Stantec Inc
TSX:STN
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Stantec Inc
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Welcome to Stantec's First Quarter 2020 Earnings Results Conference Call. Leading the call today are Gord Johnston, President and Chief Executive Officer; and Theresa Jang, Executive Vice President and Chief Financial Officer. Today's call is a webcast, and Stantec invites those dialing in to view the slide presentation, which is available in the Investor section at Stantec.com. All information provided during this conference call is subject to forward-looking statement qualification set out on Slide 2, detailed in Stantec's Management's Discussion and Analysis and incorporated in full for the purpose of today's call. Dollar amounts discussed in today's call are expressed in Canadian dollars and are generally rounded.With that, I'm pleased to turn the call over to Mr. Gord Johnston.
Good morning, and thank you for joining us. I will begin our call today with a review of our response to COVID-19 to date, and then provide an overview of our first quarter performance. Theresa will then delve deeper into the financial results. Following the presentation of our first quarter results, I'll walk through each of our business units to discuss near-term drivers and potential impacts due to the pandemic. Theresa will then provide an update to our outlook before I return with closing remarks.Since the beginning of the COVID-19 outbreak, our highest priority has been to keep our people, our families, our clients, and our communities safe. We modeled our response based on our core values, which are shown across the top of the slide. Our first value is we put people first. To protect our people, and as part of our culture of safety, Stantec assembled a Pandemic Committee more than a decade ago. This group of operational, safety and other health experts monitored the outbreak, and we mobilized our response plan before the World Health Organization officially declared the pandemic. Secondly, we are better together. We quickly transitioned our global workforce to work from home. Our investments in IT and business continuity systems have allowed our people to continue to work together seamlessly to support one another and our clients. Our third value is we do what is right, which means we provided our employees with flexible work arrangements, and we are proactively engaged with our clients to provide services to meet their evolving needs. We've also taken steps to protect our balance sheet by significantly reducing discretionary spending.And our final value is we are driven to achieve. We continue to build long-term client relationships by supporting them through the crisis with innovative solutions and service offerings to meet their needs in responding to COVID-19. Our values have allowed us to respond rapidly to protect our people, to serve our clients, and to safeguard shareholder value.Against the backdrop of this disruption, I'm very pleased that Stantec delivered solid first quarter results that were in line with our pre-pandemic expectations. We drove a 5.7% year-over-year increase in net revenue, led in large part by 4.2% organic growth. Each of our regions and businesses generated organic growth in the quarter, with a particularly strong performance from the United States. Acquisitions delivered 1.4% growth, mostly in buildings.We saw strong organic growth across all of our business operating units. Growth was especially strong in energy and resources, environmental services, and water. Energy and resources achieved 10.5% organic growth this quarter, with contributions from every sector. Work increased on several mining projects in North America. We also saw higher activity from the TransMountain pipeline project, the Koysha Hydro project in Ethiopia, and our work on a tissue mill located in Georgia in the United States.Organic growth of 6.3% in environmental services was equally split between Canada and the United States. In Canada, environmental management work for infrastructure projects was up year-over-year. In the U.S., growth was more evenly split between oil and gas, mining, water, and power transmission. In water, organic growth of 5.7% was the result of several new projects. This includes the San Fernando ground water basin remediation project, which is a progressive design build to treat contaminated groundwater.5.7% net revenue organic growth in our U.S. operations was driven by water, buildings, energy and resources, and environmental services. We saw a slight retraction in infrastructure due to some localized challenges on certain community development projects. Gross margin in the U.S. was impacted by a number of projects in our transportation business transitioning from the higher-margin design phase to the lower-margin construction administration phase. 1.8% organic growth in Canada was driven by environmental services, energy and resources, and transportation. This was partially offset by a retraction in community development, water, and buildings. Our margins were impacted by increased volume of lower-margin work related to the midstream oil and gas sector, which is impacting energy and resources and environmental services. That said, utilization for our midstream sector is amongst the highest in all of our businesses, which, combined with minimal marketing spend, drives a solid EBITDA contribution.Global's 4% organic growth was driven by the U.K. infrastructure business, a strong quarter in water, partially offset by project wind-downs in power and dams and lower activity in environmental services in Europe. Margins in our global operations were primarily impacted by project mix and some ongoing pricing pressures for our services in the U.K. and Europe. In our U.K. water business, AMP7 is now well underway, and we've continued to ramp up in the delivery of contracts we secured last year with Yorkshire Water and United Utilities. We're also pleased to report a number of significant AMP7 project wins in the last quarter, securing further AMP7 frameworks for the next 5 years. The first is with Southern Water, where Stantec has been re-selected as strategic solutions partner for the new AMP7 period from 2020 to 2025. Under this contract, Stantec will support Southern Water across all areas of the water and wastewater business, including feasibility studies and outline design, project and program management, and water resource planning and environmental management.In addition, just last week, Stantec was awarded 2 significant packages of work for AMP7 with Thames Water, the largest water provider in the U.K. These include securing positions on the Thames Water project management office framework and on the capital delivery project management and assurance framework.At the end of the quarter, our contract backlog increased to a record high of CAD4.7 billion, which represents approximately 12 months of work. This was up 11% from year-end, with 5.9% of the increase due to organic growth.I'll now turn the call over to Theresa for a review of our financial performance.
