Stantec Inc (STN) 2004 Q4 法說會逐字稿

Thank you for holding for the Stantec Inc. earnings conference call.

I would like to introduce your chairperson, Mr. Tony Franceschini.

Thank you, Janet, and good afternoon, everyone, and welcome to our 2004 fourth-quarter and annual results conference call.

Joining me is Don Wilson, our Chief Financial Officer, and we will both be available to answer any questions you may have at the end of this discussion.

As always, I would like to mention that this conference call is being broadcast live over the Internet and will be archived for future reference at stantec.com under the Investor Relations section.

We would also like to ask any members of the media who are joining us today in a listen-only mode and who wish to quote anyone other than Don or me to please request permission to do so from the individual concerned.

As usual, we will provide some brief comments on our results and the outlook for our markets, and then Don and I will address individual questions.

This morning we released the results of Stantec's operations for the year and the fourth quarter of '04.

I am pleased to report record performance in 2004, marking our 51st consecutive year of uninterrupted profitability.

Our success this year once again proves that Stantec has the momentum to continue to succeed in a challenging business environment.

For fiscal year end 2004, gross revenue increased to 520.9 million, up 13.2% from 2003.

Net revenue increased to 449.2 million, up 14.8%.

Net income increased to 30.2 million, up 20.4%.

And basic earnings per share increased to $1.63, up 19%.

As indicated in this morning's press release, a more favorable overall tax rate contributed to this performance, resulting from increased earnings and lower tax jurisdictions, as well as from income generated by our insurance captive.

Now I would like to review some of the highlights of the past year with you.

In 2004, we implemented improvements to our internal systems' infrastructure.

This activity was a successful conclusion to a three-year project that now provides us with robust systems and processes for growing the Company and integrating larger acquisitions.

Some additional results and benefits of this successful implementation were starting to materialize in Q4, particularly the improvement in our cash position.

We also strengthened our Company through the acquisition of four firms.

In April, we acquired the Sear-Brown Group, which added the biopharmaceutical sector to our practice areas, as well as a new region in the U.S. Northeast.

We also expanded and added depth to our Architecture & Interior Design group, making it the largest in Canada and one of a very few national practices.

This was achieved through the integration of GBR Architects in Winnipeg, Manitoba in May and of Dunlop Architects in Toronto, Ontario in October.

And we welcomed some new colleagues from Shaflik Engineering in Vancouver, B.C. in November to enhance our expertise and capabilities in the electrical engineering for sports facilities and transportation systems.

Our strength and stability are a direct result of our business model, through which we complete several thousand projects each year for clients throughout North America, the Caribbean, and our other areas.

I would like to highlight just four assignments that we worked on in 2004 to illustrate our ability to undertake diverse projects of any size for both the public and private sectors in our industry.

In Toronto, Ontario, we are providing environmental engineering services for an upgrade of the Ashbridges Bay Wastewater Treatment Plant, Canada's largest wastewater treatment facility.

Scheduled for completion within a 7- to 8-year timeframe, the project will address order problems that have been a concern for local residents for many years, as well as involve a major conversion of the plant's aeration system and an upgrade of the grid and screening facilities.

In Niagara Falls, New York, we are providing architecture, interior design, and building engineering services for the development of a new airport terminal at the Niagara Falls International Airport.

This is our first terminal design project in the U.S.

When complete in 2006, the facility will serve as a gateway for scheduled charter airline traffic to the many tourist attractions in the Niagara region.

Our skills are also being used in detail design and engineering of one of the most challenging downtown corridor section, covering about 8.25 miles or 13.2 km of the Central Phoenix/East Valley Light Rail Transit system in Phoenix, Arizona.

And we are providing engineering services for all phases of the development of two new world-class oral, solid-dosage manufacturing suites for Wyeth Pharmaceuticals in Puerto Rico.

Now I would like to make some general comments about our market going forward.

One of our key markets in both the U.S. and Canada is the residential housing market, which accounted for about 35 percent of our business in 2004.

We expect this market to slow this year, both in Canada and the U.S., but to still continued to be a significant contributor to our business, because our urban land activity is principally focused in areas of growing population with relatively strong economies -- principally Alberta, southern Ontario, the Southwest U.S., and the Western U.S.

