Earnings Call Transcript - TTEK Q4 2022

Operator, Operator

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 Investors 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 Investors section of Tetra Tech's website. At this time, I’d like to inform you that all participants are in a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. With that, I would like to turn the call over to Dan Batrack. Please go ahead, Mr. Batrack.

Dan Batrack, CEO

Thank you very much, Melissa. And good morning and welcome to our fourth quarter and fiscal year 2022 earnings conference call. I'd like to start this morning by saying that we had an excellent fourth quarter that completed an exceptionally strong 2022 fiscal year. Our performance was a direct result of our Leading with Science approach focused on water, environment and sustainable infrastructure. We completed the year with strong growth across all of our client sectors and generated record orders for fiscal year 2022 that resulted in an all-time high backlog of $3.740 billion. We saw strong demand for our services in alignment with climate change priorities across both our government and commercial clients. I'll begin this morning with an overview of our fiscal year and fourth quarter, followed by a financial update from our Chief Financial Officer, Steve Burdick. I'm also pleased to include today, Tetra Tech's President, Jill Hudkins, who will join me in providing the market outlook. After providing our guidance, I'll also provide some initial comments on the pending RPS Group acquisition. We had an exceptional fourth quarter and finish to our full fiscal year. If you're following on the webcast, you can see that both the fourth quarter and the entire fiscal year of 2022, the company achieved all-time record highs for the key metrics that we track. In what was a record year, we also ended the year with the strongest revenue quarter, which was the highest of any quarter in Tetra Tech's history, providing us with significant momentum as we enter fiscal year 2023. Most notably in the quarter with the record revenue, we also had record new orders of $1.3 billion, which resulted in a book-to-bill of 1.4 for the quarter and ended with an all-time high backlog of $3.74 billion. I'd now like to present the results of our fourth quarter. We hit new all-time highs across the board. Net revenue increased to an all-time high for any quarter of $736 million, up 12% from last year; a record Q4 operating income of $94 million generated earnings per share of $1.26, up 30% from last year. This represents the highest quarterly earnings per share for any quarter in the company's history. I'd now like to provide an overview of our performance by our end customer. In the fourth quarter, revenue for all of our client sectors increased compared to last year. Work for our U.S. federal clients was 29% of our revenue in the quarter and was up 15% from the same quarter last year. Growth was driven by an increase in priority water, environmental and international development programs for our key government clients. We saw continued strength in our state and local revenues, which were up organically 12% from the fourth quarter of last year, excluding extraordinary contributions from our disaster response work in fiscal year 2021. Our U.S. commercial net revenue was a quarter of our overall business, up 25% from last year. Our high-performance buildings and renewable energy services both contributed to our significant growth in this sector. Finally, our international revenues were up 15% on a constant currency basis from last year with an expansion in our sustainable infrastructure programs in Australia, the United Kingdom and across Canada. I'd now like to present our performance by our segments. In the fourth quarter, the Government Services Group, or our GSG segment, was up 8% compared to last year to revenue of $336 million. GSG generated a strong 15.1% margin in the quarter, which was up 130 basis points from last year. Performance was driven by our high-end data analytics and design services for our federal water and environmental programs, augmented by our digital water work across the United States. The Commercial/International Group, or CIG, grew by 15% year-over-year and delivered a 13.6% margin, up 80 basis points from last year. CIG's fourth quarter results were driven by growth in our international operations as well as strength in the United States-based sustainable infrastructure and renewable energy markets. Our backlog was up 8% from last year. On a constant currency basis, it was up 13%, resulting in a new all-time high of $3.74 billion. This is work that we have contracted, funded, and authorized and is only a small part of our overall contract capacity that we have. In the fourth quarter, we won new programs and task orders for differentiated water, environment and renewable energy services while adding over $1 billion of additional contract capacity just in the fourth quarter. We won new programs for key U.S. federal agencies, including the Department of Energy, the U.S. Environmental Protection Agency, USAID, the Army Corps of Engineers and others, that advance the government's priorities in water, environment and resilient infrastructure, including climate change and mitigation programs. In the fourth quarter, we also had strong commercial orders of over $400 million to provide renewable energy, environmental restoration and sustainable infrastructure services. At this point, I'd like to turn the presentation over to Steve Burdick, our Chief Financial Officer, who will provide more details of our financials both in the quarter and the year. Steve?

