Stantec Inc (STN) 2017 Q1 法說會逐字稿

Welcome to Stantec's First Quarter 2017 Earnings Results Call.

With us today from Stantec management are Bob Gomes, President and Chief Executive Officer; and Dan Lefaivre, Executive Vice President and Chief Financial Officer.

(Operator Instructions) Today is May 11, 2017, and this conference will be recorded and broadcast live over the Internet.

It will be archived for future references at stantec.com under the Investors section.

Any members of the media who are joining in on a listen-only mode and who would like to quote any other than -- quote anyone other than Mr. Gomes or Mr. Lefaivre must ask permission from the individual concerned.

Stantec management would like to caution you that this call will include forward-looking statements and forward-looking information [within] the meaning of applicable U.S. and Canadian Security Laws.

By their very nature, forward-looking statements require Stantec management to make assumptions that are subject to inherent risks and uncertainties.

Stantec management would also like to mention non-IFRS measures.

I would now like to introduce your host, Mr. Bob Gomes.

Please go ahead.

Thank you.

Good afternoon, everyone, and thank you for joining us for Stantec's First Quarter 2017 Earnings Conference Call.

For those of you following the slide show, we're now on Slide 3.

I'll open the call with some introductory comments and then Dan will provide a more detailed summary for the quarter's results.

After Dan provides his commentary, I'll offer some brief operational highlights and our outlook for the remainder of 2017.

Following that, I'll ask our operator to open the call for questions.

Please note that a copy of the slide show is posted on stantec.com and it will be archived in the Investors section of the website.

Today, we released the results of Stantec's operations for the first quarter of 2017.

Stantec had good operating results in the quarter, led by acquisitions completed in 2016 and organic growth in our water and infrastructure business operating units which together make up nearly half of Stantec's gross revenue.

Operations in the United States also experienced organic revenue growth.

We are also pleased to see that the range of organic revenue retraction we've experienced in some areas of our business is trending in a positive direction.

Retraction decreased from 4.4% in the fourth quarter of 2016 to 2.4% in Q1 '17.

Growth of our new construction services business segment is meeting expectations, driven mainly by large project wins in the United States.

Earlier this month, we finalized the sale of Innovyze Inc., the software -- water software solution firm that was part of our acquisition of MWH, for gross proceeds of USD 270 million.

Selling Innovyze was the correct strategic choice as there were no synergies that could be applied to our core business and this sale allows both companies to prosper with the best available resources and support.

This transaction results in a reduction of goodwill, intangible assets and debt.

Unfortunately, the way we're required to record this transaction has a negative impact on our reported financial results.

Our operational results paint a truer picture of Stantec's performance this quarter, which are in line with our expectations and which are trending in the right direction for 2017.

Even these adjusted operational results were impacted by the continued full integration efforts of MWH and the investment in that strategy.

Those impacts will dissipate over the second half of this year.

Now Dan will review our financial results for this quarter and explain the impact of the Innovyze sale in a little bit more detail.

Dan?

Thanks, Bob.

Hello, everyone.

This afternoon, I'll start with our Q1 results.

As Bob has pointed out it's been a good quarter, notwithstanding the impact of the Innovyze sale, which is a positive move for the long term but will have some impacts in our reported results through 2017.

These impacts will make it necessary for us to report adjusted results, something that we said we were not going to do for the rest of 2017.

We are doing this, however, in the interests of providing clarity and transparency so investors get a true picture of our core operating results.

Gross revenue increased 69% to over $1.2 billion.

This was mainly due to acquisitions both in Q1 '16.

Revenue was also impacted partially by organic gross revenue retraction in some of our business operating units and the strengthening of the Canadian dollar.

Gross margin increased to 54.1% in Q1 '17, mainly due to the mix of projects.

EBITDA rose to $89.8 million this quarter, an increase of 35%.

Administrative and marketing expenses increased slightly as a percentage of net revenue, 43.6% in Q1 '17.

This increase was due to higher marketing and business development and labor costs and the continuing integration of MWH, in large part, related to IT costs.

Labor expenses will fluctuate due to lower utilization in the winter months and the mix of clients and projects along with the number of acquisitions completed in each quarter.

We are continuing to report adjusted diluted earnings per share this quarter and we're also reporting adjusted net income since we believe these measures better explain our operating results.

Net income was impacted by a $90.4 million tax charge stemming from the recently completed sale of Innovyze, MWH's water software solution company, as Bob had mentioned in his opening remarks.

Note that the divestiture amounts reported are subject to change due to balance sheet adjustments and foreign exchange fluctuations as we finalize the accounting in Q2 '17.

Excluding the tax impact from the sale, our net income for Q1 '17 would've increased 5.9% over Q1 '16 to $32.4 million.

Adjusted diluted earnings per share is stable at $0.40.

Moving to Slide #7.

The impact of the Innovyze sale, the $90 million deferred tax charge decreased our diluted earnings per share by $0.79 in Q1 '17.

We've also provided additional information reflecting the estimated pro forma impact the Innovyze sale will have one our Q2 and 2017 year-to-date earnings.

The net proceeds of the sale will allow us to reduce an estimated $290 million of goodwill and intangible assets, pay down about $200 million of our debt and results in a pretax accounting gain of about $53 million.

The tax charge does not impact our liquidity, our cash flows from operating activities or our debt covenants this quarter.

You can review all of this information on Page M29 of our Q1 MD&A.

Our 2017 targets, we're on Slide #8 now, remain as outlined in our 2016 annual report.

At the end of Q1 '17, we met our target for gross margin as a percentage of net revenue at 54.1%.

EBITDA as a percentage of net revenue is at 10.3%, below our targeted range of between 11% and 13%.

However, we do expect to achieve this targeted range by the end of the year.

Administrative and marketing expenses as a percentage of net revenue are at 43.6%, just above our target of between 41% and 43%.

