Welcome to Stantec's First Quarter twenty twenty Earnings Results Conference Call. On the call today are Gord Johnson, President and Chief Executive Officer and Theresa Zhang, Executive Vice President and Chief Financial Officer. Stantec invites those dialing in to view the slide presentation, which is available in the Investors section at stantec dot com. Today's call is also webcast. Please be advised that if you have dialed in while viewing the webcast, you should mute your computer as there is a twenty second delay All information provided during this conference call is subject to the forward looking statements qualification set out on Slide two, detailed in the Stantec management discussion and analysis and incorporated in full for the purposes 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. Gore Johnson.
Well, good morning, and thank you for joining us. I'll begin our call today with a review of our third quarter performance. Teresa will then delve deeper into the financial results, review our 2020 outlook and provide our 2021 targets. I'll then return to provide our closing remarks. We delivered another solid quarter in Q3, with net revenues in line with the outlook we provided during our Q2 call.
Our business discipline, coupled with the improved operational efficiencies driven by our 2019 reshaping initiative, ongoing staffing management and controls on discretionary spending, drove a strong seventeen point three percent adjusted EBITDA margin, a 5.1% year over year increase in adjusted diluted EPS and a 5.4% increase in adjusted net income, in spite of net revenue and gross margin retractions. Backlog grew organically in Q3 to a record high of 4,800,000,000 and our balance sheet continued to strengthen. Subsequent to the quarter, we closed on our $300,000,000 bond offering at very attractive terms. Theresa will discuss this in more detail in her section of the presentation. At the end of the presentation today, I'll review how our core value creators, people, excellence, innovation and growth continue to underpin our competitive advantage and further enhance shareholder value.
Q3 net revenue was consistent with the outlook we provided in our Q2 call. Compared with the same period last year, net revenue for the quarter decreased 3.8 or $36,000,000 to $916,000,000 Revenue retracted organically 4.7% in the quarter. Year to date, net revenue is holding up very well despite the COVID-nineteen pandemic, with organic retraction of only 1%. Water demonstrated strong year over year organic growth in the quarter, with healthy activity continuing in The United States, United Kingdom and Australia. As discussed on our last call, this was driven by significant project awards in The U.
S, the AMP7 Framework Awards in The UK and a multiyear Framework Award in Australia. Looking ahead, we've just started to mobilize for the Irish Water seven year framework. And just last week, we announced our leadership role in San Diego's multibillion dollar Pure Water Initiative, which will supply sustainable water to the city's 1,400,000,000 residents. Environmental services continues to perform well and slightly ahead of expectations. Essentially, all of our environmental services contracted backlog remains in place and is being executed with limited COVID related delays or cancellations.
Key projects in LNG facilities and pipelines continue to advance. As well, existing large infrastructure projects in the Northwest Territories, Manitoba and Alberta, grew in scope during the quarter. Energy Resources had a strong quarter given the ongoing pandemic. Increased midstream pipeline work in Canada was offset by reduced mining activity in both Canada and our global operations due to pandemic related shutdowns and deferred industry spending. We're seeing increased opportunities in renewables, particularly in solar.
While this market slowed briefly earlier in the year, it's picked up, and we were recently awarded large scale solar projects in Canada, The US and Australia. In general, given the critical nature of power generation and transmission infrastructure, utility market has not slowed. We're seeing strong growth in electrical transmission opportunities, especially in The US, because of resiliency programs, the growth of renewables and fire threat mitigation. Infrastructure revenues retracted in the quarter, primarily due to several large rail transit projects in The United States, which were beginning to wind down. At the same time, the ramp up of some of our other major transportation projects has been a bit slower than normal.
We expect our transportation business to be a beneficiary of various infrastructure stimulus programs as they're announced around the globe. And while we have seen concrete stimulus spending commitments in various locations, there will be a time lag between when these programs are announced and when we begin to generate meaningful revenue. That said, our participation in Edison's Valley Line West LRT fee tree was announced just last week. The commercial, airport and hospitality sectors in our buildings business continue to be impacted by the pandemic. However, we're seeing continued growth in work for e commerce clients.
We've also seen a significant increase in the pursuit of activity in the health care sector, and we were recently named as the lead designer of the preferred performing team for the $1,400,000,000 Clipsquake Hospital in Melbourne, Australia. Our public sector exposure in buildings remains greater than 50%, which is higher than many of our peers. And we're seeing a trend towards greater exposure to publicly funded projects in our buildings business, which should bolster future resiliency. While Q3 twenty twenty net revenue in The U. S.