Thank you, Gord, and good morning, everyone. Adjusted net income from continuing operations increased 8% to CAD54 million in the first quarter, and adjusted earnings per share increased 9% to $0.49 per share. This was largely due to a 5.7% increase in net revenue and lower administrative and marketing expenses driven by our cost reduction initiatives. Gross margin for the quarter increased 3.7% to CAD507 million. As a percentage of net revenue, gross margin was 53%. Admin and marketing costs were CAD367 million, representing 38.5% of net revenue. The 100 basis point year-over-year improvement is the result of our drive for operational efficiency and a focused reduction on discretionary spending. Adjusted EBITDA increased 10% to CAD140 million, representing 14.6% of net revenue, a 50 basis point improvement relative to the same quarter last year.Our balance sheet remains strong. At March 31, net debt to adjusted EBITDA, which typically expands in the first quarter, remained at the low end of our targeted range at 1.3x. We remain in full compliance with all financial covenants. Days sales outstanding was 86 days at quarter-end compared to our target of 90 days. DSO increased by 7 days since year-end partly as a result of contract terms that influenced the timing of invoicing, as well as slight disruptions in payment processes for some of our clients due to COVID-19. Bear in mind that DSO at year-end benefited from the receipt of certain milestone-based payments.We remain focused on invoicing and collection activities, but also anticipate that DSO may increase over the balance of the year. Given our strong mix of public sector clients and high quality of our private sector clients, we do not believe our credit risk has increased meaningfully as a result of the pandemic.Moving on to liquidity and capital allocation, our free cash outflow for the quarter improved by 38% compared to Q1 '19. Operating cash flows for continuing operations, typically an outflow in the first quarter, were CAD45 million, a CAD43 million improvement compared to Q1 '19. The improvement was driven by an increase in cash receipts from clients and a decrease in cash paid to suppliers. Cash flows used in investing activities were CAD21 million, a CAD78 million decrease compared to Q1 '19 when we funded the Wood & Grieve acquisition. Capital expenditures were also lower this quarter compared to Q1 '19.We used CAD24 million for net financing activities compared to cash inflows of CAD62 million in Q1 '19. This quarter, we saw a CAD65 million net reduction in drawings on our revolving credit facility, a CAD21 million increase in share repurchases, partly offset by a CAD20 million increase in proceeds from the exercise of stock options. I'll hand the call back to Gord now to review our 2020 outlook.