This is typical in Q1 as seasonality has an impact primarily related to lower staff utilization in the winter months and, as we noted, the integration-related costs.

We reported a loss as a percentage of net revenue this quarter of 6.6%, again, because of the tax impact from the Innovyze sale.

Without the deferred tax impact, adjusted net income as a percentage of net revenue was 3.7%.

A cash dividend of $0.125 per share was declared to shareholders of record on June 30, 2017, and will be paid on July 13, 2017.

We believe that we will meet our 2017 annual targets given our robust work backlog, anticipated revenue growth and reduction in admin and marketing expenses.

With that, I'll hand things back to Bob for some operational highlights.

For those of you that our following along on the slide show, we're moving to Slide #9.

Thanks, Dan.

The takeaway for this quarter is that we've achieved good operating results and are trending in the right direction in accordance with our expectations.

It was a good start to the year and we expect our results to improve throughout 2017.

As I mentioned previously, we are seeing overall organic retraction at a reduced rate and we expect this rate of improvement to continue throughout the rest of '17.

As you can see, on Slide 10, our infrastructure and water business operating units performed very well this quarter.

Together, they make up nearly half of our total business.

Infrastructure achieved organic gross revenue growth of 2.3% over Q1 '16.

This was due to strong organic growth in the United States transportation sector and stability in the Canadian transportation activities.

We're in good shape for continued growth in this sector thanks to our strategic market position in bridge inspection, bridge projects, program management, roadways and light rail transit.

Overall, our transportation business is benefiting on both sides of the border from the continued interest and attention to investments in infrastructure.

Stantec's water business operating unit achieved organic gross revenue growth of 2.2% over Q1 '16 with growth occurring in both Canada and the United States.

On to Slide 11, for those of you following along.

Our Environmental Services business operating unit had stable organic revenue in Q1 '17 compared to Q1 '16.

This business operating unit continues to be impacted by low commodity prices and reduced capital spending, leading to project delays and cancellations.

We're seeing more request for proposals, though, and because of our strong client relationships and expertise, we're continuing to win a stream of generally smaller projects in North America.

Energy & Resources continued to retract because of weakness in the oil and gas sector in Canada and the Middle East.

That being said, the oil and gas sector within Energy & Resources and Environmental Services now represents just 6% of Stantec's overall gross revenue and the pace of retraction has definitely slowed.

We continue to see signs of a stabilizing environment in our oil and gas and mining sectors, which is good news after the last 3 years of retraction.

Our position in these sectors provides us a market-leading opportunity to take advantage of a future recovery.

Our Buildings business operating unit experienced organic revenue retraction compared to Q1 '16 but it should be noted that Q1 '16 was a very robust quarter for buildings.

The retraction is, again, due to continued weakness in the Canadian and Middle East oil and gas sectors which affected public and private spending.

Also, we pursued and won a number of P3 projects in Buildings recently, but those won't start generating revenue until later this year.

As Dan noted, the tax implications of the Innovyze sale will have a negative impact on our results for the rest of 2017, but the sale remains the correct strategic choice.

The software business is very different from the consulting business.

We also didn't want to divert management attention and capital to growing the software business.

It's not our field of expertise, so it made strategic sense to divest.

In the end, the sale allows both companies to prosper with the best available resources and it provides us with an opportunity to reduce debt by about CAD 200 million.

By divesting now, Stantec takes full advantage of the outstanding performance of Innovyze and the current market value of this firm.

We have unlocked that value for the benefit of Stantec's shareholders.

As noted on Slide 13, this quarter, we made substantial progress towards integrating MWH projects and financials into Stantec's systems and we are very pleased with our progress to date.

We've integrated items such as the benefits plan, payroll, IT, insurance and business networks.

We've migrated 15,000 MWH projects into our Oracle system and we're in the process of harmonizing our policies and practices.

We expect full integration of MWH to be complete in 2018, except for Construction Services which will continue to be operated as a separate business.

However, even though the construction business will not be fully integrated, we continue to explore and execute on the synergies of bundling our consulting and construction services on projects and with clients that benefit from that strategy.

It's always difficult when you merge 2 large organizations, but so far, we're seeing that it's a very good fit, and the staff are working well together.

We're very happy about how the integration is going.

We should be on track for achieving the USD 15 million in cost synergies by the end of the year and we're identifying opportunities and winning work together.

We expect to achieve our revenue synergies over the next year.

To review our outlook for the remainder of 2017, there have been no material changes to the expectations outlined at the end of 2016.

We expect to achieve a long-term annual compound growth rate for gross revenue at 15% through a combination of acquisition and organic growth.

For 2017, we anticipate continued economic improvement in the United States, increased infrastructure spending in both Canada and the United States, increased spending in the water and wastewater sector and strong spending growth in the U.S. transportation sector especially at the state level.

We expect a modest improvement in the energy and resource sectors compared to 2016, continued support for P3s in Canada with increasing opportunities for APD in the United States and a modest economic -- global economic growth.

Overall, 2017 continues to look better than 2016, with the clear majority of our business poised for growth, for stability and a small minority that may need more time to move into organic growth.

As we (inaudible) through the second half of 2017, we expect the efforts of the full integration of MWH to have less of an impact on our SG&A costs.

As you can see on Slide 15, we have a strengthening backlog of significant projects across a wide variety of sectors and geographies.

The projects listed represent just a small sampling of the work we have in our strong backlog.

To sum up, this quarter showed that consistent performance is the result of strategic acquisitions and the strategy of complete integration and effective management and delivery of a wide range of services across a larger global platform.

We built our business to adapt to changing market conditions industry drivers and client needs, and we're seeing the benefits of that strategy.

One final note.

We recently published our annual sustainability report, which reports on our ongoing commitment to social, environmental and economic sustainability, our sustainability performance for 2016 and our plans for this year.

