Stantec Inc
TSX:STN
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Stantec Inc
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Welcome to Stantec's First Quarter 2018 Earnings Results Conference Call. With us today are Gord Johnston, President and Chief Executive Officer; and Dan Lefaivre, Executive Vice President and Chief Financial Officer. The call today is webcast, and we invite those dialing in to view the slideshow presentation, which is available in the Investors section at stantec.com. All information provided during the conference call is subject to the forward-looking statements qualification, which is set out on Slide 2 and detailed in our MD&A and incorporated in full for the purposes of today's call.With that, I'm pleased to turn the call over to Mr. Gord Johnston.
Thank you. Good morning, everyone, and thank you for joining us this morning. For those of you following the slideshow, we're on Slide 3.For today's call, I'll begin with a high-level overview of our first quarter performance. After that, Dan will provide a little bit more specific commentary on our financial results. When Dan concludes his remarks, I'll provide some operational highlights and our targets and outlook for the remainder of 2018. Finally, to wrap up, I'll ask our operator to open the call for questions.Moving on to Slide 4. Overall, the company performed well in Q1 with solid organic revenue growth. In fact, this quarter marks the fourth consecutive quarter that we've achieved overall gross and net organic revenue growth. This shows we're focused on the top line and our strategy of building and maintaining strong client relationships around the world continues to enable us to win new work. We haven't ignored the bottom line either. Cost-reduction efforts, office consolidations and improved employee utilization resulted in a decrease in administrative and marketing expenses as a percentage of net revenue when compared to Q1 '17.Stantec is long focused on continuous improvement, and currently we're in the process of reviewing employee utilization, cost-effectiveness and project execution. This quarter's results show that our actions are already having a positive impact on our performance.We completed 2 key acquisitions this quarter. In the United Kingdom, we acquired ESI Limited, which expands our environmental services consulting business in that geography. And in the Southwestern United States, we acquired Occam Engineers Inc., which bolsters our water, transportation and public works presence in that region. Just after the quarter ended, on April 1, we acquired Traffic Design Group Limited, a transportation firm with offices throughout New Zealand and a single office in Sydney, Australia. This acquisition makes us one of the largest transportation players in the region.Also subsequent to the quarter, we signed a letter of intent to acquire Norwest Corporation, an energy and resources firm headquartered in Calgary with offices in British Columbia, Colorado, Utah and West Virginia. Once complete, this acquisition will boost our strength in the recovering E&R sector in Canada and the United States. We also signed a letter of intent to acquire Cegertec, an engineering and project management firm headquartered in Chicoutimi, Quebec with offices in Montréal and Québec City.And finally, on April 26, Stantec initiated a strategic review of our Construction Services segment. Stantec acquired constructors through our acquisition of MWH Global in May 2016. And as part of this review, we will evaluate a range of strategic options to optimize the value of constructors to provide the best prospects for our people, our clients and our shareholders.With that, I'll now turn it over to Dan to provide additional detail on our Q1 financials. Dan?
Thank you, Gord. Good morning, everyone. Overall, our performance improved in Q1 2017 (sic) [ 2018 ], and we had performance improvements in revenue, EBITDA and EPS compared to Q1 '17. I'll provide more detail and context as we go through the remainder of this summary.Prior to speaking to our specific operating results, however, I'd like to provide a brief summary of the impacts of 2 new accounting standards that resulted in changes to our accounting policies that became effective January 1, 2018. We adopted IFRS 15, revenue from contracts with customers, which impacts the way we recognize and record revenue as well as IFRS 9 financial instruments. With respect to IFRS 15, the impact on ongoing or on opening retained earnings was a reduction of $23.9 million, due to changes in the classification of contracts with multiple services, the recognition of change orders where we have an enforceable right to the change order or claim, recovery is highly probable and liquidated damages where a probability weighting of expected outcomes is now required. This primarily impacted our construction business. In addition, the change impacted how we record holdbacks from clients and deferred contract costs.Finally, contract backlog, which under IFRS 15, represents all secured work that really is the remaining performance obligations, now totaling approximately $5 billion. IFRS 9 changes the way we classify financial assets and account for debt modifications. IFRS 9 also impacts how we record fair value gains and losses on equity securities and how we calculate the loss provisions through an expected credit loss model.The primary impact associated with the adoption of IFRS 9 resulted in a $2.7 million fair value adjustment to other expenses relating to the new requirement of recognizing unrealized losses on equity investments held for self-insured liabilities through the profit and loss statement in Q1 '18. This was not factored into our adjusted net income calculation and had approximately a $0.02 impact on our reported EPS.Now let's focus on the operating results for the quarter. As Gord mentioned, we achieved positive net organic revenue growth in all geographies and all business operating units with the exception of Buildings. Buildings retracted in Q1 '18 compared to Q1 '17, primarily because of some project execution issues in the U.S. and low private and public spending in the U.K. and the Middle East regions. This retraction was partly offset by our strength in the Canadian health care sector, where we had a number of project wins over the last couple of quarters.Our Energy & Resources business operating unit performed very well in Q1, running significant new work. We're keeping an eye, however, on certain Canadian pipeline projects which, if delayed or canceled, may have a negative impact on environmental and engineering services in the oil and gas sector. Environmental Services had slight organic net revenue growth in Q1 '18 compared to Q1 '17. Growth in the U.S. was driven by increased demand for commercial, residential development and increased spending in power, transportation and water resource infrastructure investments.Canada continued to be hampered by activity in the oil and gas sector in Western Canada and a slight slowdown in the private sector projects in Ontario.Our Infrastructure BOU performed well in both our community development and transportation sectors. We believe in the future, there may be some additional state and/or provincial infrastructure funding available because of increased tax revenues in the U.S. and Ontario.Water achieved a 2.3% net organic revenue growth in Q1 '18 compared to Q1 '17, mainly due to our Canadian and Global operations. We also recorded a $3 million recovery on a U.S. -- on a major U.S. design-build project where we took a provision in Q4, and we talked about that in Q4 '17.These net organic revenue results were largely offset by the impact of foreign exchange and the 2017 Innovyze sale where we had recorded revenues in Q1.Gross margin was down in Consulting Services from 55.5% to 54.5% in Q1 '18. This reduction in margin was primarily because of project execution issues in the Buildings BOU, our mix of projects, competitive pressures in Energy & Resources, and the 2017 divestiture of Innovyze, which operated at higher margins and, therefore, impacted the margin performance of the Water BOU.Gross margin decreased in Construction Services, primarily related to ongoing U.K. waste energy projects where we had a further 3-point -- $3 million net impact. Our U.S. Construction Services business had no further downward adjustments on the previously noted U.S. hard-bid projects that we mentioned in Q4 '17.We reduced administrative and marketing expenses as a percentage of net revenue from 43.3% in Q1 '17 down to 41.3% in Q1 '18. These results were achieved by consolidating office space to reduce our occupancy costs, we have lower integration