In the U.S., it appears that funding for a new T21 type five-year transportation program is closer to receiving approval, and combined with a recovery in state tax revenues, is likely to be a significant factor in increasing spending on transportation, the environment, and other public sector capital projects.

Our Canadian market should also benefit from the increased transfer of federal funding to the provinces for health care and the focus of yesterday's federal budget on environmental sustainability and increased funding for city and community projects.

Infrastructure and sustainable development are our business.

So overall, the long-term outlook for our services in all sectors remains strong, with demand generally driven by population growth, from enhanced government regulations, increased outsourcing of technical and design services, and the needs to maintain, upgrade, and replace the aging North American infrastructure.

So overall, we have a positive outlook for the infrastructure and facilities market for 2005.

This concludes our brief comments for today.

Don and I are now available to answer any questions you may have.

The conference call operator, Janet, will explain the question procedure.

(OPERATOR INSTRUCTIONS) Andrea McReynolds with Sprott Securities.

Hi.

First question just on the tax rate and it actually sort of ties into your insurance sub, because I know that that helped lower the rate in the fourth quarter.

Going forward, what are you expecting the tax rate to be for 2005?

It looks like there is just an overall lowering of tax rates, or lower run rate on the taxes, than what you initially assumed for the first part of '04, as well as the impact of new insurance sub.

And then on the captive insurance company, where was that on your balance sheet prior to this quarter?

Andrea, it's Don.

The expectation for tax rates is driven by our anticipated earnings in the each jurisdiction in which we operate and the effective tax rate in each one of those jurisdictions.

So there can be a fair bit of fluctuation depending on the profitability in each one of those jurisdictions.

But what we have indicated in the MD&A for 2005 is an effective tax rate of somewhere in the range of 33 to 35%.

And in terms of the captive, this is something that came up, if you recall, back in about 2002; the insurance markets started to harden up a fair bit.

And what occurred when we started taking a look at the renewal of our professional liability insurance policy back then was that we identified that there were opportunities for premium savings with insurers by taking on larger deductibles.

And what we have done with that self-insured retention is insured it ourselves through a captive insurance company.

And the investments within the captive and the cash that we have been carrying within the captive has been shown as part of cash and short-term investments in previous quarters.

The claims provisions that we have here and are now shown in other liabilities were reported as part of accrued liabilities in previous quarters.

Okay.

So, that's fine.

Well, I guess -- sorry -- I don't remember where exactly it is in your disclosure here.

But the breakout, wasn't that something like 9 million or something that you had for the captive in the fourth quarter in assets?

That is all in other assets?

Is that right?

I think if you take a look at Note 6, that discloses the investments held for self-insured liabilities of $9.5 million.

And Note 9, Other Liabilities, discloses the provision for self-insured liabilities.

Okay.

So the 9.5 million, did all of that -- I guess I am just looking at it comparing it to Q3.

Does all of that come in the fourth quarter?

No, it has been growing over the past few quarters.

And as I say, it has been, I think, included in cash and short-term investments.

Okay, that's fine.

Just a question on your gross margin and your G&A expense in the fourth quarter.

I think gross margins were higher than your normal range that you guide to.

They were over 57%, but G&A was a bit lighter.

Does that have to do with where the revenue was coming from, U.S. versus Canada?

And if not, can you highlight what was sort of influencing those two factors?

I think that you haven't really changed your guidance for where you expect those lines to run going forward, so I was just more curious as to what happened on the fourth quarter.

And also, can you actually give us what the revenue split was between U.S. and Canada for the fourth quarter?

In terms of the gross margin in the fourth quarter, I think if you take a look at any quarter in the past -- any period, the gross margin, as well as the administrative and marketing costs, do tend to fluctuate from quarter to quarter.

So there is nothing that I would suggest is a trend in the fourth quarter in terms of gross margin.

In terms of the guidance for next year, I think what we have indicated in our MD&A is a gross margin range of between 53 and 55% for 2005, and administrative and marketing costs of between 40 and 42% for 2005.

Okay.

Can you give the U.S./Canada split?