I invite listeners to read the report on our website at stantec.com.

Thank you.

That concludes our presentation.

I will now turn it back to the operator to begin the Q&A.

(Operator Instructions) We'll go first to Yuri Lynk with Canaccord Genuity.

Can you provide some additional color on the G&A in the quarter and I guess going forward, specifically as it relates to the impact the MWH integration activities had?

It doesn't look or sound like there was -- these were necessarily costs or maybe it's more inefficiencies.

But just what's going on there and what happens in the back half to make -- to provide some better leverage on the G&A?

I think there's 2 things, Yuri, and we can't understate the utilization impacts in the first quarter.

That is really the impact on the rest of our business which isn't really driven by the MWH or the water business.

So areas like -- certainly, our Middle East was a little weak still.

The Buildings practice, still a little weak, again, a lot of time spent in [MNBD], and our Environmental Services, which is largely fieldwork, again, had some lower utilization in the winter months.

Throw on top of that the work that we're doing to integrate MWH, I expect that we will still see some utilization impacts in the second quarter as we -- as Bob mentioned, we migrated all the projects and everything.

Now it's getting them ramped up and learning the new process and new tools and new systems in order to be effective.

So we will see a bit of that impact still in Q2.

The other thing is there were some IT-related costs.

We moved all of our IT -- or all of our staff, certainly in North America and across a number of the other geographies around the globe, onto our single domain.

So there's some additional IT costs related in getting those people all up onto our same platforms.

Okay.

I mean, I'm just trying to square the commentary on the quarter with the results vis-à-vis the target.

So I just want to understand -- I understand the targets correctly, like, I thought that the low end of your targets would kind of account for seasonally weak quarters like the first quarter and vice versa.

So was the quarter in line with what you were expecting at the onset of the year?

Or was there some additional weakness somewhere?

I think there's a little bit of additional weakness in utilization, generally, as I described earlier.

But if you look at our EBITDA percentage in Q1 of '16, it was only slightly weaker than Q1 of '16, and we do expect that to improve as we get into Q2, in particular, Q3.

And we'll go next to Mona Nazir with Laurentian Bank.

I believe at the Analyst Day last June you stated that you allowed for some pricing concessions in the energy and environment sector.

And in the quarter, we saw these pricing pressures kind of persist.

I'm wondering the timing that you initially put through some of these rate discounts.

And can you speak about the contract structure and your ability to increase pricing?

Is there a certain time period where prices are locked in?

Or are you flexible, so that if there's a recovery that could then help you guys?

So some of those pricing pressures certainly continued into Q1 of this year.

Actually, in some cases, we had written agreements with some of our clients that extended into 2017.

We do see that dissipating now.

So there is going to be less of an impact on some of those pricing considerations we gave.

We do have some long-term MSAs with some of our clients that also had pricing considerations in there.

However, most of those contracts are salary-multiplier contracts that then we have the capability of going in and getting salary increases to get the multipliers up.

We've also got other methodologies of getting increases.

That business is very volatile and it is cyclical and our clients understand that.

So the good news is when things do get busy that we definitely have that capability of going back and getting some of that back.

Okay, that's helpful.

And just -- it's almost a year now since MWH was first announced.

I was just wondering, looking back, what's kind of the biggest positive surprise that you've taken from the transaction?

As you continue to work, what's an area that you've had to put a little bit more energy into than you previously factored in?

Certainly, the positive surprise, and maybe it's not a surprise because we anticipated that, it's just their presence in that global water space and their position in that global water space.

They do truly have a #1 water position in a number of geographies and, certainly, North America, certainly in the U.K. But we're seeing that their capabilities would really allow us now to get on just about any water project.

We feel that we have the capabilities to -- and we have enough of a status and top-tier position to be able to do that.

So it's maybe not a surprise but maybe a confirmation of why we did this.

We're seeing that come to fruition.

Certainly, their position in the U.K. is an outstanding position in the water business, and again, that's maybe just a validation of what we had originally thought.

Certainly, some of the global operations, they have a strong mining group in South America.

That is certainly an area that's under stress at the moment because of the mining business, but it's about 300 people.

I think we've now -- together, we've rationalized the staff down there and we're in a good solid position based on the work backlog that they have.

And they have operations in Australia and New Zealand that certainly will benefit from our diversification strategy because today, they really rely upon a water sector business.

So overall, we're very happy.

The Innovyze sale was, we believe, a very strategic opportunity that we saw right out of the gate, but it took us some time to position that business, to be able to sell it.

And going through that, I think was -- it makes the overall transaction look very good now.

And you go back a year ago and look at the metrics associated with what we did with MWH, now add in the metrics of the $270 million sale of Innovyze, doing the math, it looks pretty good.

And we'll go next to Sean Eastman with KeyBanc Capital Markets.

First question from me is just kind of high level.

I noticed in the MD&A that your kind of framework within your outlook is predicated on a moderate slowdown in the Canadian housing market.

So I guess my question is, just given that this topic's been in the news lately with some of the moves in Ontario, if you could just kind of discuss your direct exposure and indirect exposure to the Canadian housing market and how a more severe slowdown might impact the business.

So our residential exposure in our Canadian development group is really in greenfield master-planned communities, mainly in Western Canada, and I put that into Manitoba, Saskatchewan and Alberta, with probably the majority of that being in Alberta.

We have a residential, again, master-planned community exposure in Ontario.

Those are really not the areas that are probably being impacted, in Toronto and Vancouver specifically.

Where we're seeing the slowdown is mainly here in Alberta, just due to the slow growth in oil and gas, the fires in Fort McMurray last year and sort of just put everything on hold for a while.

We see that actually -- we thought at the beginning of the year being slow.

We anticipated the year was going to be, but I think we're starting to see signs it's not going to be as bad as we thought.

