Tetra Tech Inc

NASDAQ:TTEK

Earnings Call Transcript 2022-Q4

[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, Chairman and Chief Executive Officer]

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 on focus with 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 our 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 and 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 in earnings per share of $1.26 or 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 that we performed 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 our renewable energy services both contributed to our significant growth in this sector. And 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 all 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.

For backlog, well, our backlog was up 8% from last year. And on a constant currency basis, it was up 13%, resulting in a new all-time high. As I've mentioned a few times now, up to $3.74 billion. But to be clear, that is work that we have that is 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 initiatives 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 in the year. Steve?

[Steven Burdick, Chief Financial Officer]

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. And when adjusting for our 52, 53 week fiscal year, revenue was up actually 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 also both up to 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 continuing improvement of CIG's operating margin, which was up 110 basis points over last year. And about a third of this increase in operating income came out of GSG, where the margins are up 70 basis points over last year. And 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. And for those that want to take a look at the reconciliation in the appendix to this presentation, we did have a onetime employee tax credit and a significant foreign exchange hedge gain this year. And excluding these two matters, our EPS came in at an all-time record high of $4.50 for the year, which was an increase of 21% compared to the adjusted EPS last year.

Now, 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 improving our DSO to 61 days, and this is an improvement of over two days from last year. But just as important as the year-over-year improvement is our long-term focus. And over the last four years, we've improved the DSO each year and brought 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 has shown that Tetra Tech continues to generate very strong returns with a calculated return on invested capital of over 20% in the fourth quarter.

Now our long-term capital allocation strategy to continue providing these strong returns calls for a balance of investing in the growth of our business, managing the balance sheet and providing returns to our shareholders. And in fiscal 2022, cash -- as I noted before, cash from operations generated $336 million. Our strong cash flow has allowed us to successfully complete four strategically important acquisitions this year in the areas of digital water, data analytics and sustainability. And 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. And I want to announce that our Board of Directors approved our 34th consecutive dividend of $0.23 per share for this quarter, which is a 15% increase over last year. And on an annualized basis, this represents a $0.92 per share run rate.

Furthermore, this year, we utilized $200 million on our stock buyback program. And 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 the Tetra Tech's stock price increase, all resulted in a total shareholder return, or TSR, over the last trailing 3 years of 54%, which is almost 3 three higher than a key benchmark of S&P 1000, which had a return of 19% over the same time period.

So I am very 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, Chairman and Chief Executive Officer]

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's going to drive our business as we move into 2023.

Now I'm sure many of you, if not all 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 that Tetra Tech's strengths are aligned with in water, environment and renewable energy services.

Now just this past October, just about a month ago, we appointed Jill Hudkins to President of Tetra Tech. She brings to the role over 24 years of expertise in high-end water treatment programs, expansion of digital water practices here at Tetra Tech and the overall leadership of our global water initiatives. Jill is ideally suited to providing 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.

And at this point, I'd now like to turn the presentation over to Jill Hudkins.

[Jill Hudkins, President]

Thank you, Dan. I now 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 truly 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 plus-ups from the federal infrastructure funding associated with the IIJA. The IIJA funding is well distributed across our markets of water, environment, sustainable infrastructure and renewable energy. These are the markets where Tetra Tech is a market leader. We expect to see new orders with IIJA funding to begin to ramp 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 has a strong competitive position for providing high-end, sustainable infrastructure design services for U.S.-based chip manufacturers, and the CHIPS Act's funding priorities are directly aligned with what we do across North America today. For example, Tetra Tech provides high-end design of specialized mechanical, electrical and hydraulic systems for high-performance manufacturing facilities. We also design high-end facilities for advanced water treatment and water recycling. And you don't have chip manufacturing without ultrapure water supplies and sustainable water management.

I will also note that the official name of the CHIPS Act is the CHIPS and Science Act. The science component of the act potentially represents another $200 billion in scientific R&D funding that will flow to the federal agencies that we work for and is aligned with Tetra Tech's Leading with Science position.

And the most recent legislative action, the Inflation Reduction Act, or 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 10 years. The Inflation Reduction Act climate change investment is just beginning to be implemented through a variety of tax incentives, loans and agency funding. The IRA commitments advance progress towards the U.S. 2030 energy and carbon-reduction goals. The IRA also includes funding for critical infrastructure to protect our nation's assets from impacts of climate change.