costs, and management's focused on cost containment and reductions. Employee utilization also improved slightly in the quarter, despite the ongoing seasonal challenges that we faced in Q1 and Q4.Gross revenue grew overall at 0.4% and net revenue increased 0.7% in Q1 '18 compared to Q1 '17, largely due to positive organic growth, which is offset by the foreign exchange impact mentioned earlier.Adjusted EBITDA increased from $89.9 million to $90.4 million, mainly due to improvements in administrative and marketing expenses, which was partially offset by the decline in gross margin as previously mentioned.There was no material change in our estimated annual effective tax rate in the quarter, which remained at 27%. Adjusted net income increased 4.4% but was impacted by IFRS 9, as discussed previously. Adjusted diluted earnings per share increased 5% from $0.40 in Q1 '17 to $0.42 in Q1 '18. And on April 12, we paid a dividend of $0.1375 per share to shareholders of record on March 29, and yesterday we declared the same dividend payable on July 12.Speaking to cash flow, cash flow used in operating expenses was $122.9 million. Payment for capital assets and intangibles was about $24 million for total use of approximately $147 million in the quarter. This compares to about $43 million in Q1 '17. We generally do use more cash in Q1 due to the payment of prior year merit and tax payments. The use of cash is higher in Q1 as well due to higher days sales outstanding from year-end and the cash used in our construction operations. The majority of the increase in capital expenditures in Q1 is due to the leasehold improvements incurred for our new Edmonton headquarters. We expect improvements in cash from operations over the remainder of the year.On Slide 13, you can see that we are on track to meet our annual targets for Consulting Services. We are meeting our admin and marketing expense target in Construction, but missed out for gross margin and EBITDA targets as a percentage in that revenue because of the downward project revenue adjustments I discussed earlier.We also fell short on our overall goal of achieving 5% net income as a percentage of net revenue. We attribute this to seasonality, project issues in our Buildings business and Construction Services, and the $2.7 million IFRS 9 impact I mentioned earlier. We do believe that we will meet our net income target by the end of the year.So now I'll turn it back to Gord to discuss operational performance and outlook for the remainder of 2018.
Thanks, Dan. Let's go to Slide 15. I'd now like to summarize the performance of our core business in Q1 and then look ahead to our outlook for 2018.As Dan noted, we experienced overall organic gross and net revenue growth this quarter compared to Q1 '17. Our Canadian Consulting Services business achieved organic gross and net revenue growth of 7.9% and 4.3%, with organic revenue growth in all BOUs except Environmental Services.Growth was driven in the -- by the private sector, especially Energy & Resources, and by revenue growth in the health care industry in D.C., Saskatchewan and Ontario, which helped our Buildings BOU. Most sectors in our E&R BOU experienced organic revenue growth.We're seeing some actual growth in the Canadian oil and gas sector, winning several projects in the midstream business. Growth in Infrastructure in Canada was driven by community development work along with interdisciplinary projects, such as the Calgary Cancer Center, the Calgary Green Line Corridor. Our Canadian Water BOU's growth was driven by British Columbia and offset by some minor retractions on the prairies.On Slide 16, in the United States, Consulting Services achieved growth of 0.9% in both organic and net revenue this quarter compared to Q1 '17, but this growth was significantly offset by the weakening American dollar compared to the Canadian dollar. Divesting Innovyze in Q2 '17 also contributed to the gross revenue retraction.Growth came from a mix of private sector projects that called on our remediation and recovery expertise in the Environmental Services business and from stabilization in the U.S. oil and gas sector. We also saw increased activity in the U.S. airport, highway, rail and road projects. On the public sector side, we benefited from design-build opportunities in transit, bridge inspection, LRT, roadways and bridge design. Organic growth in our mining sector and new projects for waterpower and dams with higher gross to net revenue ratios helped our U.S. E&R BOU perform well this quarter.Global Consulting Services gross revenue grew by 3.6% and organic net revenue by 6.3% in Q1 '18 compared to Q1 '17. Organic growth was driven mainly by the mining sector in Latin America, our Water BOU in the Middle East and in our export business. Our participation on the AMP6 cycle in the U.K. also provided consistent revenue volume.On Slide 18, Construction Services experienced organic gross revenue retraction of 3.7% and net organic growth of 2.3% when comparing Q1 '18 to Q1 '17. There were a number of projects approaching their closeout phase, which resulted in gross revenue adjustments. In the U.S., we had significant and steady work on several major water and wastewater treatment plant construction projects. And in the U.K., we had ongoing activities in the AMP6 cycle projects. Our core water business in the U.S. and the U.K. continues to perform well. However, legacy waste energy project issues continue to impact our U.K. operations. We actually recovered $7 million in subcontractor claims, but this was more than offset by $10 million in costs related to project delays and certain asserted performance issues. On the U.K. waste energy projects, we're pursuing claims on a number of these overruns.Since our announcement that we are initiating a strategic review of Construction Services, we've heard from multiple parties interested in exploring a more detailed discussion about the business. We are focused on gathering core information to share with interested parties and hope to have these in-depth discussions with them over the next several months. Our aim is to complete our strategic review before the end of the year.I'd now like to highlight some of our recent project wins, as you'll see on Slide 19. Our backlog stands at $5 billion, representing $3.8 billion in Consulting Services and $1.2 billion in Construction. Now this backlog looks a bit larger than what you might expect, but that is because of the IFRS changes that Dan mentioned earlier that now requires to take our entire backlog into account rather than just the last 12 to 18 months as we'd previously done.During this quarter, we publicized several major project wins. Among them, that we'll deliver the conceptual design for raising the Warragamba Dam west of Sydney, Australia, to improve flood mitigation in the downstream community; that we'll provide engineering, geotechnical, surveying and other services for the Mid-Breton Sediment Diversion project, which is a key component of Louisiana's master plan for sustainable coast. And just this week, we announced that we're designing the Hampstead bypass and US 17 highway improvements in North Carolina. These are just a few examples of our wins this quarter.We believe our overall business is strong, with a growing backlog and continued success on strategic pursuits that should transition to continued growth in Q2 and Q3. This success combined with solid project delivery should make it possible for Stantec to meet its business goals this year.Our outlook for 2018, as shown on Slide 20, hasn't really changed since our last earnings call in February. To reiterate, we continue to target our long-term average compound gross revenue growth rate of 15% through a combination of organic and acquisition growth. We believe that's doable. Our backlog and business outlook are favorable, and our acquisition funnel is as full as it's ever been.In 2018, we anticipate overall organic gross revenue growth in the low to mid-single digits supported by continued economic growth in the United States, increased infrastructure spending in both Canada and the U.S., modest improvements in the Energy & Resources sector, global economic growth and our ability to continue to expand our global footprint.Before we finish up today, I want everyone to know that we recently published our 2017 annual sustainability report. The report covers our ongoing commitment to environmental, social and economic stability and shows our sustainability performance for fiscal year 2017. I invite everyone to read the report, which is on our website at stantec.com.That concludes the presentation section for today. Operator, please, let's start the Q&A portion of today's call.