It is a business that has matured, I'd say, over the last couple of decades to a point of not getting overbuilt, and are a little easier than to respond to some of the fluctuations in the housing market.

So we're always cautious because that housing market responds quickly to the ups and downs, but we don't see it as being a major concern right now.

I think we've adjusted for it, and now it's a matter of waiting for how that market's going to recover as oil and gas prices recover in Western Canada.

So really it's more of a Western Canada play than an Ontario play.

Dan?

And maybe just to add a bit more context, Sean.

The Community Development business is a little less than 10% of our overall revenues and you can consider probably a little bit less than half of that is Canadian.

So as you're thinking about it, it's probably less than 5% of our overall revenues is exposed to the Community Development market in Canada.

Okay.

And second question is, it's good to see a little pop in backlog this quarter.

It sounded like you did have a couple of lumpy awards in the Buildings segment.

So I'm just wondering kind of how you're thinking about the backlog trajectory through the year and maybe if you could provide some context with sort of the bidding activity you're seeing and whether there's some kind of incremental lumpy big awards that could hit backlog in the next few quarters?

I would say that, overall -- and it sounds like maybe a too positive a statement, but overall, just every one of our businesses right now are seeing an increase in opportunities.

That includes our oil and gas business and mining business.

So we're -- the only one that we're a little concerned about our opportunities is Environmental Services that's sort of lagging behind.

But certainly, every one of our other businesses are seeing more opportunities, are seeing an increase in backlog and an increase in backlog per FTE, full-time employee.

So all those metrics point towards good signs for us.

You have to still win those opportunities, obviously.

And you have to still execute the backlog well.

So those are the -- certainly aren't givens, but we're also very happy to see the backlog increase and also very happy to see the opportunities.

From a large award perspective, I certainly think that Buildings is a group that probably has had more of their share with some of the P3s, but that probably only makes up about 20% of our revenue in that Buildings operations.

They still rely upon a lot of smaller projects at the local level.

And I think that's, again, a strength of the company is probably 60% to 70% of our backlog in revenue comes from those sort of smaller local projects that just continue to feed the backlog, and we're seeing those areas very strong.

And we'll go next to Jacob Bout with CIBC.

Maybe me just following on with a question on organic growth.

Maybe just talk a bit about when you think organic growth is going to turn positive?

What that trajectory looks like?

And then maybe talk a bit about the importance of Energy & Resources, Environmental Services and Buildings.

And specifically, what I'm getting at here is how important is the Canadian infra spend here in driving that growth and particularly in Environmental Services and Buildings?

So with regards to when, by the end of the year, overall for the annualized basis, we will have positive organic growth, and organic growth will improve in the second half of the year.

So that will give you some general guidelines with the organic growth.

With regards to the impact that oil and gas, Environmental Services and Buildings will have on it and then the impact of the Canadian economy or the Canadian business on that, there's no doubt that's where the retraction has been.

And the retraction has been in those areas and we see the retraction slowing in those areas, specifically in the oil and gas and Environmental Services.

Really, the question will be is how much will they grow?

The retraction will continue to be less.

It's really how much less in comparison to the growth we get in other sectors?

Buildings is more of a timing issue and some of the larger P3 projects and also a comparison to what was a very strong quarter last year.

So we see that improving maybe quicker and getting back to positive organic growth may be quicker in the Buildings group.

But certainly, those 3 will have an impact because those are the 3 that, right now, are having the negative impact.

So they're obviously going to have an impact on the positive turn for us into positive organic growth which we're saying is going to be in the second half of the year.

Sorry, I should've specified.

Specifically, the Canadian federal infrastructure spend, how important is that to you?

I don't see that as being something we need to turn things around.

So let's put it this way, we're now looking for a significant bump in our, what I would call, our water business and our transportation business in Canada to necessitate then a positive turn to organic growth.

Right now, our plans have what we see in front of us and the opportunities we see in front of us really do not consider a huge spike in opportunities in the Canadian infrastructure business.

Maybe just my second and last question here.

The pause in acquisitions that we've seen over the past 6 to 9 months, is that a function of the focus on the integration of MWH?

Or is it just a function of things are just too expensive right now?

No, definitely it's of function of a pause for MWH.

We knew that we had to focus on taking that transaction and because, again, we fully integrate, you don't sit there and wait.

You've got to move very quickly.

So we decided to put our efforts into that.

Now that being said doesn't mean that we did not continue to invest in developing some relationships, continuing on, I would say, with our U.S. strategy.

But certainly, we weren't in a hurry with any of those and we would allow those to sort of be bold and didn't push them.

But certainly, we now see the opportunities in the U.S. continuing.

We really haven't seen any change in pricing or multiples.

They're always really -- they're always there, so I don't see a change significantly in that.

Now we're also seeing opportunities for us in the U.K. and Australia, and that was the other thing that we took some time to start focusing on those markets, take the time to understand what our opportunities are there, which sectors we wanted to focus on, what relationships did we need to investigate in.

So we're working on that as well.

We've done small little acquisitions and we'll continue to do that throughout this year and with the hope, again, that we could expand that into the U.K. and Australia, also by the end of the year.

And we'll go next to with Benoit Poirier with Desjardins Capital Markets.

Just to come back on the organic growth recovery for Building.

I'm just wondering if the recovery is due to kind of an easy compare as you started to experience a negative organic growth in Q2 last year?

Is it really on the back of kind of an easy compare?

That will be a part of it.

I wouldn't say that, that's going to be the sole responsibility for it.

We do see some of the larger projects that they have won late last year into the first quarter starting to ramp up which will help that revenue growth and, therefore, help the organic growth.

So but some of it will also be as part of the fact that we are comparing.

So I don't know if it's on the back of it or if it's just contributing to it, but I wouldn't say that it's all that.