In 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. In fact, we hold top 10 rankings with engineering news record for hydropower, wind power and solar power. Also, Tetra Tech designed first-of-their-kind flood protection solutions, such as the Mississippi River surge barrier that protects the people of New Orleans, Louisiana from hurricanes. Our design was for the largest civil works design-build project in the Army Corps of Engineers history.

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

[Dan Batrack, Chairman and Chief Executive Officer]

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. We assume, however, that the material increases associated with the IIJA and the other new legislative items that Jill just discussed are going to build pretty slowly throughout the year. In fact, in late 2023, we expect them to begin contributing, and therefore, we've not anticipated a material contribution from these funding sources into the guidance that we'll be providing today.

State and local should continue to grow at a double-digit pace for us. Our state and local non-episodic revenues will grow at a rate between 10% and 15% for the year. U.S. commercial is expected to be about 20% of our overall business and grow at a 5% to 10% rate. This increase in revenues will be supported by our renewable energy consulting and engineering practice as well as environmental compliance and restoration services.

International. International work is expected to be about one-third of our business, evenly split between government and commercial work. Our international work is expected to grow at a 5% to 10% rate as we increase our support for sustainable infrastructure and climate change services in the key geographies of the United Kingdom, Australia and Canada.

I'd now like to preside -- to 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 for a range of $675 million to $725 million with an associated earnings per share of $1.15 to $1.20. For the entire fiscal year of 2023, our net revenue guidance is for $2.9 billion to $3.1 billion with an associated earnings per share of $4.70 to $4.90.

There are some assumptions that this guidance is based on. This guidance does include an estimated intangible amortization over $10 million for the year or converted to earnings per share, $0.14 charge during the year. It does assume for this first quarter and for the guidance I just provided that we will have a tax rate of 23% with a 26% for the remainder of the year. That will be for our Q2, 3 and our fourth quarter. Does assume we have 54 million average diluted shares outstanding, and it does exclude any 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. And although the transaction is not completed yet and is not included in our guidance, I'd like to provide you with some preliminary background on the RPS Group and our rationale for the combination with Tetra Tech.

The RPS Group, very much like Tetra Tech, is a high-end global consultancy. RPS has over 5,000 staff with operations primarily in the United Kingdom, Europe, Australia and here in the United States. We have worked with the RPS Group for many years now, and we know the company extremely well and believe that culturally, the RPS Group is very similar to Tetra Tech.

The strategic rationale for the combination of Tetra Tech and the RPS Group is actually very, very strong with highly complementary clients, expertise and geography. We have very little or no overlap. The RPS Group brings us a strong water practice in the United Kingdom with long-term relationships and multiyear contract vehicles with the major water utilities all throughout the United Kingdom.

Our environmental services are also highly complementary for restoration, investigation and environmental data management programs. The RPS Group expands our client base also while adding new geographies, such as Norway and the Netherlands, while increasing the resources that we can put on our programs in the United Kingdom, the Republic of Ireland, Australia and here in the United States.

The RPS Group brings a high-end global practice in renewable energy, especially in offshore wind, that is highly complementary to our first-in-class practice that we have here in the United States. And finally, the RPS Group brings new software solutions for chemical spill and fate and transport modeling and real-time oceanographic analysis systems, which further expands Tetra Tech's Delta suite of technologies that we can offer our clients all throughout the world.

In summary, we had an excellent fourth quarter in all of fiscal year 2022, setting new records across the board for Tetra Tech's performance. As we enter fiscal year 2023, we see a 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 both an excellent momentum for future opportunities and excellent positioning as we enter into the fiscal year.

And at this point, Melissa, I'd like to open the call up for questions.

[Operator]

Thank you. The question-and-answer session will begin now [Operator Instructions] Our first question comes from the line of Sean Eastman with KeyBanc Capital Markets. Please proceed with your question.

[Sean Eastman, KeyBanc]

Hi, everyone. Thanks for taking my 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 to be interesting. This notion that the ramp will be slow in fiscal '23 and not come until the back half, why is that? I just wanted to try to parse out maybe some conservatism versus the mechanics of what's happening around the legislation.