In the quarter specifically versus for the year?

You know, I do not have that broken out for the quarter at my fingertips here.

Let me see if I can find that and I will address it later in the conference call.

Okay, that's fine.

Tony, just one question for you, pretty standard question here.

How are things going on the acquisition front?

I know that timing is always an issue and I know you mentioned last time private equity, you're seeing some competition.

Any changes in the overall environment?

I guess one of these days we will be able to say we finally have one of the deals that we are following, that we've concluded them.

I think we said part of our approach has been to maintain the discipline.

And I keep telling you it's the same story as we have had really for the last year.

The opportunities are there.

Some are becoming a little more difficult to do.

We still have the same issues with either private equity and other firms.

A number of other people have started to enter the market.

They are all reading our annual reporting information form and they think that -- a number of other firms are starting to follow the same things that we are.

We still believe the difference in the end is going to be in the execution and the integration, so we are not concerned about other people.

But there is always a flurry over a short period of time when a number of new players enter the market and they sometimes tend to confuse the issue.

So yes, the simple answer is we don't have anything specifically to report; we're still optimistic that it's just a matter of time.

The pipeline is definitely there.

We are talking to firms.

And if anything, we are just moving to larger -- mid to larger size firms, as well as with some of the smaller deals that we've done in the past.

So I am still optimistic and just hang with us and one of these days we will continue with some of the acquisitions that we have done in the past.

Okay, thanks, Tony.

Andrea, just to finish off on your previous question, the revenue split -- and this is in Canadian dollars, of course, converted at the relevant exchange rate, about 35% of our revenue in the fourth quarter -- net revenue came from the U.S.

35 percent net revenue.

Okay, perfect.

Thanks, Don.

Richard Stoneman with Dundee Securities in Toronto.

A couple of questions.

First of all, the federal budget that came down last night, will that affect your tax rate this year and next year?

Richard, from what I have seen, we don't anticipate any current impact from the budget.

I think the numbers that I was seeing were that the surtax and the basic federal rate were going to be reduced beginning in about 2008.

I think there was some indication of the capital tax reduction beginning perhaps this year, but that is a pretty small number.

The liberals are not doing you any favors?

(indiscernible) stay out of political commentary.

And the tax rate in '05 and '06, similar to what it was last year?

It's really difficult, Richard, to predict for '06 what the tax rate might be because it really does depend on the split of income in every jurisdiction that we look at.

As you take a look at last year's MD&A and our expectation of the tax rate at that point when we drafted it, and then each quarter throughout 2004, we kept providing indications of lower estimates of tax rates based on what we were seeing and where the income was being earned.

It is pretty difficult to predict with any accuracy, but for 2005 we have indicated our best estimate is a range of 33 to 35%.

Okay, now in the primary markets that you operate in, breaking them into two segments, housing and other, have you seen any major shifts in any of your major markets in demand?

Richard, this is Tony.

I think that the simple answer for all four would be no -- that with respect to our firm, excluding whatever the macroeconomic indicators are, that the amount of work that we did in '04 in Southern Ontario, Alberta, and the Western/Southwestern U.S., which are our major land development markets, the amount of work we were doing on land was comparable to '03 and '02.

So as a firm, even though at the macro level there may have been in some cases a softening or a peaking in terms of where that overall number of housing starts in real estate development was, that we did not see that impact.

It was very modest if there was any.

But overall it was pretty well the same.

In '05 and '06, the macro projections, even in some of the key markets that we are in, in Ontario, Alberta, and the Southwest U.S., would suggest that the experts are predicting about a 10 percent drop in housing activity in both Canada and the U.S.

So if that comes to pass, it is certainly an order of magnitude number that we can absorb.

We're talking 10, 15 % reduction, we don't see that as being that significant for '05.

But like everyone else, we can't predict it any better than the next fellow.

We just sort of see from the projects we're doing that people are still optimistic about '05 and even '06, but the market will decide.

And in the infrastructure capital spending area, is that picking up or dampening down?

The infrastructure, the one area that we saw an improvement in '04 was the environmental market.

We are probably up a few percentage points overall in terms of the split of what we do.