[Operator Instructions] And our first question will come from Mona Nazir with Laurentian Bank.
My first question just is a clarification. So I think you had just stated that for 2018, you're expecting organic growth to be in the low- to mid-single-digit range. Was that on a gross or net basis?
Actually, on both, Mona.
Okay. And then just secondly, touching on the potential divestiture of your Construction arm. When you first purchased MWH, it was stated that it was closely coupled or correlated to some of the consulting work, particularly in the U.K. And I'm just wondering, should a sale or divestiture occur, how stable are those consulting revenues? Could we potentially expect some softness or contraction of how closely coupled those 2 divisions are in some geographies? And just secondly, on that strategic review of that division. Given the nonmaterial contribution just on the EBITDA level and the negative margin this quarter, would you ever consider just slowly exiting or winding down the business? Or is that not a possibility?
Okay. Thanks, Mona. I'll start with your question with regards to the U.K. So both in the U.S. and the U.K., there are, in the U.S. in particular, starting there, there are a number of opportunities where our consulting business works together with our construction business on various design build jobs, both in the public and the private sector. That said, there are a number of situations, particularly in the U.K., where our objective is to secure the work. And sometimes our consulting business will partner with our construction business. In other situations, either due to client pressure, client -- sorry, preference, workload of the construction business or geographies where our construction business isn't active, our consulting business will partner with other construction firms. And that works in both directions as well. So in the U.S., we see very little negative revenue impact, if, again, a divestiture would proceed. In the U.K., there are a few clients where they are more closely coupled, our engineering business with our construction business. In that case, what we're -- during the strategy review process, we're spending a particular amount of time talking to clients, talking to our -- both our consulting and our construction business, and talking to staff. Because our objective would be, again, if we did go forward with the divestiture in the U.K., to ensure that there is no disruption to our clients, to ensure the projects continue to be executed properly. And certainly, our objective would be to ensure that the same consulting staff that's currently working on the projects, maintains work -- continues to work on them going forward from a continuity perspective for the project and for the client. So that is absolutely a consideration, Mona, as we review any potential firms that have come forward with us is that, we want to ensure that our current consulting business in the U.K. does not deteriorate. And to your second question with regards to, would we ever just wind down the operation, I mean, certainly, we could do that, but that's -- it's a very robust operation. And the core business in both the U.S. and the U.K. is very vibrant. And what's been a pleasant surprise to us, since we announced that we're going forward with the strategic review, is the amount of inbound interest that we've received, more so than I even thought that there would be. So I don't think the -- while the option of winding down, of course, is always there, I don't foresee that if we did proceed with a sale that, that would be a requirement. I'm seeing a lot of positive interest in the asset.
And we will now hear from Derek Spronck with RBC.
The -- you've been fairly active doing them, quite a few nice little tuck-in acquisitions recently. What's your pipeline looking for the remainder of the year? And the acquisitions that you have done, what sort of kind of year-over-year growth would that provide once they get kind of full run rate into your system?
Yes. Thanks, Derek. The acquisitions that we've announced so far this year, you're right, have been smaller tuck-ins, sub-100. Cegertec where we announced the LOI is about 250 people. And those were great opportunities to strengthen a particular line of business in a particular geography. And sort of they're more surgical in nature. So we're continuing to look at those sorts of opportunities in North America. But we're really focusing, as we've -- I think as we've messaged in our strategic plan, we want to continue along with our growth in the U.K. and the Australia, New Zealand region to support that footprint that came to us through MWH. So we've been spending a lot of time in those regions, in particular. We've got a pretty robust acquisition funnel. And I think we'll see that M&A is poised for increased activity in 2018, particularly in the Australia, New Zealand and the U.K. regions.
I think maybe there's another point to make on this, Derek. And that really is that some of these acquisitions actually have closed, the real smaller ones. Cegertec won't close till likely later in Q2, if not the beginning of Q3. And so I think it's important that even though these have been announced, they are not in our revenues. And when I go through and read through all of the analyst expectations and reports, many of you -- of the analysts include acquisition growth in their projected numbers to be assuming large acquisition growth in the first and second quarter when these transactions really haven't gotten closed yet, I think is a bit of a overstatement. So we just have to be a little careful in managing those expectations around acquisition revenue growth. It doesn't start when it's announced. It starts actually after the deal is closed, yes.
Yes. Again, that makes sense. Just based on the -- your current pipeline and what you've done, is it kind of teeing up at roughly a 2% kind of revenue lift in 2019 from acquisitions, given the current landscape?
Yes. It's a good question. The funnel is full. We do see increased activity in 2018. Hard to predict these. They -- it's lumpy. We have expectations. But until we get folks to sign up, they haven't signed up, so it would be hard to provide guidance because we don't really know when those might close.
Okay. No, that's fair enough. Just on your longer-term strategy in, just some color around refining it, could you maybe talk a little bit further about that, specifically what the refinements were because it seemed by and large pretty much the same strategic strategy. Has anything changed at all?