I would say the Buildings business was a lot more active in terms of their focused [MNBD] last year and it's starting to pay dividends for us this year.

Okay, perfect.

And just to come back on organic growth for Energy & Resources, did you say that you would expect to be in a positive territory in kind of the second half?

No, I said we'd be less negative in that category.

We see it improving, the trajectory of that improving as it goes through the year.

I think something would have to happen in the marketplace to get it to positive.

Now that's not saying that couldn't happen, but we'd have to have a significant event in the oil and gas business, hence a very strong increase in oil and gas prices, for that to happen.

Based on the trajectory to date, they will continue to improve but it will still be negative organic growth.

But it will improve quarter by quarter as we move through '17.

Okay.

And just in terms of special items, aside the $90 million of deferred tax related to Innovyze, I was wondering, are there any nonrecurring items or integration costs that we should take into account?

And maybe if you could quantify the IT spending in the quarter, that would be great?

So on the Innovyze, I think what we've tried to do is provide as much information in the materials and the pro forma information around the impact of the sale.

So we aren't expecting anything more to come out as certainly we're going to have some adjustments, certainly looking at the tax implications and all of that as we finalize the accounting in Q2.

So I think what you see is going to be pretty close to what we end up with, so not expecting anything materially different from what we've shown.

With respect to the IT costs, there's a lot of additional effort and time and costs incurred in integrating.

And to put an exact number on it would be pretty difficult, but it's in the order of $10 million, I would say, in terms of the impacts of the additional IT costs that we incurred in the quarter.

Okay.

And is it fair to say that those additional costs on the IT side are mostly over or there will still be some in Q2 then?

I think there'll be some in Q2, and remember, when we set our targets at the beginning of the year, we talked about some additional costs of setting up our new core infrastructure, our new data center and those type of things.

So those aren't related to the MWH integration, but they are still costs that we will incur through 2017.

So there may be some impact there, but I think that's all tied into our estimates that we had previously.

So I don't see that having a material impact that will change our targets that we set out.

Okay.

And pro forma, post the Innovyze divestiture, could you then provide where would you expect your net debt EBITDA to stem at on a pro forma basis?

Sure.

I think we reported in the quarter, I think we're about 2.4 as of the end of Q1.

I think by the end of Q2, we'll probably be well below 2. I think we'll be at 1.7 to 1.8x, is where my expectations would be.

So very comfortable at that level.

Okay, and am I right to say that in terms of M&A strategy, obviously the focus is on the MWH integration but maybe some tuck-ins, like you said, in the U.K. and Australia?

Correct.

No, that's what we're really trying to do is look at diversifying MWH's operations in the U.K. and Australia and still continuing a U.S. strategy, that which shouldn't -- we still felt that even without MWH, we still had opportunities in the U.S. to continue to fill in a number of sectors in a number of geographies.

So really, we're looking at 3 platforms, the U.S. continued platform, the U.K. and Australia and New Zealand.

So we anticipate going forward, we're going to get back to a pretty busy M&A strategy.

Okay, and last one for me, just in terms of gross margin for construction, a slight improvement versus Q4, so 37.4.

I was just wondering if there was some seasonality or maybe the level in the quarter was a little bit higher than expectation?

Yes, less to do with seasonality.

I think it's just the mix of projects in the quarter.

You're going to see a little bit of fluctuation quarter-to-quarter but nothing materially outstanding there.

And certainly that group is performing very well at this point.

And we'll go next to Ben Cherniavsky with Raymond James.

Dan, I know you and I -- I've asked you sort of a recurring question, but the conversion of gross to net revenue, it's quite -- the numbers are quite sensitive to that and they've been moving around.

I understand, obviously, they've gone up with MWH, but can you help us pick a good number as a run rate for what can we expect this year and next on that ratio?

Yes.

I think in my mind, Ben, for the -- so you have to break it down between the construction business unit and the consulting business operating unit or operations.

And for consulting, I would put the number at around 21%, 22%, 20% to 22%.

So gross revenue would be 122% of net revenue.

Want to make sure I make that clear.

And on the construction business, it's somewhere between 175% and 170% of net revenue.

So if you look at it on that basis, I think that's pretty close to what we're thinking it would be going forward.

Okay.

So it's best to break out construction separately and back into it that way.

Absolutely, absolutely.

Very different businesses.

Especially in that metric, they're really different businesses.

Yes -- no, I understand that.

But I mean, assuming your mix doesn't change, the overall impact should be a blend of the 2. I won't do the math right now but, like, it's the weighted average of the 2. But I guess what you're saying is it wouldn't be -- one shouldn't assume the mix will be the same, like we should expect the consulting revenue to outgrow construction over time?

Or how should we work with that?

Over time, yes, but on a quarter-by-quarter basis, there could be fluctuations then.

But over time, I think what we've said is on an organic growth basis and then certainly, because of an M&A strategy in consulting and not having one in construction.

It will all grow it, but that's probably longer term.

On a short-term basis, probably the mix isn't going to change significantly in the next couple of quarters, I'd say.

And have you guys reconsidered at all the divestiture option of construction?

Is that still integral and inseparable to the water business?

We're continuing to work through that.

Everything we've seen today, they operate it as a separate business but they really do bundle it well especially in the U.K. The U.K. is a very different business than in the U.S. and I would say the design build is defined much differently in the U.K., so they work much closer together and it was really a strategy that was very successful and them winning the majority of the AMP programs in the U.K. So certainly, there it's very evident.

In the United States, the design build sector is probably, at this point in the water business, maybe 10% to 15% of the overall market, and there is a differentiator going into some clients and on some projects on a bundled basis.

So what we're analyzing, Ben, over the next year is the value of that, the upside of that versus the additional risk, and we're continuing to go through that.

And at this point in time, the business operates well.

The last thing we want to do is distract it.

So for right now, absolutely focused on maintaining that business and exploring where we could accelerate those synergies.