[Dan Batrack, Chairman and Chief Executive Officer]

Well, Sean. Good morning. And it's a really good question. We've been following this obviously since it was enacted. And we find, as having been a U.S. federal contractor for many decades, that there is indicators in a sequence by which funding flows to actually hitting the marketplace.

So the first items we see are procurements and solicitations for contract capacity. So long before revenues actually are recognized by Tetra Tech, the very first series of sort of three steps are -- the first step is we actually see solicitations for contracts and increased contract capacity. And in fact, that's what we're beginning to see now.

We've actually seen more contracts come out with larger IDIQ ceilings, which actually would be used to facilitate and execute lots of projects. And they're just seeing the solicitations pick up. And in fact, I mentioned in my prepared remarks, over $1 billion of new contract capacity was added, largely with the U.S. federal government here just in the fourth quarter. So that's the first step. So the contract solicitations that come out and contract awards typically are the first step, and many of them are just initiating now.

So you'll go through the solicitation process and be awarded the contract. It may take one to two quarters, which would take us through Q1 and into Q2. Then you would see it actually show up in our orders. And while we had a fantastic $1.3 billion quarter of orders in Q4, essentially none of that is associated with IIJA funding that came out of those contracts. This was for other work out of the federal budget and other clientele.

So we would expect the new contract capacity being put in place now and through the next quarter roughly, quarter to 1.5 quarters, to then begin translating into contract awards, and then you'll see it in our backlog. Once it shows up on our backlog, which would be late Q2 or Q3 and we are seeing the indications of that, again, on the contract capacity of the vehicles being put in place, you'll then begin to see orders. You'll see it show up in our quarterly reports with respect to backlog growth.

And then the third step is you'll actually see it in revenue. So one is contracts, contract ceiling solicitations; two is actually into backlog as orders; and three, then convert it to revenues. And if we look at the timing, we've just not seen things move materially faster than what we're seeing at this time. But the good news is the confidence level begins to increase as you see contract capacity put in place, and then you'll see it convert to orders. So that is our experience in the marketplace and what we're seeing from our interactions with our clients at this time.

[Sean Eastman, KeyBanc]

Okay. Very interesting. Thank for that, Dan. And 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 kind of a placeholder out there right now. I was hoping you could talk through what that contemplates in terms of RPS margin enhancement relative to what Tetra Tech thinks the ultimate potential could be and perhaps how that margin enhancement playbook around the RPS acquisition compares or contrasts with what you guys accomplished around other acquisitions like WIG and Coffey.

[Dan Batrack, Chairman and Chief Executive Officer]

Well, I'll address that, starting with the -- our experience in the two previous acquisitions with Coffey in Australia primarily; and WYG, White Young Green, in the U.K. Both of those two excellent entities that were highly aligned with Tetra Tech did come with lower margins. The goal was to move them to higher-end professional services focus to actually begin bidding them and margins that were more in line with Tetra Tech.

Both of those took about two years to move from the margins that they had coming into Tetra Tech, which were really in the low single digits, 1%, 2%. Our goal was to move them to double digits or 10% roughly within one year, which we were successful in. And then in the second year, move them up to margins similar to that in Tetra Tech. There was a little delay in WYG because of something called the COVID pandemic. So it did push us back about 6 months, but that was all it pushed us back.

And in fact, I'm pleased to announce that the inclusion in our guidance that includes work in the United Kingdom that WYG is the principal lead on are at margins similar to that in Tetra Tech overall. And just to be clear, what that is, that's about 13%.

Now with respect to RPS, historically, if you go back in years, their margins historically have actually been higher than Tetra Tech. In fact, that operation has performed in the upper teens in the past, higher than even what Tetra Tech is currently targeting. We do think that in the first year, and I will say by the end of Tetra Tech's fiscal year 2023, which you could say we're -- we'll soon be getting to the end of our first quarter here in another month or two. So to leave about nine months left, I think we'll go from their current margins up to roughly 10% or double digit.

And I think within the second year in 2024, they'll be performing in margins very similar to Tetra Tech. And all the communications I've had with their operations, their back office, their leadership, I think that we have that very much an alignment of where we're going, how we're going to get there. And if you want to say, how does it align with the playbook of Coffey and WYG, I'd say, quite similarly.