Retracted slightly more than anticipated compared to Q2, we're seeing continued growth in water and strong performance in environmental services. The pandemic has had an unfavorable impact on buildings and has contributed to the slower ramp up of some major transportation projects. Gross margin as a percentage of net revenue decreased 1.7% in the quarter to 52.9%. This reflects a shift in our project mix, primarily driven by the major projects in our transportation sector. During the quarter, we won a number of new major projects, including the San Diego Pure Water contract, the Arctic Research Support and Logistics contract and the I-ninety 3 North York widening project in Pennsylvania.
In Canada, Q3 net revenues were slightly ahead of Q2, which was consistent with our outlook. While Canada experienced a 5.2% organic contraction compared with Q3 'nineteen, we're seeing growth in our Energy and Resources business, largely due to midstream pipeline work and in our transportation sector. As well, environmental services performance has remained consistent year over year. The impact of slowed economic growth, amplified by the COVID-nineteen pandemic, was more pronounced in buildings and community development. Gross margin decreased 1.8% as a percentage of net revenue in the quarter to 15.4%.
This was mainly due to a shift in our project mix, driven largely by the increased volume of lower margin work related to our midstream pipeline and rail transit work. Some of the major contracts we won in the quarter include the design for Canada's fighter jet squadron infrastructure upgrades in both Alberta and Quebec and a new integrated academic and student housing facility in British Columbia. Net revenues in our global business achieved 5.8 growth over Q2, which was generally in line with our expectations. Year over year, Q3 net revenue grew nominally as favorable foreign exchange rates offset a slight organic retraction. Continued strong performance in our UK and Australian Water business, our work in New Zealand's transportation sector and progressive recovery in core markets in our UK infrastructure business all contributed to a strong showing in our global operations in Q3.
The impact of COVID-nineteen was most pronounced in our UK and Australia building and European environmental services business. Our mining business was also affected by pandemic related short term mine closures in Peru. Gross margin as a percentage of net revenue decreased 3% in the quarter to 53.5%. Margins were impacted by project mix and some ongoing pricing pressures for our services in The U. K, Europe and Australia.
Additionally, localized challenges on certain projects reduced gross margin in our Middle East water and buildings business. During the quarter, we were awarded a number of major contracts in our global operations. As I mentioned earlier, we were selected as a building services engineer for the Plenary Health Consortium, which has been selected as a preferred proponent for the new Flutzgray Hospital project. And we were also selected by the European Commission to support development of a continental generation and transmission master plan to meet Africa's growing power needs. Backlog expanded in Q3 to a record GBP 4,800,000,000.0, which represents approximately 12 of work.
Backlog has grown 12.7% since the end of twenty nineteen, of which 10.6% is organic growth. And since Q2, backlog has grown organically by 3.2%. Our book to burn ratio for Q3 twenty twenty was 1.1 compared to one point zero for Q3 twenty nineteen, and it's greater than one across each of our five business operating units. Overall, our sales pipeline remains healthy after the brief dip in activity we saw in Q1. The number of new pursuits in our pipeline returned to more typical levels, and not surprisingly, we're seeing more opportunities in the public sector than we are in the private sector.
I'll turn the call over to Theresa for a review of our financial performance and our outlook.
Thank you, Gord, and good morning, everyone. Adjusted net income from continuing operations increased 5% to $70,000,000 in the third quarter or 7.6% as a percentage of net revenue. Adjusted earnings per share increased 5% to CAD0.62 per share. This is largely due to a 9% decrease in administrative and marketing expenses and a 33 reduction in net interest expense. Gross margin for the quarter decreased 7% to CHF $479,000,000.
As a percentage of net revenue, gross margin was 52.3%. The pandemic continues to disrupt our and our clients' operations to a degree, causing some inefficiencies in project execution. As demonstrated by our solid adjusted EBITDA margin of 17.3%, we're managing the business carefully, and we've taken steps to mitigate COVID-nineteen's impact on organic growth and gross margin. Our balance sheet remains strong. At September 30, net debt to adjusted EBITDA was below our targeted range at 0.8x.