Thanks, Theresa. Turning to our outlook for the remainder of the year, the pandemic has created an unprecedented degree of uncertainty. While we are not able to reliably forecast the financial impact for 2020, we can give you some insights about the key drivers to our business. Our business is well-diversified across geographies and sectors. We've learned the importance of maintaining a balanced mix to guard against over-exposure to any particular end market, and we feel that we've achieved a good balance. Client mix is also important, and our weighting towards public project, and those for which the end client is a public agency, is now more than 50%. Having said that, no one will be immune to the impacts of the pandemic, including us. Water will likely be the most resilient of our businesses, and we are actually seeing an acceleration of contract awards in the U.K. We see strong investment drivers continuing here, as well as the potential for government stimulus spending. Infrastructure is holding up quite well, with the vast majority of projects continuing without interruption. The maintenance deficit in global infrastructure will require continued investment, and this space also has the potential to receive government stimulus spending. We have, however, seen a slowdown in community development, which you might expect.Our buildings business is currently very busy assisting healthcare institutions and governments in addressing the COVID-19 pandemic. This includes the design of temporary hospital facilities, like McCormick Place Convention Center in Chicago, and the retrofitting of isolation wards into existing hospitals. We expect to see a decrease in commercial and hospitality projects in the near- to mid-term. But COVID-19 will likely shift the paradigms for workplace, education and healthcare environments, and we are well-positioned to help transition these spaces to what will become the new normal. Even though most of the work we do in environmental services is for the private sector, we continue to benefit from investments in environmental stewardship, renewable energy, and Greenfield developments. An example of this is the midstream contract we won in Q1 to provide environmental services to LNG Canada for the construction and commissioning period for the LNG project in Kitimat, British Columbia. While lower commodity prices will be a headwind for our mining and oil and gas sectors of energy and resources, we see continued support for the renewable power sector. In our oil and gas group, the majority of our activity supports the midstream sector, which continues to proceed on schedule thus far. Our exposure to the more challenged upstream oil and gas sector remains immaterial at less than 1% of net revenue in Q1 2020. We also anticipate there will be opportunities to participate in the recently-announced orphan well remediation program for western Canada.So as we stand back, we see our business as being quite resilient to the impact of the pandemic, noting that water and infrastructure, among our largest businesses, are expected to be the least impacted.I'll now turn it back over to Theresa to review our Q2 outlook.
Thank you, Gord. So while we aren't able to reliably forecast our financial results for the full year, we do have a line of sight to Q2 relative to our first quarter results. We expect nominal organic net revenue retraction for Q2, partially offset by the expected continued benefit from a strengthened U.S. to Canadian dollar exchange rate. More than 50% of our net revenues are generated in the U.S. In the U.S., we expect Q1 revenues to remain relatively consistent with Q1 before the expected benefit of foreign exchange, as project delays in the commercial sector of our buildings practice and the completion of certain water projects are expected to be offset by the continued ramp-up of activity on major infrastructure projects. In Canada, we expect nominal net revenue retraction in Q2. Our global business is experiencing some delays in private sector work, and these challenges are partly offset by recent project wins in water.Given the unprecedented uncertainty facing the global economy, and our inability to provide a reliable forecast of net revenues for the second half of 2020, we are withdrawing our guidance for the balance of the year. We remain committed to strong project execution and driving solid gross margins. We're monitoring the quality of utilization for our fixed fee contracts in particular, which make up less than half of our total portfolio. And while we're on solid financial footing, we've taken steps to further bolster our resiliency. Our Board and senior leaders have taken voluntary reductions in compensation, and discretionary spending has been significantly reduced. We've implemented a number of staffing strategies that are intended to preserve the quality of our workforce to ensure that we're positioned to quickly rebound when the economy begins to recover. We'll work diligently to maintain administrative and marketing costs at or below 39% of net revenue, the upper end of our previous target range.As previously mentioned, our balance sheet remains strong. Based on our internal modeling, we expect to remain within our 1x to 2x leverage range throughout 2020. With no near-term debt maturities that require refinancing, and in addition with more than 70% of our debt at a floating rate, the current low interest environment will provide a tailwind. We have ample liquidity, with more than CAD250 in undrawn capacity on our revolving credit facility. We also have access to an additional CAD600 million in funds, if required. We remain committed to deploying capital to generate the best risk-adjusted return for shareholders. All non-essential capital expenditures have been put on hold. We've paused acquisition activities, but remain very well positioned to act when an opportunity presents itself. And we're adjusting to the realities of the current environment. We remain committed to returning capital to shareholders through the payment of a dividend. And while we were active in repurchasing shares during the first quarter, we've slowed this activity.And I'll hand the call back to Gord now to wrap things up.