Right, but correct me if I'm wrong, but I got the impression the initial strategy was we're not -- it's not really even an option to separate and now you're saying it could be under the right circumstances?

I think separating is not what we want to do, but you have to continue to explore where the synergies are.

The only way you can maintain that long-term strategy is understanding where the synergies are.

And like we said, we've explored it in the U.K. and certainly, it's there.

We're exploring it further in the U.S. You never say never, but at this point in time, we have no interest in talking about divesting of construction.

Could you carve out just the U.S.?

Unlikely, today that there are some synergies of working on some clients, especially the process is very strong -- the process capabilities of the treatment operations in the U.K. is very strong.

And the way the U.K. operates is also, I think, progressively a decade ahead of the United States.

So we do see some opportunities there.

Again, you never say never, but certainly, that's not our intent.

Okay.

If I could just ask you to clarify something in the MD&A that -- where you note that the oil and gas sector now represents only 3% of gross revenue, that you're carving out oil and gas within the oil and gas -- within the Energy & Resources?

Correct.

It's about 3% oil and gas represents -- the oil and gas portion within Energy & Resources represents 3%, and oil and gas within Environmental Services represents about 3%.

So together, they represent about 6% of our total revenue.

But then there's other ways that you guys are -- I think even within the Energy, you said there was some impact from low gas prices that's affecting energy infrastructure.

And of course, the Buildings has a knock-on effect.

I mean, what would you say is the overall sensitivity of your business to oil and gas prices?

So the areas that it was impacting was the Middle East operations.

Their projects and buildings are very connected.

So obviously, the clients there are very connected to oil and gas.

Some of the buildings operations in Western Canada connected and some of the Community Development operations in Western Canada connected to that.

You sort of add it all up, Ben.

I still don't think it's more than 10% of our overall business now is probably impacted today because it's already been impacted.

Those projects in the Middle East were buildings that have already been put on hold.

So you can't go even further on hold.

They're already on hold and not generating revenue.

So I'd say today, the future impact is still less than 10%.

Plus, you've chunked up your gross revenues with the construction business and you've grown the water side, like, you've just diluted that business down and it has shrunk.

So like compared to 2 or 3 years ago, it might've -- the overall sensitivity might have been 1/3 of your business.

Is that fair?

I mean I'm not going to hold you to the number but just get an idea of how that...

Yes, I think if you turn the clock back, yes, absolutely.

I think, that to me is what's the upside opportunity of all this.

We need just one thing to change right now to go back to that and that is oil prices to increase, but you're absolutely right, it was a huge impact.

Today it's a much less impact overall in our business.

Ben, before you leave, Dan here again.

I just want to circle back again.

Looking at my numbers again.

For gross revenue as compared to net revenue I think I said 170%, 175%.

If you use 280%, because there's so much more -- a big portion of that is sub-consultants which is included in that gross to net.

So if we used 280% gross revenue to net revenue, that would be a better number for construction.

I think I've been guiding around 170%.

I think that's too low.

That's only the sub-consultant portion of it, not all of the other (inaudible) costs.

Hopefully, that clears that up.

And we'll go next to Sara O'Brien with RBC.

Just wondering on the water segment, what you need to see to see a real lift in that organic growth.

I mean, I think it was sort of 2% quarter-over-quarter.

Maybe year-over-year, what are you seeing internally at MWH?

And what do you expect to see that is really going to drive that forward in the U.S. and the U.K. from here?

That's a good question.

The U.K. right now is entering the last phases of its AMP program.

So you're probably not going to see significant organic growth in the U.K. for the next couple of years as they wind down AMP6 and they starting rebidding on AMP7.

So it's not going to be a retraction but I don't think you're going to see significant organic growth there.

We're going to see more organic growth than we've experienced in the U.S. because as we continue to now join together, we're starting to see our win rate go up and we're starting to see some big opportunities.

I think the Australia, New Zealand operations are starting to get their feet under themselves, but that may not be all in water.

That may be in some transportation and other sectors.

So water, if you're looking at organic growth pickup, that is really going to be in the U.S. and it is something that doesn't come immediately.

It really comes as we join with MWH, how successful are we going to be now in winning those projects.

The good news is lots of opportunity.

That pipeline is probably as full as we've seen it because it's just been a wider pipeline for us to capture opportunities because of having both groups together operating together.

So the 2%, actually, we're somewhat happy with that.

I think it could continue to increase but it's going to be subject to the U.S. and how well we execute on winning those projects.

That 2% relates, just to be clear, to the legacy Stantec business because we show all the other acquired revenue in the acquisition growth.

Maybe can you comment on how the acquired business, MWH, has done in the U.S. and the U.K. in terms of organic growth or quarter-to-quarter because that's what you have?

Yes, we haven't tracked, Sara, how they've done organic growth relative to their prior years' revenue.

What we can say is they are meeting their budgets, they're performing as we expect and actually slightly better than we expected.

Certainly, in the water sector, I think, is where they are exceeding their budget.

So I'd have to say that, intuitively, if we would've said what were they doing this time last year in water to this time last year and added it to our organic growth in Stantec, it would be higher than 2.2.

Okay.

And then just going back to the restructuring costs, the $10 million.

That was $10 million of expenditures during the quarter for -- or expense on the P&L that went through for new platforms and software?

That's correct.

Okay.

And is that related to MWH?

Or is that Stantec, in general, redoing systems and investing?

A lot of it is MWH.

There is -- when you merge companies, you have to align on your business software and all your other systems.

So a lot of it is related to that.

Some of it is related to the core network, but a good portion of it is really getting everyone onto our domain, and a lot of extra effort there.

The majority has been -- the majority is the domain.

Okay.

And you said we should expect some more of these types of costs in Q2.

Does it kind of taper off there?

Or should we expect this to go on through the year?