Days sales outstanding was eighty two days at quarter end compared with our target of ninety days. DSO has remained unchanged since Q2, and we've not seen any notable impacts due to the pandemic. Moving on to liquidity and capital allocation. We generated £124,000,000 in free cash flow for the quarter, a 31% increase compared with Q3 twenty nineteen. Sequentially, our free cash flow has improved every quarter for the past four quarters on a trailing twelve month basis.
On October 8, we closed our inaugural bond offering, issuing GBP300 million in senior notes for the seven year term bearing interest at 2.048%. The notes were rated BBB with a stable trend by DBRS, and we used the proceeds to pay down our revolving credit facility, which means that our 800,000,000 facility is currently largely undrawn, giving a significant dry powder to weather the pandemic and to fund growth through acquisitions. As a result of the uncertainty created by the pandemic, we withdrew our 2020 guidance in May. We remain committed to our strategic plan launched in December 2019. However, disruption caused by the COVID-nineteen pandemic will likely delay the achievement of our targets within the original time frame.
At this time, we're unable to set a revised time line with a high degree of confidence. Today, we're reiterating our outlook for 2020 as set out in August. We're also providing our targets for 2021. These targets assume a continued gradual global recovery but may not be valid to our key geographies experience a severe worsening of the pandemic. In terms of our revenue expectations, in The U.
S, we expect the step down we saw from Q2 to Q3 to continue into the fourth quarter due to the effect of project slowdown, combined with the difficult downturn in activity related to the onset of colder weather and seasonal holidays. For the full year, we expect revenues to be comparable to, although slightly below, 2019 in native currency. U. We expect the same seasonal dynamics to be at play in Canada, which will result in Q4 twenty twenty net revenues retracting relative to Q3. Given the weak outlook for Canada before the pandemic, we expect a nominal retraction in revenue for the full year compared with last year.
In total, we expect that Q4 twenty twenty net revenues will be down slightly relative to Q3. Our UK buildings practice appears to be more impacted by pandemic related headwinds than anticipated. However, we expect strong performance from our water business in The UK and Australia and our transportation sector in New Zealand, which has largely offset the impact of project slowdown in the private sector for our other businesses. We expect this to result in 2020 revenues being comparable to, although slightly below, 2019. Taken together, we expect 2020 net revenues that are comparable to, although slightly below, 2019.
Adjusted net income and adjusted EPS are expected to be comparable to 2019 as a result of lower admin and marketing costs and lower interest costs. As noted last quarter, we expect to achieve roughly 55% of our 2020 earnings to
be
concentrated in Q2 and Q3, with 45% in Q1 and Q4. Our balance sheet is strong, and we continue to have excellent liquidity. Our capital allocation priorities have not changed. Our M and A activity has been reengaged, and we're committed to returning capital to our shareholders through the payment of our dividend, and we'll continue to repurchase shares opportunistically. Moving on to our targets for next year, we expect our business to continue to demonstrate resilience and believe we're well positioned to generate solid earnings.
For 2021, we anticipate low to mid single digit organic net revenue growth. We anticipate muted net revenue growth in The U. S. In the low single digits. While we believe we're well positioned to benefit from stimulus spending, we haven't yet incorporated any potential upside for this in our revenue expectations due to the uncertainty around the timing of such legislation being passed.
I should also note that our outlook for 2021 assumes a US to Canada exchange rate of 0.76, so a weaker US dollar than the average we saw in 2020. Organic growth in Canada is expected to be in the mid single digits, driven by work in the midstream pipeline space, where activity is anticipated to be at peak levels in 2021. Excluding this activity, organic growth in Canada is expected to be in the low single digits. Global organic growth is also expected to be in the mid single digits, benefiting from strong performance in the regulated water market and with stimulus funds beginning to flow. And while we've reengaged our M and A activity, we have not incorporated any acquisitions into our 2021 outlook as it's difficult to predict the cadence of when a particular transaction may close.
For 2021, we're targeting adjusted EBITDA to be in the range of 14.5% to 15.5%. This range is the result of our expectation that gross margin will hold steady relative to 2020, while admin and marketing costs normalize. We anticipate gross margin to be somewhere in the range of 52% to 53.5%, which reflects our expectation that the pandemic will continue to impact productivity both within our operations and that of our clients and an anticipated meaningful increase in the cost of employee group benefits. We also expect 2021 gross margin to be impacted by an increased volume of lower margin work on our large midstream pipeline project and on several of our lower margin multi billion dollar transportation projects, which are nearing completion. Meanwhile, admin and marketing costs will likely return to the typical range of 37% to 39% of net revenue.