Steven Burdick, CFO

Thank you, Dan. So as Dan had just reviewed the fourth quarter operating results, I would like to now review the GAAP financial results for the fiscal year ending 2022. Overall, we had record revenue, earnings and cash flow. The strong performance from our operations was marked by record fiscal year revenue of $3.5 billion, which was up 9% over last year, and record net revenue amounting to $2.84 billion, which was up 11% over last year. When adjusting for our 52, 53 week fiscal year, revenue was up 11% and net revenue was up 13% over last year. We experienced strong revenue growth from all of our end markets, including international, commercial, state and local, and federal government. Our operating income and earnings per share for the fiscal year were both at all-time highs. Our reported operating income came in at $340 million, up 22% over last year. This improvement came from both segments. About two-thirds of this increase was driven by our 28% growth in the CIG segment net revenue and the continued improvement of CIG's operating margin, which was up 110 basis points over last year. About a third of this increase in operating income came out of GSG, where the margins were up 70 basis points over last year. On a consolidated basis, these improvements resulted in our EBITDA margin increasing 100 basis points over last year. GAAP EPS came in at $4.86, an increase of 14% over last year. For those who want to take a look at the reconciliation in the appendix to this presentation, we did have a one-time employee tax credit and a significant foreign exchange hedge gain this year. Excluding these two matters, our EPS came in at an all-time record high of $4.50 for the year, which represented an increase of 21% compared to the adjusted EPS last year. Cash flows generated from operations for fiscal 2022 totaled $336 million, an increase of 10% over last year. Our focus on working capital and cash flows has resulted in further improvement in our DSO to 61 days, an improvement of over two days from last year. Over the last four years, we've improved the DSO each year, bringing it down from over 80 days to an industry-leading best in the low 60s. This lower DSO trend continues to reflect 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. Our net debt amounts to $74 million, and this net debt on an EBITDA basis was at a leverage of 0.2 times, with a total cash position of about $185 million. As we presented here today, the continued high-quality operating and financial results with improved EBITDA margins, strong cash flows and lower working capital requirements have shown that Tetra Tech continues to generate very strong returns, with a calculated return on invested capital of over 20% in the fourth quarter. Our long-term capital allocation strategy aims to provide these strong returns through a balance of investing in the growth of our business, managing the balance sheet, and providing returns to our shareholders. In fiscal 2022, cash generated from operations totaled $336 million. Our strong cash flow has allowed us to successfully complete four strategically important acquisitions this year in digital water, data analytics, and sustainability. We continue to provide significant returns for our shareholders through dividends and share buybacks. Regarding our dividend program, we paid out $46 million in dividends in fiscal 2022. I want to announce that our Board of Directors approved our 34th consecutive dividend of $0.23 per share for this quarter, a 15% increase over last year. On an annualized basis, this represents a $0.92 per share run rate. This year, we utilized $200 million on our stock buyback program. All told, we returned $246 million to our shareholders through these dividends and share buybacks. These continuing strategic investments, our capital allocations to shareholders, and Tetra Tech's stock price increase all resulted in a total shareholder return, or TSR, over the last trailing three years of 54%, almost three times higher than the key benchmark of the S&P 1000, which had a return of 19% over the same period. I am pleased to share these results of our fiscal 2022. I want to thank you for your support, and I will hand the call back over to Dan.