And again, I'll repeat one comment I've made during the prepared remarks, we have very little overlap with them. It's complementary new clientele, new geography, new services, and this is really 1 plus 1, is something much greater than either RPS has on its own or Tetra Tech. And they're not joining us as an acquisition, not at all. They're joining us as an equal partner that are going to help Tetra Tech become better than either one of us are today.

So I'm really looking forward to this. And I know that my enthusiasm is eclipsed by that of the people working at Tetra Tech. So that's our playbook and timing, Sean.

[Sean Eastman, KeyBanc]

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

[Operator]

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

[Tate Sullivan, Maxim Group]

Hi. Thank you. Following up on the RPS commentary, you have in the slide deck annual revenue of $700 million for RPS Group. I'm wondering if that's their current run rate or how -- or if that's what you're projecting for fiscal year '23, please. 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, Chairman and Chief Executive Officer]

That's based on their current run rate, and they do have reporting. I know they reported a mid-quarterly update here just recently. So this is right off of their financials and their forecast and actually their historical numbers. In fact, one item I would make note of as we were putting together our offer here late summer, the exchange rate was a little bit different. And in fact, our internal numbers had that in the $800 million. So the exchange rate has brought it down to $700 million. So it's very much to be influenced by the exchange rate. But that's basically their current run rate and forecast that they have.

[Tate Sullivan, Maxim Group]

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

[Dan Batrack, Chairman and Chief Executive Officer]

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

[Tate Sullivan, Maxim Group]

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

[Dan Batrack, Chairman and Chief Executive Officer]

It's interesting. That's a good question. We have an equal level of strong clients and funding contributions coming from Australia and the U.K. And I got to include Canada also. But the -- but generally, the national governments, we might refer to as analogous to U.S. federal governments, quite often, at least in Australia and Canada, don't provide these types of ceilings. In many instances, they're open-ended and don't define a specific number.

We have a press release in the U.K., what they referred to as framework contracts. And we have several billions of dollars in the U.K. under the framework ceilings that have been identified. And again, I would comment that here at Tetra Tech, those do not include any of the water utilities or the different frameworks that exist that RPS will bring across. But it is typically smaller with respect to ceilings or undefined in some of these other commonwealth countries. And so that's why we're more specific with respect to U.S. federal contract capacity.

[Tate Sullivan, Maxim Group]

Thank you, Dan.

[Dan Batrack, Chairman and Chief Executive Officer]

Thank you, Tate.

[Operator]

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

[Andrew Wittmann, Baird]

Great. Good morning and thank you for taking my questions. I guess I also had some questions on RPS. And I guess I just wanted to start, Dan, strategically, I think the end market mix and I think you've had aspirations to grow internationally for some time. So I think nothing strategically from that way is surprising. But I'm just wondering if you see RPS as maybe -- I guess maybe a platform or a launch point by which you could do more bolt-on acquisitions internationally to continue to build this out. Is that part of the strategic rationale as you see in the longer term? Obviously, recognizing you haven't closed on the deal yet, but I'm just trying to understand the thought process on that. Thanks.

[Dan Batrack, Chairman and Chief Executive Officer]

It's a really good question and good observation, Andy. Yes, I think that with the existing operations we have, plus RPS in the geographies of specifically Australia and U.K., it will give us a first-in-class and both in scale in both of those geographies to allow additional bolt-ons or we refer to tuck-ins to actually enhance technical expertise in certain areas.

But it also is our first foothold, I would say, into Continental Europe with the presence in Norway and in the Netherlands. We had an opportunity to select a few countries that we would want our first initial presence in, in the Nordics, no doubt it would be Norway. Fantastic economy, great contributions and priorities to infrastructure and great funding sources through the different wealth generation that's being generated in that country.

And of course, if we're going into not just the Nordics but into Continental Europe, Netherlands, of course, has a high priority on water programs, flood control, watershed, water treatment, water supply, many areas that we've had huge investments here in the U.S. And I know flood control. Some of it has gone from Norway to the U.S. But on water supply and water treatment, it's coming from the U.S. to the Netherlands. And we think that is best-in-class. This will be a great platform for us to move in that direction.

I also think I'll make a comment, Andy, that, yes, I've been very much interested since the beginning of my tenure in this role. Tetra Tech was a 100% U.S.-based-only firm. We didn't have a single office, we didn't have a single staff on a dedicated basis outside the U.S. other than specific project assignments. And I'm pleased to state that Tetra Tech today has about third of its revenue outside the U.S., primarily Canada, U.S. and the United Kingdom. And I see that growing even more to bring the expertise that we have to the international clients and vice versa.

