on our investor slide deck, you'll actually see for your and the Q and A portion of the call will be available on our website. 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 Q4 and for the full year. For the Q4, our consolidated net revenue guidance 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 $3,660,000,000 to 3,710,000,000 with an associated earnings per share of $5.23 to $5.28 Following along on the slide presentation, you can see the assumptions. I'll highlight a few of these.

Speaker 1

Our guidance for the year does include of intangible amortization of $15,000,000 or $0.21 that's incorporated already into the annual guidance. It does include effective tax rate in the Q4 of 27%, 54,000,000 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.

Speaker 1

In the Q3, as I've already commented on and Steve's highlighted, we did set new records to really all of our key financial metrics, Revenue, net revenue, operating income, EBITDA, earnings per share. And of course, we feel very proud and we think it's a great metric looking forward with ending the quarter with an all time high backlog. The rapid integration of RPS is actually exceeding our expectations. We had very high And so to exceed that was quite amazing. And for 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.

Speaker 1

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.

Operator

Thank you. The floor is now open for questions. Queue. Please be aware that there will be a 30 second pause in our webcast to allow for buffering. And if you please remember to mute the audio on your computer if you are not using that platform as well.

Operator

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 KeyBanc Capital Markets. Please go ahead.

Speaker 4

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?

Speaker 1

That's a great question, Sean, and good morning. You didn't hear a specific area of beat with respect to any single unusual contributor, whether or not a quarter ago, in the second quarter, We had an extraordinary unexpected contribution for work from USAID in Ukraine, but 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, hurricanes. I actually did receive a few calls and questions that, is our performance going to be up Marketly because of the fires in Canada.

Speaker 1

No, that was not a market opportunity. We were we certainly observed here in the U. S. The smoke and ash from it from up north, but it was not actually a project driver for us. It was in some ways, I've had some around here say it was an unexciting quarter because it was really very broad based.

Speaker 1

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 were 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%.

Speaker 1

I was really glad to see it back up at 16% sort of above and mid teen rates. That was 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 was really across the board.

Speaker 1

We talk about 3 major segments. We talk about defense, we talk about civilian agencies and we talk about aid. No, they were all up. Civilian Works was up slightly more as part of that mix. That's why we called it out.

Speaker 1

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 of the company. Internationally in the U. K, Canada and Australia was up as we called out in our slide, it was up upper single digits, so it was 7%.

Speaker 1

But if you've taken to effect some of the short headwinds we had in some of the international development in places like the U. K. And Australia, that was a little bit slower in their international development work. The real 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.

Speaker 1

Although, 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 U. K. 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.

Speaker 1

So I guess that's kind of a long winded way of things look pretty good here across the board in the quarter, Sean.

Speaker 4

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.

Speaker 4

So what should we extrapolate from that, Dan? I mean, Does it feel like this kind of pace of growth can be sustained?

Speaker 1

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 It wasn't driven by any one area. I also say it'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 $100,000,000 sequentially. Now if you take the midpoint of our guidance for the Q4, so I will talk about Organic growth and what we've included in our guidance.

Speaker 1

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, I just provided. So yes, it will continue through here. I would say, directionally, things look very strong, but I'm going into 2024. And I think Jill Hudkins provided some good insight into a few areas that are going to contribute.

Speaker 1

But I do want to stay away from specific numbers on fiscal year 2024. And I know it's only 90 days away and I'll provide that specifics on the next call. But I would say we don't see anything from a Economic outlook from the markets we're in or from our clients or in any of these geographies that looks like there's a material change as we're moving forward.

Speaker 4

Okay. I'm going to sneak one more in. Just relative to the RPS business, sort of 2 quarters, it's been in the mix. 2 quarters you have kind of walked up the outlook, indicated it's tracking ahead of plan now 2 quarters in a row. Perhaps what in particular would you communicate to investors is driving the better than expected results out of the gate here from RPS?