Not particularly, Derek. The one likely change was that we announced our review of the -- of our Construction Services segment. And that's something that we thought long and hard on, just to look at where we saw our company in 3, 5, 10 years from now and whether that's factored in. And so that's really why we're having a good look at that now seeing what the market interest might be. But in terms of our strategy of continuing with our growth through acquisition, no changes there. What we have now is a larger geographic platform to work with through our acquisition of MWH. We're going to continue, we're not going to take our foot off the gas in North America in any way. But we're going to really focus on Australia, New Zealand and the U.K., where we have -- already have a strong footprint, just to continue to grow that. That said, we're beginning to look at in a 3- to 5-year plan outside of U.K., Australia, New Zealand, where else might be attractive locations for us to begin to consider. Other than opportunistically, not looking at any strategic reviews there right now or what options might be, but just beginning to see what might come after Australia, New Zealand and the U.K.
Is it largely geographic -- geographical focus? Or could you perhaps move into new end market segments?
At this point, we're really looking at continuing with the successful model that Stantec has run. We have our 5 major BOUs. And we look at how we can diversify within those -- our existing sectors in those newer regions. For example, in the U.K., we're the #1 water firm, but we're a single sector in water. So there's lots of opportunities to build out into other sectors, Environmental Services as you saw with ESI. There's lot of opportunities in transportation, in Buildings and other sort of core infrastructure work that we do there. So I think we're looking to continue with the tried-and-true Stantec playbook, using that wedge of getting in there. Example, in the U.K. #1 water firm and now expanding into other service lines. But at this point, not looking into new service offerings at this point.
And our next question will come from Jacob Bout with CIBC.
Wanted to go back to the strategic review. And just -- what is your current thoughts right now? Is it to completely exit the construction business? Or keeping part of it? And also what's your thinking on the type of process that you're thinking about running?
We're -- as part of the review, we are looking at all alternatives. Certainly, a sale of the asset might be one of the alternatives that comes out of it. We have -- as you know, we've engaged an adviser to help us through that process. They've received numerous inbound interests at this point, and they are in the process of preparing the [ SIM. ] So we'll work through a process with that, we'll see what sort of interest comes from that. At the same time, we're talking with our clients, we're talking with our staff and looking to see other ways that we can improve our current operations to make them more sustainable in the long term and certainly grow and continue to provide good service to our clients. So we haven't messaged to the market that we're -- that a sale is the only alternative. We're just still looking at a range of alternatives. But that's sort of what a process would look like as we're evaluating interest from potential acquirers. A number of the folks that have approached us would be interested in both the U.S. and the U.K. Others have said, only the U.K. Others have said, only the U.S. So there's a wide range of folks that have approached us. So we're really just looking at all alternatives at this point, Jacob, and seeing where it takes us.
I think it's important to point out, again, that it's still early days. We only announced this 2 weeks ago. So the ball is just getting rolling in terms of the full process that's going to be enacted here in the next couple of months.
Yes, good point, Dan.
Maybe my second question here just on your acquisition strategy. In the light of the new U.S. tax reform, has that changed your approach to your acquisition strategy in the U.S.?
I don't think it's materially changed our approach. I think certainly companies are looking out at vendors or sellers are looking out it and saying, "Well, we get the benefit of a lower tax rate. Therefore, we should get a higher EBITDA multiple." Certainly, we factor all of that in as we go through our pricing mechanisms and really try to get the most favorable outcome, both for the seller as well as Stantec and our shareholders. So it hasn't really changed our approach, but it's certainly another factor that we consider in our acquisition strategy.
Would it be fair to say it just made a little more expensive for you to buy something in the U.S.?
I think it's -- every transaction will have a multiple that makes sense, some that make it higher, other that may not have had any material impact.
And we will now move to Yuri Lynk with Canaccord Genuity.
Just want to make sure I understand what's in the adjusted EBITDA number. Is the -- the $2.7 million fair value adjustment, in -- that's in the adjusted EBITDA number, correct?
No. That $2.7 million actually falls into other income below EBITDA. So we're -- really there is virtually nothing really impacting adjusted EBITDA this quarter, very little anyway. So that's actually below in other income.
So that was about $0.02 of EPS, roughly.
Yes.
So if we had adjusted for that, it would've jumped us from $0.42 to $0.44.
Right. Okay. Maybe I'll take it off-line. It's fine. Can you quantify -- so your Consulting Services backlog compared to where it was at the end of the year is up about $1 billion, so a big move. You did talk about new contract awards but you also mentioned IFRS 15. So can you just quantify the impact IFRS 15 had on backlog this quarter?
It's very difficult to try to get significant detail. But I think the message is, we are now recording all of our backlog based on remaining performance obligations for signed contracts where we have notice to proceed whereas previously, we only showed the 12 to 18 months. We do know that we have had a number of project wins in the quarter, which have added to backlog organically. So there has been some organic backlog growth. Very difficult to quantify what that number is because we have to go back to January 1 and restate where our backlog was, so difficult to completely get that number, although I do expect that there was growth, which was offset by, again, some change in the foreign exchange rate, strengthening of the Canadian dollar in the quarter. So I guess, the bottom line is, some of that is organic growth offset by FX and then the change in IFRS.
Okay. So you -- okay, so safe to say that for Consulting Services, the book-to-bill in the quarter would have been above 1?
That's exactly what I think, yes.
Yes.
Okay. And in Q2 and Q3, you talked about a pretty healthy bid pipeline. So just want to make sure I understand the -- what you're saying the -- you think that, that book-to-bill can stay above 1 for at least the next 2 quarters?
I would think so, Yuri. We're seeing a lot of really strong proposal activity in our major projects, our risk review process really has ramped up for a number of large projects that we've got in the pipeline. So I do feel good about looking forward to Q2 and Q3 as well.
Okay, that's helpful. And just a follow-up question on the strategic review. Can you share with us what the bulk of your competitors are doing vis-à-vis owning versus JVing with construction companies?
I think...
These competitors in the design space?
Well, yes, the competitors that you would be going up against on the design side. I mean, how many of them are bringing integrated construction capabilities to the table?
I think most of them are partnering. When you look at a competitor like AECOM or SNC, they have more of the integrated design construction O&M type firms, but most of the other normal competitors that we run up against would be partnering. Gord?
Yes. I would agree with that, yes. The majority of the firms in our space would be partnering on a project by project basis with where it makes sense with construction firms that have the right technical, the right expertise in that line of work, strong in that particular geography, just so you can put together the most competitive team.
Okay. So you wouldn't be at any major disadvantage by not having those capabilities in-house?