Dan Batrack, CEO

Thank you very much, Steve. I'd now like to spend a few minutes discussing our outlook and the major market drivers that we see today that will drive our business as we move into 2023. I'm sure many of you have been watching the results of the midterm elections here in the United States. Regardless of the final outcome, we expect the Biden administration to continue to prioritize the U.S. Federal Government Agencies focus on infrastructure, resiliency, and decarbonization. With current funding commitments and our strong backlog entering 2023, we see a favorable outlook for our U.S. federal work. In the United States, a sequence of three major legislative actions have set the stage for future spending increases. These three funding streams augment an already strong focus by our clients on areas where Tetra Tech's strengths are aligned: water, environment, and renewable energy services. Just this past October, we appointed Jill Hudkins as President of Tetra Tech. She brings over 24 years of expertise in high-end water treatment programs, expanding our digital water practices here at Tetra Tech and the overall leadership of our global water initiatives. Jill is ideally suited to provide an update on the recent legislative programs and how we here at Tetra Tech are prepared to help our clients navigate the various funding streams. I'd now like to turn the presentation over to Jill Hudkins.

Jill Hudkins, President

Thank you, Dan. I want to address the three key legislative actions that were passed in the last year. First, the $1.2 trillion Infrastructure Investment and Jobs Act, the IIJA, provides unprecedented levels of infrastructure funding, with a combination of commitments from existing appropriations and $550 billion in new funding over the next decade. Almost a full year after the act was signed into law, we are just starting to see an increase in client solicitations for projects that will benefit from federal infrastructure funding associated with the IIJA. This funding is well distributed across our markets of water, environment, sustainable infrastructure, and renewable energy—markets where Tetra Tech is a leader. We expect to see new orders with IIJA funding to begin ramping up in the second half of fiscal year '23. The second major legislative action is a $280 billion CHIPS Act, which represents an additional $53 billion investment focused on revitalizing domestic semiconductor manufacturing. The CHIPS Act was passed with significant bipartisan support and will fund the expansion and development of semiconductor facilities in the U.S. Tetra Tech is well-positioned to provide high-end, sustainable infrastructure design services for U.S.-based chip manufacturers. The CHIPS Act's funding priorities are directly aligned with our current operations. For example, Tetra Tech provides high-end design for specialized mechanical, electrical, and hydraulic systems for high-performance manufacturing facilities. We also design high-end facilities for advanced water treatment and water recycling, which is critical for chip manufacturing. Additionally, the official name of the CHIPS Act is the CHIPS and Science Act. The science component represents another $200 billion in scientific R&D funding that will flow to the federal agencies we work with and aligns with Tetra Tech's Leading with Science approach. The most recent legislative action, the Inflation Reduction Act (IRA), was signed into law on August 16, 2022. The IRA includes a $369 billion investment in energy security and climate change over the next decade. The climate change investment is beginning to be implemented through various tax incentives, loans, and agency funding. The IRA commitments support progress towards the U.S. 2030 energy and carbon-reduction goals and provides critical infrastructure funding to protect our nation's assets from climate change impacts. Over the last decade, Tetra Tech has provided high-end siting and permitting consulting for more than 1,000 utility-scale hydro, wind, and solar projects. We hold top 10 rankings with Engineering News Record for hydropower, wind power, and solar power. Tetra Tech has also designed first-of-their-kind flood protection solutions, such as the Mississippi River surge barrier that protects New Orleans from hurricanes. Now I'd like to turn the presentation back to Dan.