As the pandemic continues to unfold, we remain focused on monitoring and responding to potential impacts to our clients, our communities; and, most importantly, our employees. Our end markets have proven to be resilient in past downturns, and we are better positioned than ever to weather the impacts of this downturn thanks to our increased geographic and business diversification. Our balance sheet is in great shape, and investors should take comfort in our solid cash flow, low leverage, and robust access to capital. Our core value of putting people first has never been more important, and I want to extend my heartfelt thanks to our employees for supporting our clients and our communities as we continue to navigate these exceptional circumstances together.And with that, we'll open the call to questions. Operator?
[Operator Instructions] Our first question will come from Jacob Bout, CIBC.
Could you provide a bit more granularity about the risk in the private sector? What areas do you think is most vulnerable? And then maybe about the collection of receivables in the private sector to date?
Sure. Well, I'll start talking about the private sector overall, and then Theresa can talk more about receivables.So from the private sector, as we've said, in western Canada, the majority of the work that we do, and everyone has thoughts, of course, first [about] oil and gas. But our work in oil and gas in Canada is really related to the midstream pipeline sector. And so we're seeing there, between our work on TransMountain, our work on Coastal Gas and so on, we're not seeing any concerns there.One area where we're seeing a bit of trepidation, I think, just from a confidence perspective, is with private sector land development clients. We're seeing a bit of that in the southern United States. We're seeing some of that, some of the planning work that we had anticipated would come in in the U.K. The latter part of last year, I think we've mentioned before, was a bit slow as developers were looking for certainty related to Brexit. And now, we see that, now that the COVID uncertainty has caused a little bit of confidence issues with some of those developers, as well. So those would be the two main areas that we'd be looking for in the private sector. And over to Theresa on the collections side.
Sure. So, I think the first thing I'd say is that we're obviously monitoring it very closely. And we haven't yet seen really any shift in the behaviors in our receivables. And so that's positive. Our cash flow appears to be in line with our expectations, as well. So we're not seeing much of a change there yet.In terms of our overall receivable profile, it's interesting. If you look at our balance sheet, we've got about CAD1.3 billion that comprises our receivables and our [WIP]. And as we look at our 10 largest clients in North America, that doesn't represent a disproportionate piece of those receivables or [WIPS]. In fact, our largest client with receivables and WIP outstanding makes up about 3% of that, and then it just kind of goes down from there. So that really speaks to the strength of the diversification of our portfolio. And I might add as well, that is the top 10 clients that I just referred to, those are all largely well-capitalized companies, or federal or other large government agencies. So we don't believe that there is really any significant risk at all where it comes to our receivable profile.
And is there much of a difference in DSO between private and public?
No, not really. I don't have a statistic off the top of my head for this. We look at DSOs more broadly. We don't tend to see much of a difference at all.
My last question here, just along the lines of what you're learning from the pandemic so far, what changes are you thinking about, longer-term, that you can make on how you're operating. Obviously, working from home, less travel, along those lines, what are you thinking right now?
I think the first learning that we had was just how incredibly resilient our employees have been. As we've moved them home, as we've gotten set up on our IT systems, it's been extremely -- we've seen the productivity continue very strong. So really pleased with the strength of our overall employee base.But certainly, some of the other things that we're looking at is, as we begin to move these people back to the office, what percentage of them will we need to bring back? And then, what would be the long-term impact, the short- and long-term impact on real estate? But the other thing that we've been talking about quite a bit is we've seen how efficient we can be working remotely, working via Skype and videoconferences and so on. So I do think that you'll see a reduction in travel for meetings, going forward, because we've found that we can operate extremely efficiently without having to get people on airplanes all the time and really utilize the technology that we've invested in over the last couple years.
Our next question will come from Mona Nazir, Laurentian Bank.
So, firstly, just in regard to your guidance for Q2, which is appreciated, the nominal retraction that you're seeing in Canada and the U.S., I'm just wondering if you could share what you factored in for the energy and resources or environmental segments. Is it safe to assume, particularly for the energy segment, that it turned to contraction from the 10.5% organic growth in Q1?