Well, I don't see that would be the case. And in particular, as well, our construction business right now is only active in our Water space, and only in the United States and the United Kingdom. So big slots of our business still are -- aren't covered by that and still are continuing to grow and perform well.
And our next question will come from Sean Eastman with KeyBanc Capital Markets.
I just wanted to drill down on the Buildings segment, hoping you guys can provide a little bit more color on those execution issues cited and your commentary. And also for Buildings, the U.K. and Middle East softness, it would be helpful to get some perspective on the size of that piece within Buildings. And whether there's any signs of life on some recovery in those more-challenged geographies for this segment?
So Buildings has, as you noted, a number of moving parts there. Maybe I'll start with the U.K. and the Middle East. We had some large healthcare projects that we were working on in 2017 and 2016, in particular, that drove our Middle East business, and a lot of that was centered out of London. So with that market more or less retracting, and our healthcare business has really tightened up with the Middle Eastern clients really putting either on hold, deferring or canceling healthcare facilities in areas like Qatar and Saudi Arabia and Kuwait. So we are -- have really retracted in that market for the last -- essentially the last year, and it's continuing to go downhill. We're pretty much near the bottom, though. There's not much business left there. And that's impacted our London operations as well, for sure. With respect to the rest of the Buildings business, this is just ongoing project management. Some of it has to do with acquired entities and getting the estimated cost to complete and budgets lined up, so that the expected margins on these projects are accurate going forward. So good part of it is that, some acquired entities. That is ongoing, as they get used to operating in really a public company accounting environment. Some of it is just project execution, not managing our projects well in terms of budgets and, again, performance of -- out of the cost to complete. We're taking a number of steps to rectify that, really getting down deep into project reviews with project managers. And really focused on the underlying principles of good project management fundamentally is what it comes down to. When you have thousands of projects that are having small incremental provisions on those projects, it adds up over time. So we're really taking a hard look in our Buildings practice to really try to turn that around. And I think we've got some good strategies in place to do so.
Okay. It's helpful. And I guess, moving over to Energy & Resources segment, double-digit organic growth in the quarter, but also citing some margin pressure from competitive dynamics. So just like to get a better understanding of what's going on there. And whether this double-digit organic growth is sustainable in your view? It sounds like it's kind of hinging on a particular pipeline project, so thoughts around those items would be great.
No, there is -- you're right. There is a large pipeline that we're working on in Canada. We continue to work on it through this evaluation phase. But there is lots more than just that one pipeline project ongoing in our Energy & Resources business. The -- in our -- our main -- one of our main oil and gas offices in Calgary, the -- just anecdotally, the biggest concern we have right now there is parking because we've -- through the last half of last year and so far this year, we've been hiring. And so -- that's just anecdotally there, what we're seeing there. We're seeing a lot of growth in the mining sector. We're seeing -- particularly in Latin America, we're seeing a lot of the -- in addition to that, a lot of the risk reviews, that I mentioned earlier, they are coming in are related to additional mining work that's -- that continues to come in the door. Waterpower and dams, seeing some continued growth there. We talked a little bit about the Warragamba Dam project already in Sydney, Australia. So really a lot of the groups there, mining, we're seeing strengthening; oil and gas, still feels good. Waterpower and dams is still coming along, and we're seeing even in the power sector some additional work coming in, infrastructure improvement type work, environmental compliance, resiliency, a lot of continued activity in the power sector as well. So I do feel good about the Energy & Resources sector as we flow through the rest of the year.
And I think it's important to note with the change that we've seen over the last several years as a result of commodity prices. Oil and gas business in Energy & Resources was north of 50% of that entire business operating unit. We've got a much better balance and diversification there with the addition of waterpower. Power and mining have both now started to come back. So pretty equal distribution of revenues generated from that business unit, which gives us some more confidence as well.
And we will now hear from Benoit Poirier with Desjardins Capital Markets.
Just to come back on the previous question on Energy & Resources, obviously, strong organic growth. But when we look at the gross margin, it's been down year-over-year due to mix of project and some competitive pressure. So could you talk about your ability to improve gross margin? And maybe provide more color about the mix of projects.
Sure. Maybe I'll touch on that one first. In the -- in certain sectors, the industrial sectors, margin is lower generally than you would see in Buildings and Infrastructure. So that's just the nature of the business, largely time-and-material projects where you don't have really a fixed fee project where you can generate a higher internal gross margin. If you recall over the last several years, we said we were negotiating new MSAs with the oil and gas clients at lower rates to help them get through the need of retraction relative to that business, so they pushed all of their cost retraction or pressure downstream on to their service providers. We had signed a number of MSAs earlier on in the process, which did provide some compression in our gross margins. But that's -- you can have a slightly lower gross margin, but high utilization has more than made up once you get to the EBITDA number, so -- because you have people highly utilized, you're not having to go out and really bid on a lot of projects, a lot of it's sole-sourced. So I don't know that you'll see a material change in gross margin going forward in the Energy business, but those would be some of the reasons why.
Okay. And when would you -- when are those big MSAs are up for renewal? And would you expect some pricing increase as a result of, let's say, a better oil and gas sentiment?
I think as -- there will be adjustments over time as market improves. If we could ever get some of the pipeline political and social issues resolved, that would really help the business in Western Canada. But I think clients still, certainly on the upstream side, are still pretty cautious, not putting a lot of money into CapEx, which is impacting the midstream business. And that's more impacted though by, again, the political issues that we're facing in this country. The issue though is, if those go forward, I do expect that there will be some price escalation as things get busy again.
Okay. That's very good color. And on the pipeline side, could you quantify, in the quarter, your exposure to pipeline? Just trying to gauge what could be kind of a downside scenario, assuming some negative news in Canada, Dan?
There are a lot of smaller type projects that are ongoing, the one project that we mentioned in the first part of the call. The client has said they're only doing essential services. We're doing bits and pieces of the work, but I wouldn't suggest we're at full capacity yet, subject to that review. So I think if that review gets completed and things go forward, it will have a positive impact. If it doesn't -- the oil and gas business in our engineering business now is only -- it's less than 5% of our overall revenues in Stantec. And on the Environmental side, oil and gas is less than 5%. So combination, it's still less than 10% of our overall business in oil and gas now.
Okay. That's very good color. And when we -- you previously talked about the project performance issues for Buildings, you gave a lot of color about the U.K. and Middle East. But could you talk a little bit about what type of improvement we could see going forward on a gross margin and organic growth basis given the year-over-year comparison, the healthcare market downturn that started a year ago? Just trying to gauge how the comparison will be in the second half.