Dan Batrack, CEO

Great. Thank you very much, Jill. I'd now like to present our outlook for fiscal year 2023 across each of our four end-client sectors. For U.S. federal government, our U.S. federal revenue should grow at about 10% in alignment with the administration's priorities and increased budgets. However, we assume that the material increases associated with the IIJA and other new legislative items that Jill discussed will build slowly throughout the year. In fact, in late 2023, we expect them to begin contributing, so we haven't anticipated a material contribution from these funding sources into the guidance I'll be providing today. State and local revenues are expected to continue to grow at a double-digit pace for us, with non-episodic revenues projected to grow between 10% and 15% for the year. U.S. commercial work is expected to make up about 20% of our overall business, growing at a rate of 5% to 10%. This increase will be supported by our renewable energy consulting and engineering practices as well as environmental compliance and restoration services. For international work, we expect it to account for about one-third of our business, evenly split between government and commercial work, with expected growth of 5% to 10% as we increase our support for sustainable infrastructure and climate change services in the key geographies of the United Kingdom, Australia, and Canada. Now I'll present our guidance for the first quarter and for all of fiscal year 2023. Our guidance is as follows: For the first quarter, our net revenue guidance is a range of $675 million to $725 million, with associated earnings per share of $1.15 to $1.20. For the entire fiscal year of 2023, our net revenue guidance is $2.9 billion to $3.1 billion, with associated earnings per share of $4.70 to $4.90. This guidance does include an estimated intangible amortization of over $10 million for the year, or a $0.14 charge during the year. It assumes a tax rate of 23% for the first quarter and 26% for the remainder of the year for Q2, Q3, and Q4. It assumes an average diluted share count of 54 million and excludes contributions from future acquisitions. With respect to acquisitions, just six weeks ago we announced an offer to acquire the RPS Group, a publicly traded company based in the United Kingdom. Although the transaction is not completed yet and is not included in our guidance, I'd like to provide some preliminary background on RPS Group and our rationale for this combination. RPS Group, similar to Tetra Tech, is a high-end global consultancy. They have over 5,000 staff with operations primarily in the United Kingdom, Europe, Australia, and the United States. We have worked with the RPS Group for many years, and we know the company well; we believe that culturally, they align very closely with Tetra Tech. The strategic rationale for the combination is strong due to highly complementary clients, expertise, and geography—there is very little overlap. RPS brings us a robust water practice in the United Kingdom with long-term relationships and multiyear contract vehicles with major water utilities across the United Kingdom. Their environmental services complement ours for restoration, investigation, and environmental data management programs. RPS Group expands our client base while also adding new geographies such as Norway and the Netherlands, increasing resources we can dedicate to our programs in the United Kingdom, the Republic of Ireland, Australia, and the U.S. They bring a high-end global practice in renewable energy, especially in offshore wind, which complements our first-in-class practice in the U.S. Furthermore, RPS brings new software solutions for chemical spill modeling and real-time oceanographic analysis systems, expanding Tetra Tech's Delta suite of technologies we can offer our clients globally. In summary, we had an excellent fourth quarter and a strong fiscal year 2022, setting new records across the board for Tetra Tech's performance. As we enter fiscal year 2023, we see strong demand for our differentiated Leading with Science approach for water, environmental, and sustainable infrastructure programs. Our all-time high backlog of $3.74 billion and $25 billion in U.S. federal contract capacity provides us with excellent momentum for future opportunities and positioning as we enter the fiscal year. At this point, I'd like to open the call up for questions.

Operator, Operator

Thank you. The question-and-answer session will begin now. Our first question comes from Sean Eastman with KeyBanc Capital Markets. Please proceed with your question.

Sean Eastman, Analyst

Hi, everyone. Thanks for taking my question, and congrats on a strong finish. I thought the comment about no material contribution from the IIJA funding being contemplated in the fiscal '23 guidance was interesting. This notion that the ramp will be slow in fiscal '23 and not come until the back half, why is that? I wanted to parse out some conservatism versus the mechanics of what's happening around the legislation.