I think as I indicated, we're going to have some more utilization-related costs, things that are going to impact utilization, mostly training associated with the MWH folks, and we will get some more IT costs as we go through the year, but we'll try to articulate that as we go through.

It will be less because I think this one was the U.S. and now we're moving into other areas.

Okay, and then I just wondered on the Innovyze sale, if there were any targeted synergies from that, whether they be tax or cross-selling or something, that you had factored in when you bought MWH?

Sorry, synergies associated with Innovyze?

That's right.

Like did they have tax loss carryforwards that would've benefited?

No, if they had tax loss carryforwards, we could've used that to lower the taxes, then.

That would be nice, but no.

No, unfortunately.

And we do have a follow-up question from Yuri Lynk with Canaccord Genuity.

Was Innovyze -- that was included in Q1 EBITDA and it will be included into May 5 of Q2?

I just want to make sure I'm thinking about that right.

You're thinking about that correctly, Yuri.

And we'll go next to Anthony Zicha with Scotiabank.

Bob, can you give us a bit of color on the California market and how does it compare to last year at this same time?

And how important of a market is it for your overall U.S. growth?

And what are some of the prospects in Western USA?

I think California now, we have a much larger presence in California because of MWH.

So it has become a larger part of our growth and a larger part of our performance.

And it is an important market.

It's the size of Canada from a population perspective.

And when you look at water, especially, it has every problem you can think of in water, so last year, droughts; this year, floods.

So it is a very intriguing part of our business right now.

I think we can get stronger in a number of other sectors in that.

I think we have now a #1 water position in California as a result of combining with MWH.

What we'd like to strengthen is our transportation sector in that area.

That certainly is an area where we're not as strong as we'd like to be.

So I think our growth in California is going to be how well do we execute on combining MWH and Stantec to win what are some great opportunities in California and some very large ones.

And two, how can we execute better an M&A strategy up and down the West Coast really in the United States, where we have not been as successful as we have been in the U.S. East.

So that is certainly opportunities for us and California is the center around that.

Okay.

And then what about the western region beyond California?

Certainly, we don't have as much exposure in Seattle and up in the Pacific Northwest that we'd like to have, even in Colorado.

So that whole western part of the United States, if you look at the Stantec map and look at our density, that's really where we see some opportunities, both organically and from an M&A perspective.

Denver now, with having a very strong base of operations with MWH's headquarters there, we see that's an area for investment.

And we did a very small firm in the Pacific Northwest this quarter, that was really to start strengthening and diversifying.

So that is a part of the United States that, from a geographic standpoint, we feel is an opportunity for us.

We'll go next to Maxim Sytchev with National Bank Financial.

Dan, I just wanted to follow up on the one-off or onetime costs.

So in terms of IT, it was roughly $10 million.

And were there any incremental restructuring costs that were incurred in the quarter?

I think you refer to it as restructuring costs.

We're always balancing our workforce wherever there is weakness or strength for that matter.

And so there was some severance costs incurred again in the quarter.

We go through that every quarter.

I wouldn't say it was materially different than -- or is completely different than what we had in Q1 of 2016.

So they were pretty close in terms of the severance costs that we would've incurred.

Other than that, there was really no other what we would refer to as restructuring costs, Maxim.

Okay.

And anything specific on integration costs?

Or the only impact was the utilization?

It's impacting utilization and, as we mentioned, some of the IT.

I think I just can't stress that enough though, that utilization is -- it's your most senior people, unfortunately, that need to get together and figure out how do you work together, devising what systems you're going to use, the best of both companies.

It is that full integration strategy.

It's not easy to do, especially in that first year.

So I think you're seeing signs of that.

That should improve as we go, but it is still something that we will continue to incur as we go through that full integration strategy.

Yes, for sure.

And I mean, just some food for thought.

Is it possible to disclose these numbers on a going forward basis in a press release or MD&A?

Because we'll have to wait basically the entire day to get that granularity, if it's possible.

I think what we try to do, Max, is where there are impacts that are materially different from what we would've previously disclosed, then we'd like to highlight those.

But if they are a part of our business and part of our business is integrations, we don't try to make excuses for what is impacting the results, then we report it the way it is.

But if there are material differences, then we will highlight those.

Well, I guess $10 million in IT costs, it is fairly significant, right?

Well, on a $4 billion business, that's where you have to kind of weigh whether -- what's material and what isn't.

But certainly, I take your point.

I think the MWH, just because of its size, some of those costs are starting to creep up to be more material because it's just a bigger transaction.

But as Dan said, we've done the same thing with every transaction we've done.

We just never really have disclosed it because it's never been as big.

Now MWH is just bigger.

It's 30% of our company, so that has a bit of an impact, but we really don't want to go down that path of, okay, let's start disclosing all this because, as we said, it's part of our strategy.

While we're adjusting for it, we've got more important -- yes.

Okay, that's helpful.

I just had a quick question in terms of the U.S. momentum.

Just looking at some of the public comps, it feels that the organic growth numbers that are coming from those entities appears to be a bit higher than you guys.

Are you feeling that maybe you're losing a bit of market share?

Or is it just really a positioning where some of the legacy energy weaknesses is creeping up in those organic numbers, which doesn't make it necessarily sort of an apples-to-apples comparison?

Yes.

I told [not] to compare to other companies' organic numbers when you really don't know how that organic number is calculated and the basis on which it's calculated.

We can only disclose ours and we feel the 2.4 in water and 2.2 in transportation are pretty good, and they're stronger in the United States.

So we feel actually we're pretty happy with our market presence and our growth in those areas.

Yes, you compare it to some other disclosed numbers that seem to be higher.

You sort of wonder, but all you can do is worry about your own business.

And we're pretty comfortable with what we have in transportation and water right now.

Especially in the United States, we feel pretty comfortable about it.