Speaker 1

I attribute it well, first of all, they have excellent workforce. They're experts in the areas that they serve primarily in the UK, Australia, of Of course, Ireland and Norway with a reasonable presence also in Holland in the Netherlands. But I would say it's really the culture. The culture within RPS is very closely aligned to what we have at Tetra Tech. They're not commodity providers.

Speaker 1

They're not final detail designers that are doing shop drawings. They really are providing high level value front end of consulting services that are very much in alignment with Tetra Tech. And I would say that, having now had them with us for just 6 months, so a couple of quarters, I'm amazed that at the high level, I thought Tetra Tech was very early in the overall life cycle process. If you want 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 would work for Department of Public Works, different political parties on how they would prioritize their infrastructure and renewable energies and climate change work is actually is very complementary.

Speaker 1

I didn't think you could go much earlier in the lifecycle than us, but RPS certainly does bring some of that in their advisory work, particularly in Australia. It opens up a whole new set of clients and project opportunities. And where I think it could go and then 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.

Speaker 1

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've seen 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 Yes, folks.

Speaker 1

So 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.

Speaker 4

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

Speaker 1

Okay. Thank you very much, Sean.

Operator

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

Speaker 5

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 every conference call.

Speaker 5

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 Tetrotech 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 and what we can expect for it from it in the future.

Speaker 1

I'll tell you Andy, the Tetra Tech Delta is one of the areas that I'm really excited about here at Tetra Tech. For those that have worked with me over the years, 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 We started off as the well, we've always had these models that we've used.

Speaker 1

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 100 of 1,000,000 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 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 3 d cameras can then be identified and have sequential erosion rates and determine what type of operation and maintenance.

Speaker 1

It allows us to do work that would normally take 100 people, 2 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 and we're seeing a lot of progress on our projects, where it's been used anywhere between 200 to 500 basis points, so 2 to 5%.

Speaker 1

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 most exciting to me, so I'm kind of geeky that way. I love using these tools. I love how we can actually make us better, cheaper, faster for our clients.

Speaker 1

I particularly like it that we can come in and win a project on a competitive basis Being selected technically number 1, 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 I'm still this is still a 3 or 4 levels beyond what I can contemplate myself. Unfortunately, we have people in the company that are experts on this. This generative AI that Tetra Tech is now employing and I'll go to market size in dollars here on this.

Speaker 1

We're actually putting this in place where we've been using it for a few years now. It's actually measured in several 1,000,000 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 and I guess you call subscription.

Speaker 1

But we can do things that the clients can use it and we can come in and Provide customization. That program is somewhere revenues generated whereas revenue generated without Tetra Tech labor associated with it. It's somewhere it's probably $25,000,000 and I think it's growing quite quickly. I I think that number has gone from 5 to 10, so it doubled. It doubled again here this last year to well over 20.

Speaker 1

And the part that Seems most promising to me as 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.

Speaker 1

It's currently being adopted by state DOTs here in the United States. The current number of licenses we have are measured somewhere between 2000 to 3000 of these and this is only with 1 or 2 DOTs. If you really took a look internally, we have a goal of having 1,000,000 users for our generative AI here over the next 2 or 3 years. Current size is probably included in that $25,000,000 I've been hesitant to daylight this. By the way, I'll come back to complete the financial portion.

Speaker 1

Maybe $25,000,000 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 SaaS 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 is something that we can track CAGR rates and recurring revenue renewal on subscriptions, all of the other things that with this model.

Speaker 1

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.

Speaker 1

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.

Speaker 5

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?

Speaker 1

I would say yes. Yes, we don't call out. It's interesting. We you hear us be gradually talk about gross margins. So I'll actually talk about embedded operating margins in it because I've always thought gross margins is just a pocket trick where people call Overhead G and A and then they don't count the costs.

Speaker 1

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. It is some of it's actually pricing power because some of the work that we're doing is very high demand, very fast track that has to be done. So there is some pricing power, but the rest of it's kind of mix.