Our environmental services and energy and resources, a lot of that work that we're doing in Canada in particular is related to the midstream pipelining work, so I don't see a significant retraction there. In Canada in general, where we were thinking is that the overall Canadian economic picture was never forecast to be as strong as the U.S. going into 2020. So as we're early into Q2, we're not seeing a lot of the typical ramp-up in field programs and project starts and so on that we would see this early into the second quarter. But again, we're only a month in, so as provinces and others begin to open up, we may see some additional strengthening of that. However, the slower Q2 ramp-up, coupled with the overall weaker Canadian economy, is really what made us forecast that NR might retract nominally from Q1 in Canada.
That's helpful. So just to confirm, for Q2, you have not factored in -- you're still seeing work, and you haven't factored in a material contraction?
That's correct.
And in your MD&A outlook, you speak about preserving the quality of the workforce so that you're well-positioned to quickly rebound. I'm just wondering, given your guidance for Q2, if you could speak about the balance of maintaining a certain margin profile in keeping staff. I'm just wondering, have you identified certain thresholds or time periods? And where are your thoughts on preserving workforce, and how could that change?
So, what we did, Mona, at the very beginning, we developed an overall playbook to help us as we were thinking about workforce management through this. So we gave people options, such as rather than having to move to a layoff or a furlough situation, we'd look at things like a reduction in hours or a work sharing, or if people wanted to use up some of the banked time that they had in jurisdictions where we're allowed to bank time. So we're looking for a lot of alternatives in order to have people not charging time if they weren't busy, of course, but also to maintain that staff load, to the best that we could, through it.So I think you're right, that that whole workforce management is very, very important, because as we come out of this, and I think nobody is really sure what the recovery will look like, we want to ensure that we have the staff that we need to respond to appropriately, but through those strategies, like work sharing, reduced work weeks and so on. And I should clarify, we have not asked our broader employee base to take a salary reduction. We want to keep those folks with us and engage the best we can so we're in best position for the recovery.
And just lastly for me, just wondering if you could give us some insight into the type of conversations that you're having with customers in your end market and where you're seeing some of the most significant pivots. I know that you touched on water accelerating, for example.
Right. Well, it's interesting. As we've talked to a number of different levels of government, we're hearing some discussion about what projects might there be available that we could pull forward from a subsequent year into this year. And of course, we're on the front end to that with the environmental work and the design work that needs to be done. They're looking to what projects can we pull forward to even increase capital spending in 2020 and early 2021 so that we can get these projects out on the street and get people working again.So, certainly in the public sector, we're hearing a lot of talk about potential stimulus programs, what shovel-ready program projects might there be that they could advance. And so I think pretty positive from that perspective, but, again, we haven't seen any programs announced yet from an infrastructure stimulus perspective. But I think I'm still encouraged by the amount of discussion that we're having on it.
Our next question will come from Benoit Poirier, Desjardins Capital Markets.
First question, when we look at your backlog, it grew 5.9% organically on a sequential basis, so that was a nice achievement. Could you talk about what drove that sequential increase and whether it's sustainable in light of your bidding pipeline you see in front of you?
Thanks, Benoit. We saw an increase in backlog in each of our Canada, the United States, and global. So it was probably -- it was very broad-based. And certainly, we saw a lot of great water projects coming in in Q1. We saw some good transportation projects. So I think we feel pretty good about it. We have seen the cadence of new RFPs issuance did slow a little bit near the end of Q1, and we saw that a little bit through April, as well.Now, we've seen a bit of strengthening in that in some jurisdictions in [indiscernible], but I think it's probably still a little bit lower in terms of new project RFPs than we would typically see this time of year. But we're hopeful, as I mentioned into Mona's questions, would be the discussions that we've been having with various government clients in particular, that they're looking to bring some projects forward. And if they do, then as soon as people hopefully can get back to the office, we'll see the issuance of some of those RFPs and, hopefully, we'll see that return to a more normal level. But again, time will tell.
With respect to the government stimulus, you mentioned that there is a lot of discussion that are taking place, although we haven't seen anything yet. But more specifically, about the CAD1.5 trillion that was recirculated by Mr. Trump lately, could you talk about that potential opportunity and maybe whether it might materialize, and the timing, and which sector would benefit the most, Gord?