I do think that this acquisition will accelerate our strategic plan in the United Kingdom and Australia by probably three to five years. The AMP cycles with water clients in the United Kingdom, they're moving from AMP7 to AMP8, if you're a techie in that business, which is the big cycle. And so, those next set of major procurements for water suppliers and the water utilities don't even come out for two years. And then we would have to get to a position to compete, be a prime, and it would be very difficult to come from ground zero. And RPS brings us from a plan to actually implement it.

So for all those reasons, this is strategically exceptional. And I think the financials has been asked earlier. We stated upper teens accretion to our earnings per share, is actually quite good for our shareholders. So strategic, yes, a big move; and yes, there'll be platforms; and yes, it should allow for additional acquisitions as tuck-ins or bolt-ons as we go forward.

[Andrew Wittmann, Baird]

Thanks for the context. I guess for my follow-up question, I wanted to ask a little bit about the implicit margins in your guidance here. I'm getting something around -- EBITDA margins around 13% maybe at the midpoint. And Dan, I was just wondering if you could talk a little bit about what's driving -- what would be around, I guess, 30 basis points of margin improvement year-over-year. Is that a pickup in mix, the higher-margin stuff growing faster in other words? Or are you expecting to push on the utilization a little bit more?

I guess the nuance to all of this is that last year, you had $75 million of disaster restoration work, which is not inconsequential, typically high margin. And in your guidance, you're basically assuming none of that. So I guess you'd call that a margin headwind, yet you're still putting up around 30 basis points. And just want to see where you're contributing that growth, too, I guess. Thank you.

[Dan Batrack, Chairman and Chief Executive Officer]

It's a good comment and good observation and a great context as to what helped drive this year's margins. It's primarily mix and it's not increased utilization. So the increase in the margin that we have at the midpoint for 2023 is based on more high-end work with respect to data analytics, digital water and other higher-margin services that are in high demand.

I think that on top of this, if you see that we have outperformance from the midpoint, which would actually you would see that we are, you're right, about 13% at the midpoint. You can see this last quarter, we were up in 14%. I think higher utilization driven by either a response to natural disasters, hurricanes, fires or other items which drives utilization would drive that margin on any given quarter higher or also faster growth rates by which we would perform with our existing workforce. And you saw that in the fourth quarter with our Government Services Group margins in the 15s, so 15.1%, driven by increased utilization because of the federal work that sort of a catch-up from a slower Q2 and Q3.

So if either of those happen, increase flow of revenues, whether or not just from a disaster or other faster-growing areas, that would be incremental on top on a margin basis from what we provided in our guidance today.

[Andrew Wittmann, Baird]

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

[Dan Batrack, Chairman and Chief Executive Officer]

Thanks very much, Andy.

[Operator]

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

[Michael Dudas, Vertical Research Partners]

Good morning, gentlemen and Jill. Congratulations, Jill.

[Jill Hudkins, President]

Thank you.

[Michael Dudas, Vertical Research Partners]

My first question is for Jill. As Dan talked about some of the lag in timing on IIJA, maybe you can discuss a little more further detail since CHIPS and IRA were later implemented into legislation how that might flow through. And what areas of the business will see some of that earlier rather than catching up later in the cycle?

[Jill Hudkins, President]

Yes. So I think Dan talked through IIJA fairly well earlier, and I'll hit on your IRA and the CHIPS Act. So we already see momentum behind the CHIPS Act. And the U.S. based chip manufacturers starting new projects, that will have CHIPS Act funding. So we see that happening around the same time, the end of fiscal year '23 based on the solicitations we're seeing now.

And IRA, I believe, will have probably the longest lag of the three acts. And we'll probably start seeing contributions from that in fiscal year '24. The IRA probably is the act that had the least amount of bipartisan support, so we're still watching the impact of the midterm elections. Although there are many funding benefits that will benefit congressional districts on both sides. And so we believe the IRA will withstand any political pressure from results of the midterm election.

[Michael Dudas, Vertical Research Partners]

I appreciate that. And maybe, Dan, if you can maybe talk about with regard to midterm looking at defense allocation budgets or where the opportunities are, of course, where you're strong. I can't imagine there'll be any issues, but if the Republicans take the house, there could be some -- a lot of noise, I would think.