We've had a close look with our Buildings leadership to look at our forecast for leased out into Q2 and do expect to see some improvements in margin and operating performance. It really is getting down to project by project and almost hand to hand combat and making sure that we're executing these projects well.
Okay. So pretty much at the bottom right now, right, Dan?
Bottom of performance expectations?
Yes or kind of it's -- yes, okay. Perfect. And last one for me. You mentioned that there was, obviously, significant cost overrun incurred to date on some legacy hard-bid project. But on the other side, it seems that there is an opportunity to recover. So could you maybe quantify what could be the amount that could be recovered? And also provide some color about the timing on those potential recoveries.
Every project is unique with respect to the stage of either negotiation or, what's the right word, it's not remediation, but the litigation...
Litigation.
And mediation in any one of these projects that's different, and you have different stages, so the timing is certainly uncertain. The -- with respect to the probability, we do put a probability weighting on it. But we cannot recognize any of that into revenue until it's highly probable that we've come to a conclusion with the client and that we will get paid for those claims. We -- I think we indicated in the fourth quarter, we had about $50 million in claims, of which we've recognized about 15% of that. So that number hasn't materially changed in Q1.
And our next question will come from Maxim Sytchev with National Bank Financial.
I just wanted to ask you a question in terms of your U.S. footprint. When we look at some of your U.S. peers, specifically, it seems to me that the organic growth momentum there is stronger. And I'm just wondering is it just the question of positioning? Or do you feel that perhaps you are starting to lose a bit of market share in that important sort of the bottom market?
No. I don't think we're losing market share at all there, Max. We've got a lot of great wins in the transportation sector over the last little bit that are just starting to ramp up. We talked about the Long Island Railroad. Good wins in the water sector. We talked about the Mid-Breton Sediment project just ramping up again. These are some larger projects. And really in each sector we're seeing that. So I think the market there is strong. I think we're winning our fair share. And a lot of these larger projects that we've secured really are just beginning to ramp up now.
Okay. That's helpful. And then in terms of -- there was a commentary in the Buildings division where you had some client departures from the acquired firms. Any color on that front, please?
Really what that is -- because we operate as an integrated buildings firm, where we've integrated our buildings engineering and our architecture businesses. When you have buildings engineering in a legacy business, generally a lot of their clients who they work for are the architects. So when you bring that engineering business in-house, some of those architects don't want to work for a firm -- or don't want to a vendor working for them that has also got architecture expertise. So that's really what that relates to. It's not material. We see it all the time as we do buildings, particularly, engineering acquisitions. But we do get the benefit when we do architecture acquisitions where we can generate more revenue internally by using our own internal engineering expertise. So it's a bit of a trade-off sometimes.
Right.
Okay. And then just going back on construction, I guess, we'll see how the process is going to play out, but if it's a status quo situation obviously, the margin is lagging right now relative to your 7% to 9% EBITDA guide. So how should we think about the rest of the year? Is there a catch-up dynamic? And what gives you confidence you're going to able to hit those, well let's call it 8% midpoint EBITDA?
Yes. I think the -- we have seen good progress on the waste energy projects in the first quarter. We received a turnover acceptance of one of the projects. We've hit some critical milestone dates on another project and the third project is essentially completed, it's in O&M, and we've got 2 of them in now operating and maintenance. And so we've made some really good progress. We aren't seeing a whole lot of additional negative headwinds on those projects. Although to qualify that, there's still work to complete on one in particular to get the final turnover and acceptance. But good progress in the quarter on that. And again, in the U.S. I think it's important to note that the core water business both in the U.S. and the U.K. is very strong. It's a good business and operating well. We didn't take any material hits on the design-build projects and fixed bid projects that we had to take some provisions on in Q4 -- in Q1. So our estimates to complete are holding up and we expect that to continue. And we're just ramping up on some other projects that are new that should help generate good revenues in the next couple of quarters for construction.
And we will now move to Michael Tupholme with TD Securities.
And just to pick up on the last question. Dan, is part of the issue this quarter in Construction Services the fact that some of these projects that were challenging in the last quarter are running at 0 margin until everything is completed?
Not 0 margin, but they're certainly running at a lower margin. I think, frankly, a lot of the margin on these projects have been recognized quite early. And they didn't leave enough margin for the tail end of these projects. We're at the end of them. But I wouldn't say they're at 0 margin or negative margin, but significantly lower margin that was anticipated at the start.
Okay. And the one project that's not yet fully completed or very close to completion that you mentioned, when is that due to be finished?
We're expecting to get turnover -- we have to go through about a 2-week -- forget exactly what the...
Performance testing.
Performance testing on the plant. It's all constructive. Now we're in the actual final phases of making sure that can generate power on a consistent basis over 14 days. We achieve that acceptance and it turns over. It's always subject to discussion and negotiation with the client. But we do expect to see that either towards the end of Q2, perhaps in the beginning of Q3, but we expect to get that in the next quarter or so.
Okay. And then just in terms of the -- your comments about the strategic review. I think you suggested, you expected to be completed before the end of the year and I just want to be clear about what you mean. Do you mean, you will have decided on what path you're going to take by the end of the year? Are you would expect any transaction, for example, if there is, in fact, a sale to be closed by the end of the year?
No. We're active in that review process now. Our anticipation is that we would have made the decision on our direction. And if it -- if we were going to proceed with the transaction, it would be our expectations that we would complete the transaction by the end of the year. [indiscernible]
Right. Okay. Perfect. You've been asked about Buildings a number of times so just want to circle back on one follow-up question regarding Buildings. It sounds like there were a number of issues in that segment that were impacting the quarter. But if we look at the margin being down and you mentioned, execution issues, is there any way to help quantify what the gross margin might have looked absent these execution issues?
I think the gross margin would have been closer to what our expectations are and what we had forecast for gross margin for Buildings. So it should have been closer to what our historical gross margins were in Buildings. We're off a couple of percentage points, is really what that quantification is.
And given the focus on improving execution in that segment, it sounds like you expect improvement, but should we expect that improvement to show up in the next quarter or so?
I think it will be incremental, and we'll see it through the year. We're implementing a lot of things, including reevaluating Project Manager certifications, making sure we have right PMs on projects to improve the margins here and developing proper project plans and so on. So by the end of the year, I expect us to be improved for sure.