And part of it is a reflection of -- and that's why I highlighted Ashbridges Bay project in Toronto -- that environment was clearly up.

Transportation was about flat, with a modest reduction in some areas.

And the reductions that we saw in '04 were not in Canada, but in the U.S.

And again, it is still tied it to that T21 long-term funding, which has effectively suspended or put on hold a number of projects.

So in some of our U.S. regions we definitely saw a slowdown in the transportation area.

But for the most part -- and I say that for the most part 00 the Canadian operations pretty well offset the reductions in the U.S. in the transportation side.

So the investment in Canada in transportation has been fairly strong, particularly in our two biggest markets, Alberta and Ontario, but B.C. as well in '04.

And finally, Don, the disclosure that you have on the breakout of organic and acquisition growth is the best I've seen and it's easy to understand.

Thank you.

Frederic Bastien with Raymond James in Vancouver.

Can you comment on the big swing in cash flow in the fourth quarter, please?

Yes, I can.

As a matter of fact, I think it is not just in the fourth quarter, but it is during the entire fiscal year.

If you take a look back at the end of 2003, one of the things that we pointed out there was that with the implementation of our new enterprise system, there was a learning curve and there were some process adjustments that we had to make.

And what happened was it took us a while to begin invoicing the clients using the new system; and if you recall, we implemented that new system in the fall of 2003.

So at the end of 2003, our investment in accounts receivable and work in progress in terms of measured by Days Sales Outstanding was up to 119 days.

And by the end of 2004, we had got that number back down to 101 days of revenue, which compares very closely to the Q2 2003 number, which I think was 104 days, so we are backed down to that pre-implementation range.

But what happened in 2003, if you take a look at our cash-flow statement for 2003, you see cash flows from operating activities was very light, and that was because of the growth in those two assets.

And in 2004, we have been able to reduce the investment in those assets back down to a normal level, which has brought the cash flows from operating activities up to a higher than normal level.

Are these good metrics to use going forward?

The DSO number?

Right.

At 101 days, that has been fairly close to about where we have been operating prior to implementation of the system.

Obviously, we would always like to improve on that number, but it becomes difficult once you get past that point to see too much more improvement.

Can you comment now on how Sear-Brown has been contributing and how well it is performing?

What happens with acquisitions is that that after a certain amount of time, it is more difficult to begin to break out any numbers related to a specific acquisition.

Because part of our strategy in terms of doing acquisitions is to integrate all of these operations.

I think one of the things that we talked about after Q2 when we did the acquisition on April 2, and that acquisition did have an impact on our Q2 results in terms of additional administrative costs and integration costs, and we were able to quantify those.

I think if you take a look at our year-end financials and the gross margin percentage, the admin cost percentage compared to last year and compared to prior years, we are now back into a normal range.

And as a result, I think that you can look at Sear-Brown and say it is part of our consolidated numbers.

One last question.

Are you foreseeing any significant CapEx this year?

Our CapEx in typical years probably runs somewhere between 3 to 4% of net revenue.

In 2003, it was a little bit higher because we completed the construction of our Edmonton office building and did the enterprise system, which resulted in some additional CapEx. 2004 was a little closer to a normal level.

Great, thank you.

Mike Cohen with National Bank Financial in Toronto.

I just wanted to get back to this additional income from the regulated insurance subsidiary.

I'm wondering first of all if you could just tell us how much that was, and specifically, where that is embedded on the income statement, to get a better idea of your margin in the quarter.

Mike, it's Don.

The captive is -- if you understand how the captive works, we charge our operating profit centers premiums for insurance at commercial rates, which is reflected as income in the captive.

But because it is consolidated, those are eliminating entries; so it is just transferring from one pocket to another.

So to the extent that we have reported income in the captive, all that means is that we have had costs incurred by individual profit centers that have not been reflected by external claims costs that we have had to accrue.

So what it really means is lower administrative costs.

Okay.

And can you tell us is that material?

What I can say is that from -- let me work back from the impact on income tax rates.

Because this is a captive that is incorporated and operates in Barbados.

And the Barbados tax rates on non-Canadian-sourced income are 2.5%.

The tax rates on the income that relates to Canadian-based risks are taxed at Canadian rates.