Dan Batrack, CEO

Well, Sean. Good morning. It's a really good question. We've been following this obviously since it was enacted. We find, as a U.S. federal contractor for many decades, that there are indicators in a sequence by which funding flows to actually hit the marketplace. The first items we see are procurements and solicitations for contract capacity. Long before revenues are recognized by Tetra Tech, the initial steps are solicitations for contracts and increased contract capacity. In fact, we’re beginning to see more contracts come out with larger IDIQ ceilings to facilitate and execute numerous projects. I mentioned in my prepared remarks that over $1 billion of new contract capacity was added mainly with the U.S. federal government in just the fourth quarter. That's the first step—contract solicitations that come out and contract awards. Many of them are just initiating now, which may take one to two quarters, likely through Q1 and into Q2. You'll see it show up in our orders. While we had a fantastic $1.3 billion quarter of orders in Q4, essentially none of that is associated with IIJA funding; it came from federal budget work and other clientele. We expect the new contract capacity being put in place now through the next quarter to then begin translating into contract awards, which will show up in backlog late Q2 or Q3, and we're seeing indications for that on the contract capacity of the vehicles being put in place. Once it’s seen in our backlog, you’ll begin to see orders come through that will reflect in our revenue. We've just not seen things move considerably faster than expected at this time. The good news is confidence levels begin to increase as you see contract capacity put in place, which will ultimately translate into orders, and then to revenue. That’s our experience in the marketplace.

Sean Eastman, Analyst

Okay. Very interesting. Thank you for that, Dan. The second one for me is on the RPS acquisition. You guys have a mid to high teens accretive to fiscal '24 EPS essentially as a placeholder out there now. I was hoping you could discuss what that contemplates in terms of RPS margin enhancement relative to Tetra Tech's potential, and how that margin enhancement playbook contrasts with what you accomplished with other acquisitions like WYG and Coffey.

Dan Batrack, CEO

I'll address that by starting with our experiences with the Coffey and WYG acquisitions. Both of those entities came with lower margins. Our goal was to move them to higher-end professional services to bid at margins more in line with Tetra Tech. It took about two years to transition them from margins in the low single digits to double digits. I'm pleased to announce that the guidance includes work in the U.K. that WYG now leads, and it’s at margins similar to Tetra Tech overall—about 13%. With respect to RPS, their historical margins have been higher than Tetra Tech's. I believe that, by the end of our fiscal year 2023, their margins will reach roughly 10%, approaching what Tetra Tech targets. Within two years, I expect them to match our margins. Communication with their operations indicates strong alignment in our goals. This acquisition is mutually beneficial with complementary clients, expertise, and geography. It is more of a partnership than an acquisition; together, we will achieve more than either could alone. It’s a very exciting opportunity.

Sean Eastman, Analyst

Thanks very much, Dan. I’ll turn it over there.

Operator, Operator

Thank you. Our next question comes from the line of Tate Sullivan with Maxim Group. Please proceed with your question.

Tate Sullivan, Analyst

Hi. Thank you. Following up on the RPS commentary, you mentioned in the slide deck annual revenue of $700 million for the RPS Group. I'm wondering if that's their current run rate or if it's what you're projecting for fiscal year '23. I think just in their first half, they increased revenue about 15% year-over-year. Are you assuming that similar level of growth for RPS?

Dan Batrack, CEO

That revenue figure is based on their current run rate; I know they reported a mid-quarterly update recently. So this is derived from their financials and forecast. When we were putting together our offer late summer, the exchange rate was slightly different, and our internal numbers had it at $800 million. The current exchange rate has influenced it down to $700 million. So it reflects their current run rate and forecast.

Tate Sullivan, Analyst

Great. Thank you. And at the end of your commentary, Dan, you mentioned the total amount of future contract capacity you have. What was that number?

Dan Batrack, CEO

Tetra Tech's current U.S. federal government contract capacity is approximately $25 billion.

Tate Sullivan, Analyst

And that's just the U.S., but does the list on Page seven include U.S. contract ceilings versus funded values? Is that a similar dynamic in the U.K. and Australia since you will be increasing your exposure there?

Dan Batrack, CEO

That’s a good question. We have strong clients and funding contributions from Australia and the U.K., and I should include Canada. National governments in Australia and Canada don’t provide these ceilings; often they’re open-ended. In the U.K., we have several billion under framework ceilings, which doesn’t include water utilities or frameworks that RPS will bring. It’s typically smaller or undefined in Commonwealth countries, which is why we’re specific with U.S. federal contract capacity.

Tate Sullivan, Analyst

Thank you, Dan.