Okay. And then just lastly, really strong improvement in admin and marketing as a percentage of revenue in the quarter on year-on-year basis. Something there were a number of factors at play there some of which you listed -- things like lower occupancy cost, lower discretionary spending, lower integration costs, would you expect additional improvement in some of those types of factors, sequentially? So what I mean is there -- would occupancy costs come down further, for example, in a sequential basis as we move through the year and as discretionary spending drops even further?
I think we started seeing some of the improvement in occupancy cost in Q4. So you might see a little bit more, then it will normalize through the remainder of the year. I think we're hopefully, we do see some improvements in utilization. We're now coming off of one of the weaker quarters. Q4 and Q1 are always weak from a seasonality perspective. So we should see some improved utilization in Q2 and Q3. So that should help contain and if nothing else the admin and marketing expenses as a percentage of revenue.
And we will now move to Ben Cherniavsky with Raymond James.
Most of my questions have been asked. I think, just a little more on the U.S. The organic growth rates between Canada and the U.S., strike me as maybe a little counterintuitive. I mean, the U.S. construction markets from everything that I've been seeing would have suggested perhaps higher organic growth rate there. I know you guys have touched on some of that already and break it down in the MD&A. But is there like if you're not losing market share what would be, is it just lumpiness or what would account for still a fairly modest organic growth rate south of the border?
I think some of it is lumpiness, Ben. So we don't -- it's really hard to quantify. Projects were coming on and off the projects but certainly, the lower gross margin also impacts revenue. So areas like the Building segment would have impacted our organic growth and you see that and the good portion of the business is in the U.S. over -- almost 60% of that business is in the U.S. We had fairly tepid growth on a gross revenue basis, of course, in water and a good portion of our business there about half of that is in the U.S. but we grew well on a net revenue basis and in environmental services, again, fairly flat. So I think when you look at the mix of business where about just shy of 60% of our revenue now in Consulting Services is in the U.S. and you see a little bit of weakness in some of those end markets and buildings, in particular, that's going to drive down your overall U.S. organic growth.
So without leading you into any kind of a guidance trap, do you think the number for the year is better than what you just put out like the -- or is this -- this is as good as it gets in the U.S. right now?
No. I think, Ben, we do going forward that -- our gross and net organic growth in the U.S. will improve. We talked about a number of the projects that we've got there ramping up. So no -- we certainly sub-1% would not be our expectations for organic growth in the U.S. for the remainder of the year.
Okay. That's helpful. And maybe just in a high level, Gord. The strategic review of construction. Not long ago, you guys were saying it's critical to the business, we're committed. I think when you initially looked at it, it was -- you were committed, but it was -- you were going to investigate it and then you're committed and now you're reconsidering it. I mean, what -- how should we interpret the change in the philosophy of the construction business? And whether or not it is indeed critical to what you're doing compared to what frankly has been a little bit of mixed messaging around the business?
Yes. I think, Ben, the one key to that is -- I came in with a new set of eyes, certainly it's been part of our leadership team for some time. But I wanted to come in and have a new look at everything. We're looking at the cost side of things, and we've done some work there, and you see we've had some benefits here in Q1. We've been looking at really re-kicking going with our acquisitions program. You've seen a few already, you'll see hopefully, some increased activity there through the rest of the year. That and -- but construction was something we wanted to have a good look at as well. As we were integrating MWH, as we're learning more about it and the market, I think the statement that we made was appropriate for the time, but that we're evaluating. This is -- is this where we want to be in 3 years or in 5 years. I think the -- because even though we're in construction it's only in water, only in the U.S. or the U.K., so it's not certainly in all of our BOUs. It's certainly not in all of our geographies. We perhaps found in -- as we looked at it in the U.S., it was -- we don't need that tight integration in all cases. In the U.K., we found that the tight integration with some of the clients wasn't as tight as perhaps we had thought. And in other cases, we're looking for opportunities again if we -- should we decide to divest -- to ensure that we have that continuity both in our consulting group for our revenue generation but also for the clients for project delivery. So we're just having a good look at it. Ben, I don't know that, that you'll see continued changes. I mean, once we make -- once we go through and make our decision here, we'll be set.
So could I just ask, if you take a bigger step back as a follow-up on that. Your stock hasn't really performed very well since the MWH acquisition, even maybe going a little further back since the oil downturn. What other lessons learned would you say, have there been in the last few years and things that you're considering, as a new -- generally there's a fair amount of consistency in the message, you've been in internal appointment, you've been part of the plan all along in management. But is there anything that investors -- do you want to say to investors about how Stantec -- what your -- how your mandate might look different from what's happened in the past?
Your point starting back when Oil & Gas turned down and our stock didn't see a lot of appreciation there. I think that makes sense. Oil & Gas was a big part of our business at the time. The oil market turned down. We experienced some organic retraction in revenue, and the markets rightfully saw that. Then when we acquired MWH, still committed to that was the right thing to do, we stepped back from our -- a lots of acquisition and expansion for a number of years, as we sort of processed. What did that mean? We had to get our systems in place. We had to learn little bit more about how that group functioned and how we could get them all integrated. It was a big bite for us. So I think since the MWH acquisition, things have been a little flat from an earnings perspective. They've been a little flat from a stock appreciation perspective and a big part of that I think is that we -- while we had some acquisition during that time to continue our growth, we weren't -- and this was part of the plan, we weren't extremely active there. But we, starting in the last half of last year and certainly, very active through the first part of this year and it'll continue, we're really ramping up that organic growth. So as we talk about the 4 main things I've been working on, Ben, they were looking at some of the costs containment with our leadership on how we could -- not that anything was broken, but we just wanted to continue that continuous evolution of refining our cost structure, getting utilization up. We really focused on organic growth with our campaigns and our account management plan. And you're seeing the organic growth show up this year in this quarter and all the regions. We're really focusing on acquisition growth. And you've seen 5 LOIs or things that we've closed so far this year. You'll see continued activity, I believe, in 2018. And then certainly, we're relooking at everything and one of those is, is that review of construction. So, I think, as you said, whether we liked the markets to see how my thoughts going forward, that's really it. It's the same strategy, that the tried and true Stantec strategy of continued growth through acquisition, keeping the focus on moving up the bottom line in concert with the top line. And just sort of getting back and sticking to our knitting sort of things. So I think that's what you'll see going through 2018 and beyond.