But the impact on our effective tax rate for 2004 was to reduce that tax rate by 1.2 percentage points.

Was all that a catch-up from previous years or is that just related to this past year?

As I mentioned before, we started taking a look at this in 2002 when the insurance market started to harden.

And it was in the fall of 2003 that we first set up the insurance captive.

So there was really no affect in 2003 whatsoever.

In 2004, the amount of claims liability that that insurance captive has to report was only -- we would only be able to estimate it during the year, and at the end of the year, it was made much clearer by an actuarial study that identified the liability we had for those claims.

So just to summarize, when you consolidate, it eliminates out and really only impacts your tax rate?

What happens, Mike, is that the claims costs that are shown as part of our administrative costs are lower than what we had estimated them to be earlier in the year.

And that profitability inside the captive has an impact on the tax rate as well.

All right.

And going forward, do you anticipate this to affect tax rate next year?

For example, you guided between 33 and 35%.

Do you see any impact in 2005?

We have built our expectation about what the profitability might be for that captive inside that range of 33 to 35.

I think last year, we were reestimating between 36.5 and 37.5% tax rate.

By the end of the third quarter, we had come up with an estimate that was closer to 35%.

And it was only in the fourth quarter that we had a much clearer picture of the claims liability for the captive, and that was a good part of what drove that tax rate down the fourth quarter.

I think just to clarify and to add to that is that we've only had a captive really since at the end of '03, and as part of that, we do do and will do an actuarial study each year.

And as you know with insurance, that in the actuarial study, the more information and history that you have, the easier it is to estimate that number.

So '04 was the most difficult year to estimate because it was our first year.

So once the actuarial study was done, I guess we maybe accrued a little bit more than the actuarial study indicated.

But with that background now going forward, we have better information and it gets better every year.

All right.

All my other questions have been answered.

Thanks.

Sara Elford with Canaccord Capital in Vancouver.

Most of my questions have been asked, but I have a question and I'm not sure you'll be able to answer it but I'd be curious as to whether or not you can give a bit of an idea.

Obviously, enterprise systems, the implementation of those, are reasonably challenging and can result in some distractions and other things relative to the ongoing business.

You did this particularly well relative to some other ones that I've seen go through this process that have been fairly devastating on the bottom line.

I'm just curious whether you have any gauge of what kind of impact you did see from that.

Do you have any idea as to what, had you not been going through that process, what perhaps your margins could have looked like or were they not materially affected by it?

Sara, they could have been awesome.

I think you hit on the head.

These are very, very challenging and I think everybody really has to chip in and do all this stuff.

It's a little bit difficult.

I think you can see -- and you've seen it, some of our G&A costs are up.

There is a little bit less time in terms of billable time; people are spending more time doing that.

We did have some extra outside consultants and so forth.

But we didn't try to break it all out completely because a lot of it is individual -- we have 4300 staff and maybe everybody wasted an hour a week -- who knows?

We have tried not to do it other than to say that it would be fair to assume that there was clearly a distraction and it did create some issues.

But given the type of staff that we have, I think the majority of our staff just put in extra time to make up for it.

So I think if you try to quantify it, probably the cost is high, but in terms of the actual impact, I think you're seeing some of it, but for the most part, people just put in extra time on their own time and stuff to get over it and make it happen.

And I also think we had a pretty good plan, with lots of backups and fallback positions and doing things manually when things weren't working.

So I can tell you from where I sit it's a big relief to have gone through that and have the infrastructure in place.

And the positive is that now we will be able to start to take advantage of some of the business intelligence components of it.

We really just started to scratch the surface.

We wanted to get the fundamentals down, and we had heard a lot of the same stories that other people had gone through, so that is why we tried to plan it a little bit better.

So some impact, but obviously went through it very well.

The other thing that I'm noticing just in terms of your guidance and it's been very slight, but your guidance for 2005 in terms of gross margin, the range has shifted up a point.

And then also your guidance on the G&A side, the range itself has shifted down a point.

Should I take from that and then also the tax rate range that you are also guiding to -- should I take that as your view that the U.S. market is going to be maybe a stronger market for you going into 2005 relative to 2004?