Speaker 1

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 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 revenues and the backlog we have, another 15% would go slightly beyond that.

Speaker 1

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.

Operator

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

Speaker 1

Good morning, everyone.

Speaker 3

Good morning, Michael.

Speaker 5

Hi, Dan. I'm

Speaker 6

still getting over the comment about RPS with higher margins Tetra Tech, you're really challenging the Tetra Tech folks now it seems,

Speaker 1

or at

Speaker 4

least the

Speaker 6

aspiration for sure.

Speaker 1

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 early in the morning.

Speaker 6

Thank you. Excellent. I

Speaker 4

appreciate that.

Speaker 6

A couple of overall So maybe to share some there's been noticed but much better activity out of Canada and seems like it kind of fits very well with the Tools in the mid market you saw. Is there opportunity for above average booking and revenue growth Across that market, especially in your water and say the renewable side?

Speaker 1

Renewable has been very strong up there. I'd say the area that if you'd See Canada, our infrastructure and I'd 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 on a negative item, but there's been A lot of economic activity coming out of Canada, which means a lot of rail.

Speaker 1

There have been some derailments associated with floods 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. I think that when you at least the last 30 days, you talk about Canada, you talk about fires in both British Columbia and the East.

Speaker 1

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? Yes, Canada is doing very well. But relative to other geographies we have, I would say that if this was 2 years ago, 3 years ago, I'd be glad to give even more accolades to Canada.

Speaker 1

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.

Speaker 1

TechJack has well over 500 high voltage engineers. It's a very specialized technology. It's people that are typically 500 kilobytes and up. I know our electrical engineers Well, chastise me later sending us 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.

Speaker 1

Every single one of them are in some off the beaten path location where you have to have local transmission to an interconnect to actually be used for the 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 that 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 And outperform or even above the strong performance across the board. And for us, I'd put that under our Canadian expertise that differentiates us.

Speaker 6

I appreciate that 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, Continued plus 1 book to bills as you look to 2024. And certainly in that pipeline, would we Those margins you talked about in response to Andrew's question are somewhat in that similar ranges as you're looking to book new business?

Speaker 1

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're caution not to Inferred too early of a conversion from the bill being passed to converting it to revenue is actually key program wins.

Speaker 1

So I'm really glad to see that a key program win is a contract is being put in place. And you saw programs as she spoke regarding City of Dayton, The U. S. Corps of Engineers that both she and I mentioned $200,000,000 they're using other vehicles. So I think when you ask the question, are there other things that could Contribute to allow book to bill at greater than 1 even with the revenues increasing so high.

Speaker 1

I think new work 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 2024, 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 200,000,000 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.

Speaker 1

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 'twenty four. And yes, I do believe it carries higher margins overall. It's not just government, but also commercial work on the renewable energy and climate change that we're doing for our commercial clients.

Speaker 6

Excellent, Dan. Thanks for your thoughts.

Speaker 1

Yes, absolutely. Thank you, Michael.

Operator

Thank you. At this time, I would like to turn the floor back over to Mr. Batrack for closing comments.

Speaker 1

Well, thank you very much, Donna, for turning it back and for moderating the questions. Great questions. I hope to have not only good performance in the coming quarters as we did here, but I hope to have individual high points that exceed everything else. So we really do have something that is an outlier that would be even as something to highlight and spend even more time on. I know we're getting close to the end of our fiscal year.

Speaker 1

I know that our fiscal year 2024 is For us, we're in a U. S. Federal calendar, starts on October 1st. So it's only about 6 weeks away, 7 weeks away. I'm really looking forward to a Strong finish to this year and I'm really looking forward to providing our guidance for 2024.

Speaker 1

I think it will 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 1 in the same, but I think the performance of the I guess I'll call it underlying our legacy company has been so strong and I want to track the contributions of RPS. We've provided that detail. But I will tell you within the company, We are one company.

Speaker 1

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

Speaker 1

Bye.

Operator

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

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