Operator, Operator

Thank you. Our next question comes from the line of Andy Wittmann with Baird. Please proceed with your question.

Andrew Wittmann, Analyst

Great. Good morning and thank you for taking my questions. I also had some questions on RPS, and I wanted to ask if you see RPS as a platform or launch point for more bolt-on acquisitions internationally to continue building out your operations. Is that part of the strategic rationale for the longer term?

Dan Batrack, CEO

It’s a good question. With RPS's operations, plus our existing ones in Australia and the U.K., we’ll have a solid groundwork for additional acquisitions or enhancements to technical expertise. This acquisition gives us our first foothold into Continental Europe with RPS's presence in Norway and the Netherlands, two countries with significant infrastructure priorities and funding. RPS will greatly accelerate our strategic plan in the U.K. and Australia, likely by three to five years. We’ve moved from being purely U.S.-based to about a third of our revenue from international work; this acquisition will enhance our international presence and allow us to bring expertise to clients globally.

Andrew Wittmann, Analyst

Thanks for the context. For my follow-up question, I wanted to inquire about implicit margins in your guidance. I’m seeing EBITDA margins around 13% at the midpoint. What’s driving the expected 30 basis points of margin improvement year-over-year? Is this a pickup in mix or expected utilization?

Dan Batrack, CEO

It's primarily mix; there’s no increase in utilization anticipated. The increase in margins we have at the midpoint for 2023 is based on high-end work with respect to data analytics, digital water, and other higher-margin services in demand. Increased utilization driven by natural disasters or higher flow revenues would also lift margins in future quarters beyond what we provided in our guidance today.

Andrew Wittmann, Analyst

Great. Thank you very much. Have a good day.

Dan Batrack, CEO

Thanks very much, Andy.

Operator, Operator

Thank you. Our next question comes from the line of Michael Dudas with Vertical Research Partners. Please proceed with your question.

Michael Dudas, Analyst

Good morning, gentlemen, and Jill. Congratulations, Jill.

Jill Hudkins, President

Thank you.

Michael Dudas, Analyst

My first question is for Jill. As Dan talked about some of the lag in timing on IIJA, can you discuss IRA and CHIPS regarding how that might flow through, and which areas of the business will see that momentum sooner?

Jill Hudkins, President

Regarding IRA and CHIPS Act, we already see momentum behind CHIPS as U.S. chip manufacturers start new projects, allocating funding. We see that happening around the end of fiscal year '23 based on current solicitations. IRA will likely have the longest lag, so we expect contributions in fiscal year '24. The IRA had less bipartisan support, but many funding benefits target congressional districts of both parties, which helps its stability despite midterm election outcomes.

Michael Dudas, Analyst

I appreciate that. Dan, could you discuss midterm defense allocation budgets and the opportunities, especially where you’re strong?

Dan Batrack, CEO

In previous elections, we’ve encountered noise regarding defense budgets, but we’ve adapted. A split strategy often results in stable visibility, with both parties extending current budgets without major shifts. We’re seeing funding commitments at the federal level, which is favorable for us. Even if congressional control shifts, increased visibility and commitments at the federal level benefit us.

Michael Dudas, Analyst

Thank you. My follow-up question regarding RPS's potential financial profile and capital allocation post-closing; how are you thinking about that?

Dan Batrack, CEO

At a high level, our target leverage is between one to two times our earnings; historically, we’ve been close to zero leverage. After RPS, we’ll be looking to deleverage quickly as our $336 million cash flow would allow us to reduce debt significantly. Priorities remain internal growth first, followed by dividends, acquisitions, and lastly buybacks. We’re still active in the market, seeking opportunities that fit our strategic plans.

Michael Dudas, Analyst

Thank you, Jill and Dan.

Dan Batrack, CEO

Great. Thank you for joining today, everyone. We’re excited to keep you updated on the RPS process and our continued growth strategy. I look forward to speaking with you again next quarter and wish you a great day.

Operator, Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.