Maybe just add one other things, Ben, is I think the market tends to under-appreciate the massive amount of effort and investment that we made in 2017 and we'll continue to do so, in positioning ourselves for that global growth. We spent a ton of money in terms of trying to -- and effort in trying to get ourselves positioned for that eventual acquisition growth globally. And we are very well positioned today. We've got collaborative tools around the world. We've got a platform now set up around the world. We're going through the final stages of that execution, which will take some time, for example, getting our Australia and New Zealand and U.K. operations onto Oracle and that we won't have finished by the end of the year, but it's -- we're advancing on that and a number of other initiatives internally to really strengthen the business. While at the same time really focusing on things like, as Gord mentioned, utilization and project execution and so on.
And our next question comes from Chris Murray with AltaCorp Capital.
Just a couple of quick questions for you. First just going back to the construction business one more time. I guess what I'm trying to understand, while we've talked about historically, it's always been the water business, you folks have alluded to the fact that maybe the margins weren't set up right for the construction business. You're getting yourself into trouble on waste energy projects, which I'm still struggling to understand for water business, why are you even in that business? How much of the issues that you're facing right now, do you think were part of a lack of control before you guys acquired the business? And how should we feel about where the business is today on kind of new projects or projects that are running, so we don't see any more issues through the balance of the year?
Chris, we talked a lot about that in our year-end reporting. First of all, the waste energy projects were an opportunity that MWH saw as a big business opportunity, should the market go that direction and turning waste into energy. It was subsidized by the U.K. government, which then was more or less pulled once Brexit came along. It was a good opportunity that they pursued. And they -- that thing would have turned either way where had the market continued, they would have been a leader in terms of the expertise gained in waste energy plants. So -- and we've learned a lot, obviously, in those plants in the first 3. Since then we've, obviously, put a hold on any new waste energy projects. At the same time, they addressing emerging business opportunities in 2013, 2014 in the U.S. going after design-build hard-bid projects, in areas that were outside of their traditional geographies. So they maybe didn't understand the entire supply chain, the craft labor, the equipment suppliers, et cetera, in those markets. So we pulled that back as well. And thus the, again, part of the reason for the strategic review, if it can't be that satisfying for employees in our construction business where we say we're not going after this, we're not expanding and -- by acquisition, we're keeping you close back down to your knitting in terms of where your core expertise is. All of those things we've added that additional governance and oversight since the acquisition of MWH. So I think we now have that business more or less contained and under control, focused on what they do best. And -- but it can't be satisfying for them. So another factor in the strategic review discussions.
Okay. Fair enough. And then very quickly just on Energy & Resources, we see a pretty strong number up, I guess, more just color and a couple of things. You talked about mining and energy as well as water, power, really did take a step up. Just trying to figure out is this -- are these awards that you had won a long time ago, and this is just a timing issue of when we get to the work? Or is this -- what are you seeing in terms of the pace of demand for those services? Like is this a big step up in terms of ramp or like new working coming in kind of this -- like just last month type thing to get done today? Or is this something that's been kind of in the backlog for a while? And then as a piece of this too as a follow-on. If we hear a positive FID from -- on the LNG projects this year, can you just kind of give us an idea how you think that may impact you as well?
Sure. To your first question, Christie, these are jobs that they are -- have recently come in. They are Warragamba Dam and a lot of the power and pipeline job. These are kind of the smaller work that we're doing. These are new awards. So this isn't things that have been on the books for a long term. Certainly, a lot of activity in our Latin America mining sector as well. We're hiring there again. So I think that's all positive. And should we get a positive investment decision on the LNG, certainly, a lot of activity there that we'd be well positioned for from environmental work to -- you name it, we'd be...
Pipeline work.
Yes. Pipelines and environmental, even a lot of core infrastructure, transportation and power lines, and all sorts of things there. So I think we'd be positively impacted by that.
And once again, we will hear from Mona Nazir with Laurentian Bank.
Just kind of quick follow-up. You talked a little bit on the various OpEx line items and some seasonality. But just stepping back in your prepared remarks you spoke about honing in on employee utilization, cost-effectiveness and initiatives that are flowing through and starting to have some impact on margins. I'm just wondering, trying to hear from you and your perspective. What's the biggest take away when you've been going through this process of honing in on all of these drivers?
So a number of things, Mona. It's not just one line item. So I'll give you a couple of examples, obviously, the occupancy cost, we talked about consolidating office space, that's a big impact. The accounting rules mean you have to take at least exit liability up front, but it's a long-term benefits of having lower surplus space out there. So we're continually focused on that. When it comes to things like other lines of business, travel and entertainment, is a big line item for us. We've really curtailed travel to just necessary travel. We've implemented new programs, for example, around our corporate card program, which gives us a lot more efficiencies and information visibility into our spend. Utilization is probably the biggest item where we're continuing to evaluate the demographic mix of our staff and the utilization. Certainly, trying to get -- make sure we're rightsized in each of our business units. This is not a broad brush approach. You have to be somewhat surgical in how you deal with utilization. And you really do have to look at it in a local area and look at the work backlog that we have and match our staff, so we're being very focused and disciplined in going about evaluating discipline -- or utilization. So it's always all of those type of things we're looking, as Gord said, at everything to make sure that we're optimizing our business where we can.
And this -- Mona, this will always be ongoing. It's just continuous improvement. We've invested in technology and collaboration tools to allow people to be more efficient to, which means they don't have to travel to be able to collaborate effectively. So we're really pushing the utilization of these tools to get more efficient. And at the same time, reduce some of these travel costs and things, as Dan, mention.
Okay. That's great. And just on that some of those you surgically looking at, these line items, and trying to overall reduce cost. Is some of that already factored into your guidance? Or is there potentially further upside down the road?
I think we expected when we set our guidance at the beginning of the year that, that we would achieve these targets. I'm not suggesting that by doing this that we will have a massive increase in the targets that we set. So -- but we had certainly expected when we set these that we would achieve certain utilization ratios of which we're still targeting that.
And with no further questions, I'd like to turn the call back over to management for any additional or closing remarks.
Well, I just want to say thanks again for everyone for joining our Q1 earnings call. We think we feel that we've -- we had a good quarter. We feel things are -- will be continued improvement for the remainder of the year. Enjoy the rest of your day.
And once again that does conclude our call for today. Thank you for your participation. You may now disconnect.