Or is that maybe not the right assumption?

We don't really want you to read too much into it.

We try to give you our best shot in terms of what we know.

And as Don said, we operate in over 20 different jurisdictions and so forth, and it's pretty difficult to always predict exactly what's going to happen in each one.

So everything is an aggregate, and we don't want to mislead anyone into saying take these as a certain type of interpretation.

But we are trying to provide the best ranges that we can, taking sort of our collective wisdom, for what it's worth.

Would you agree generally -- I read your comments on outlook and you discuss sort of a pickup in nonresidential construction -- the residential side staying reasonably strong relative to what it has been -- very, very strong markets over the last several years and then also some improvement on the States side.

It looks to me as though, as far as stars aligning, this is about as good as you guys can get.

Well, I hope we are all right in terms of forecasting, but I think if you look at the outlook from year-to-year, it is similar to our good years.

But the outlook is there, and again, we just have to execute.

Great, thank you very much.

Tim Caulfield with Salman Partners in Vancouver.

Just a -- the 110 days that we are now down to, can you break that out between receivables and estimated earnings in excess of billings?

It's 101 days and it's 27 days for work in process or what do we call it now -- costs and estimated earnings.

But of the 101, 27 is work and 74 in receivables.

Okay.

And I also noted there that you have sort of put in place some FX hedges.

Can you put some color on that, and is that protecting the U.S. earnings stream or what -- can you just give some color on that?

What it is, Tim, and we've talked about our exposure to foreign currency fluctuations.

There is three different exposures that we face.

One of them has to do with our U.S. earnings stream, and that, when you think about it, our U.S. operations earn their revenue in U.S. dollars and all of their costs, right down to and including income taxes, are denominated also in U.S. dollars.

So it is really only the net after-tax income that is subject to impact on foreign exchange.

So that is not a big dollar amount for us to think about doing hedging, especially when we are talking about thousands of projects that go on during any particular year.

The second part of the exposure has to do with our investment in U.S. subsidiaries.

And because the U.S. subsidiaries are designated as self-sustaining, any gain or loss in our investment in those subsidiaries is accounted for through the cumulative translation account that you see as part of shareholders' equity.

And so that, because it is just a balance sheet item, we don't hedge against that.

The third area is our Canadian subsidiaries that have U.S. dollar-denominated assets, such as Accounts Receivable, for example.

And we do have some operations in Canada that do work in the United States or do work outside of Canada that is denominated in U.S. dollars.

Their costs are in Canadian dollars, but their revenues are in U.S. dollars.

And when they produce an invoice in U.S. dollars, that is subject to fluctuating exchange rates.

So what we have done in the past is when we have created $1 million worth of receivables, for example, we will have gone out and borrowed $1 million U.S. to offset that and create a natural hedge.

After we sold the Edmonton office building late last year, we found ourselves in a position where we had no operating debt and no need to really go out and borrow in U.S. dollars.

So what we did to create an offsetting liability against those U.S. dollar-denominated receivables was to sell forward U.S. dollars and create an offsetting hedging transaction.

Excellent.

Thanks.

And my final question was the 1.2% impact that you are talking about from the insurance captive, is that a 1.2% impact in the fourth quarter or for the full year?

That is for the full year.

The impact --

Tell me what it was for the quarter.

What happens with the quarter tax rate is simply a fallout.

It's just a plug figure, essentially, for the quarter.

If you take a look at the end of the third quarter, our estimated tax rate for the year at that time was 35%.

At the end of the fourth quarter, the year-to-date tax rate becomes -- I think it was 32.4%.

And then the tax cost in the fourth quarter ends up just being a plus (ph) bigger.

It is not a number that you could look at and say here is a trend.

Okay, great.

That's perfect.

Thank you very much.

At this time, there are no questions in the queue. (OPERATOR INSTRUCTIONS) We have no questions, Sir.

Since there are no more questions, (technical difficulty) for '05.

So thank you very much and we will see you again.

Goodbye.

Thank you for participating in this Stantec Q4 2004 earnings conference call.

On behalf of myself and the rest of my teleconference team, thank you for choosing TELUS.