Okay, that's helpful.

And last question, just in terms of M&A, any commentary in terms of the expectations from sellers?

Have we seen any inflation in terms of multiples?

Any changes there?

Well, their expectations are always higher, but the final number you pay, I don't think we've seen significant changes to that.

When you see, especially in the smaller acquisitions, they see the multiples of the larger firms, they see the public company multiples.

They gravitate to that and figure that they should get those multiples, but those are expectations you can manage and go back to when really looking at their businesses, but, no, we really haven't seen significant increases.

But when you look at some of the multiples that have been paid, yes, that's -- they're at the higher end, and that doesn't make the job easier, convincing smaller companies that their expectations are unreasonable.

Right.

And I mean, in terms of transactions right now, I guess it's a combination of a smaller, medium and potentially platform-type acquisitions, right, that are still under consideration, obviously, once you digest MWH, right?

Yes, this covers the whole spectrum right now, Max.

It is a pretty, I would say, robust M&A environment out there, and all we can say is Stantec is capable of playing at all 3 levels, at a large level, midsized and small.

And I think that's what's gives us and advantage.

Is we're not reliant upon one aspect of the M&A world right now.

We can play in any area we want.

And we'll go next to Benoit Poirier with Desjardins Capital Markets.

Just a follow-up on the Q1 '16.

When you were referring to the severance costs, am I right to say you were referring to the $3.5 million costs taken in Q1 2016?

Yes, that's correct.

It was about the same as what we incurred in Q1 '17.

Okay, perfect.

And just in terms of backlog, obviously up slightly quarter-over-quarter.

Could you quantify what was the FX impact on a sequential basis?

I don't have the FX impact, Benoit, but what I can say is the backlog is up virtually in every business line or business operating unit that we have.

It's either up or flat, so very positive.

And I don't think the FX would have had a material impact in the quarter from year-end.

Okay, perfect.

And when we look at the free cash flow, Dan, any expectation or thought for the full year?

I mean, looking at your working cap, down in Q1, but there's a lot of seasonality, so any thoughts about the expectation for the year or kind of the free cash flow conversion we should be looking for?

I think we'll see similar free cash flow conversion as we will have seen in prior years.

Certainly, in Q1, consistent with every year that at least I've been in the role, we've used more cash than we've generated.

It's really as a result of the accumulation of short-term incentives and tax payments that are generally due in the first quarter.

We do generate -- start to turn around and generate positive cash flows in Q2 and Q3 and maybe a little bit flat in Q4.

With the drawdown of the debt, that should reduce some of our cash flows as well around interest expense.

So I do see some positive cash flow momentum going through the year.

Okay, perfect.

And last one for me.

Any thoughts on the BC election just that just happened, whether you see some positive, neutral or a slightly negative implication going forward in all of your business segments?

It's not over yet.

So I guess we'll have to wait and see what actually -- how the dust settles.

Certainly, with a minority government, a liberal that was supporting pipeline development and resource development now opposed by an NDP and Green Party that may carry the weight.

So that could cause some noise.

It will be interesting to see how -- at this point in time, it's unknown how it's going to go forward, but that unknown is also not good.

So basically, it's just going to cause a pause.

A lot of companies are just going to have to wait to see what happens.

And we'll go next to Michael Tupholme with TD Securities.

Dan or Bob, can you provide a bit more color around how should we think about the organic growth progression within the Buildings segment?

So it sounds like you've won some awards and I guess it's just a matter of time before you start to see some of those kick in, but I'm trying to get a sense for how we should think about that organic growth number going forward.

Yes, Dan and I are pointing at each other to answer the question because you weren't specific on who, so I guess I'll answer it.

It is a hard one to look at and we try to dig in to see.

We know how much work we're doing.

We see the utilization increasing.

They've won the work.

Those work, it does -- it ramps up.

It doesn't happen overnight.

Those projects also are slow to start because we're doing schematic design at the beginning.

We're comparing against a not as strong Q2 as we had in Q1, when you look at last year.

So all those factors are -- it will be better.

Whether that will turn to a positive in Q2, it's hard to tell.

We'd like to hope it is.

Hope's never a good strategy, but at this point, there's not enough clarity to say, but it will be better and certainly throughout the year, we see that turning positive.

I think the other thing to point to is we've had material retraction in our Middle East business, and we're seeing some potential opportunities for projects coming back.

Nothing fully confirmed yet but things are starting to look better and that's encouraging.

And I think, unfortunately, when we look at the Middle East, it is not like North America.

Your clients there don't give you a clear picture.

They don't follow a schedule for their projects.

It is mainly relationships you're talking about and trying to get a feel for it.

So as Dan said, the meetings are going positive.

Things are moving in the direction.

They're asking for more information.

Those are all positive signs.

It's how quick that happens is really we're having a hard time.

We do see all that happening, though, this year.

We don't see a continued delay into '18, we see these things happening this year.

It's just a matter of when.

Okay, perfect.

And then just lastly, Dan, is there going to be any change in the amortization of intangibles related to acquisitions as a result of the Innovyze sale?

Yes, absolutely.

And I think we'll spell that out in the second quarter reporting.

There will be -- certainly a portion of the purchase price will have gone to intangible assets as well as goodwill, and we'll have that all clarified in the second quarter, yes.

But you can expect some of that to go down.

I think what's important to note, though, is the reduction in the amortization of intangibles, the reduction in the interest expense that we'll incur will -- according to what we're seeing today, will approximately offset the EBITDA contribution that Innovyze provided.

So essentially, on a full year basis, it will be more or less a wash.

Right.

I think you may be mentioned that when you first announced it as well.

So that's...

Yes.

Just to clarify that, yes.

And we have no further questions in the queue at this time.

Great.

Okay, thank you very much for your questions.

That concludes our call for today.

Thanks for joining us and we'll talk to you next quarter.