Sure. Typically, as we look at a lot of this infrastructure stimulus, I think that we would be -- it's hard to speculate, but the discussion typically goes along the lines of transportation projects. But I think we might also see some support for healthcare, going forward, as we talk about either healthcare facilities or those sorts of things. So I would suspect some areas there. Certainly, we hope to see some in the water space as well, but, again, it's all just speculation at this time because I haven't seen any details on any sorts of programs.
Obviously, given the travel ban restriction, you mentioned in the past that little bit tougher to perform due diligence. But could you maybe provide an update on the M&A opportunities and whether it's still ongoing in terms of discussion, and whether we might see some to materialize in 2020? Thank you.
We still think, Benoit, that if things go the way we hope, and from a recovery perspective, we certainly would like to bring a few across the finish line in 2020. We have a number of ongoing discussions in various levels of the process, but there's a couple things that we need to work through. We can do a lot of the due diligence through DataRoom, with a number of these firms that we're in discussions with. We've already met with senior leadership. We're very comfortable from a cultural perspective.But near the end, we still want to get in front of people, look at the whites of their eyes a little bit, and talk about projects, perhaps even talk with some clients to make sure that the long-term client support will still be there. I think we also want to have a good look at valuation now. We typically look at valuations based on performance historically. And assuming that that performance would be similar, or with some synergies, we can improve it, going forward. But the issue is now we really have to get a level of comfort with what the performance would look like, going forward, before we'd want to confirm our valuation.
[Operator Instructions] Our next question will come from Ben Cherniavsky, Raymond James.
Nice to see you got some of your mojo back in quarter. I wanted to just ask a little more about, obviously, the outlook for the rest of the year. I respect the difficulty of providing guidance, and that makes sense to me. But you did make some comments on what you've seen second quarter in terms of activity in your projects. But if I recall correctly from past downturns, yours is a little bit of a lagging business. The stuff that's broken ground continues for several months and quarters. It's a question of how you refill that pipeline, going forward, for, say, back half of the year and next year.Without getting granular about the numbers, just directionally, am I thinking about that correctly, that if you're going to see a more material impact from COVID and from some of the markets outside of, say, infrastructure, some of the private markets -- because, clearly, the macro variables are flashing red all over the place, that that might show up a little later as your business lags and you try to replenish the backlog?
Yes, I think you're right that we saw, certainly not just in our business but the overall industry, didn't see a big hit quickly like some of the consumer, hospitality and airlines and so on did. And so I think Q1 is still reasonably solid, and we've provided some color there for Q2.It's interesting. As you look at the significant increase in backlog that we saw in Q1, and so those projects we'll see starting up through Q2 and into Q3 and Q4. Hopefully with that will come some public infrastructure spend that'll come and will help to continue to fill the backlog and bolster that. But I think your point on private is a very good point, because we don't really know what our private sector recovery might look like.So as we're looking, and I think we had a little color that we do expect to see a bit of a downturn in the commercial buildings market. I would expect to see our community development, or land development business slow a little bit as well, just from an overall industry confidence perspective.So I think that's one of the reasons why we really thought that we wanted to withdraw guidance, just because there's -- until we have a little bit more certainty, it's really difficult for us to speculate.
Right, but, I mean, I'm not even really talking about how the recovery looks yet. I mean I hope we've found bottom, but we're clearly in a retraction mode now. But I guess my point is the impact of that gets felt several quarters out for just generally in your industry, particularly, like I said, on the private side. There's a lag there, right?
Right. I think that's exactly right, Ben. So if we see a real lack of private work coming in, it will be a couple quarters when we'll see more [indiscernible] in our business.
Right, and that's consistent with what we've seen the last couple downturns that you guys have had, I think. So I just wanted to confirm that nothing had changed.
[Operator Instructions] Speakers, at this time, we have no further questions in the queue.
Great. Well, I just wanted to thank everyone for joining us on the call today. I know it's a busy morning with a lot of calls there, so certainly we appreciate you spending some of your time with us. And we look forward to chatting with you through the quarter. Thanks very much.
Thank you.
Thank you very much. Ladies and gentlemen, this now concludes today's conference. You may disconnect your phone lines, and have a great rest of the week. Thank you.