[Dan Batrack, Chairman and Chief Executive Officer]

Well, for the previous administrations, we've heard a lot of noise. So it's not going to be granted to us.

[Michael Dudas, Vertical Research Partners]

Good point. Very good point. Good point.

[Dan Batrack, Chairman and Chief Executive Officer]

Maybe if you went back a couple of election cycles, I would say you're right, this might be really interesting. But we've got a little bit used to it being noisy. It is interesting with -- even if it does go one party or the other, so both the Senate and the House Republican, for example. Having a split overall with the administration on the other side and having such narrow, I think, regardless of how we're all watching this and which way it ultimately falls out, it's the narrowest of mandates for either side.

I've generally found that narrow mandates for us is actually optimal. What happens is they continue through without any major moves either left or right. Visibility is actually clear because we can see where we are today, and you don't see any big shifts. So I think to that end, it's kind of a good thing.

And I would say that what is most frequent with respect to thin majorities or split houses is the continuing resolution, which is we can't agree to change things one way or the other. So we'll just agree to take what we have today and extend it on. And with today's funding at the federal level with respect to the national annual budget, we find that quite favorable. It's good. They've actually committed to it.

And I do think I'll just add one comment that might be interesting for our shareholders and analysts to observe as we go forward. The CHIPS act -- while you look at IIJA, CHIPS Act and the Inflation Reduction Act are all federal projects and someone may look to our federal funding and revenues increase, the CHIPS Act is largely going to be moving through our commercial clients, the very large chip manufacturers.

We do work for them now. In fact, our third-largest client is for one of -- and all of Tetra Tech is for one of the high-end chip manufacturing entities here in the United States, and we're doing work for others. So take a look that that's actually going to have an indirect positive impact on our commercial work that we have while it may be initiated by the federal government, the CHIPS Act you're going to see, the outcome of that in other sectors that we have here at Tetra Tech.

So it may not be immediately obvious, but you're going to see benefits across multiple different end clients for us through the funding here. So it's not going to be just purely what happens in Congress and is it going to just show up in federal. So I hope that helps a little bit, Michael.

[Michael Dudas, Vertical Research Partners]

Oh, this certainly does. Thank you. Just a quick -- my quick follow-up on the financial side. Maybe you could share once RPS has closed, how you're thinking about financial profile, capital allocation and such as we move through the integration and the visible demand business?

[Dan Batrack, Chairman and Chief Executive Officer]

Yes. I'll come at a very high level. We've been very consistent. Our target has been to be -- have a leverage of between 1 times and 2 times our earnings. We've -- it's one area we've not been successful. Our leverage has been pretty much zero, which is not the worst place to be in light. But this -- at the peak after RPS, it'll put us right about to -- we'll be looking to very quickly delever. You can take a look at, as Steve had indicated, the $336 million generating cash in one year. You don't have to do much calculations to realize that within two year. About half of that could be reduced.

We have always said we would prioritize our acquisitions over buybacks or other areas. So number one, internal growth; number two, dividends, no change; number three, acquisitions. This fits clearly into that category; and number four, buybacks.

So take a look at our -- take a look at it from a perspective that we'll use buybacks as a lever or a knob to offset the acquisitions and our quick payment of our debt down. And we are not -- just as a comment from capital allocation, we are not out of the market, so to speak. Great companies that fit and further Tetra Tech's strategy and financial performance are still open, available and are in our pipeline of M&A. And while this does put us up at about two, obviously, our covenant limits are sort of like double that number. So we have no limitations with respect to ability to still add the best and brightest to join Tetra Tech.

[Michael Dudas, Vertical Research Partners]

Jill and Dan, thanks very much.

[Operator]

Thank you. That will conclude the Q&A session. I'll now turn the conference back over to Dan Batrack to conclude.

[Dan Batrack, Chairman and Chief Executive Officer]

Great. Thank you very much, Melissa. And I thank all of you for joining the call today for your insight and your questions and your interest. We're excited here at Tetra Tech to keep you updated on how things progress with RPS. We think it is a next big step for us, particularly in our strategy in some of these international growth areas. And I look forward to speaking to you again next quarter. And I hope you have a great rest of the day and the week. Thank you very much.

[Operator]

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