This range reflects a more normalized level of discretionary spending relative to 2020, but not a return to pre pandemic levels. We do, however, anticipate an increase in non discretionary costs, including insurance and employee group benefits associated with indirect labor. As well, we're increasing our investments to drive innovation and in IT systems to support our growing U. S. Federal government practice.
We expect adjusted net income to be equal to or greater than six percent of net revenue as we benefit from lower interest expense and depreciation and amortization. Return on invested capital is targeted to be equal to or greater than 9%, and we expect to generate 40% of our earnings in Q1 and Q4 and 60% in Q2 and Q3. We continue to advance our strategic initiative to optimize occupancy costs beyond those locations identified to date, which could result in the recording of lease asset impairments, noncash charges that reflect the change in our plan to utilize space that is currently under lease, with the long term benefit of reduced occupancy costs and increased earnings and cash flows. As our analysis is ongoing, our 2021 targets do not yet include the potential benefits from further optimization. And again, I note our targets do not include any assumed acquisitions, given the unpredictable nature of the size and timing of such acquisitions.
Finally, our continued prudent management of leverage will keep our net debt to adjusted EBITDA within or below 1.0x to 2.0x, and we're committed to maintaining our BBB credit rating. With that, I'll turn the call back to Gord for his concluding remarks.
Thanks, Theresa. We continue to execute well on our strategic plan, which we rolled out to our employees in the investment community in December of last year. I want to thank our employees for their continued commitment to serving our clients and in helping them through the unprecedented disruption caused by the pandemic. Our results this quarter are truly a credit to our people. By keeping a tight grip on administrative and marketing costs, we continue to mitigate the compression of our gross margin.
Our reshaping efforts in 2019, ongoing cost reduction initiatives and a significant reduction in discretionary spending during the pandemic continue to protect our industry leading adjusted EBITDA margins. We continue to invest in and develop innovative solutions for ourselves and our clients to meet the challenges posed by COVID-nineteen and to ensure that we emerge from the pandemic in an even stronger competitive position. We're also implementing strategies to conduct M and A activities by leveraging local resources even more while travel is restricted. And we'll utilize these strategies through the integration of Teshmat, a small but strategic acquisition that we announced subsequent to the quarter. We remain confident in the resilience of our business model our ability to navigate the ongoing challenges posed by the COVID-nineteen pandemic.
Given everything that Stantec has done in the last year, including our 2019 reshaping initiative, alignment of our organizational structure, continued focus on discretionary cost management and the staffing strategies we put in place, meaning that we're very well positioned as we head into 2021. And with that, we'll open the call up to questions. Operator?
Thank you. Our first question today comes from Chris Murray of ATB Capital Markets. Maybe
turning to your 2021 guidance. If you can just maybe we
can dig into this a little
bit more. Can you talk a
little bit about how the mix you believe is going to be the part of the impact in gross margin? Just I guess the EBITDA margins coming in maybe a little lower than we thought. And so any color there would be appreciated.
Sure, Chris. I think we caught all of that. You were coming from us a little bit soft, but I think we caught your question around 2021 gross margin and project mix. So yes, I mean, I think what we is right?
That's correct.
Okay. All right. Great. So I mean, I think what we saw in 2020, and it's important in the lead up into 2021, is, you know, some compression in our gross margin relative to, the the ranges that that we have historically seen. And, you know, really, that has been driven by a a combination of some, reduction in productivity, which is really hard to measure and to drill into.
But we do believe that there is some of that occurring both from on our side and our client side. So there's a time limit around which we're able to conduct our work and have a responsiveness from our clients. But there is also a component of overall project mix, and that has driven our gross margin down. And that's what we're expecting to see some continuation of next year. The Trans Mountain project is somewhat outsized for us relative to our other projects.
Still, overall, less than 5% of our total net revenues. So as we've always said, we don't really have any number of projects that are big enough to really push things in one direction or another. But this one particular project and contract is larger than most, and, it is at a relatively low gross margin. And so that, as we move into next next year, becomes more prominent in the overall mix and brings our gross margin down. What's important around that particular project, and we have emphasized this in the past as well, that because of the nature of that work with the employees working out in the field, there is virtually no admin costs associated with that project.
And so on balance, EBITDA margin that it generates is comparable, probably a little bit lower overall than the rest of our project work, but the gross margin reduction is not indicative of what flows through to the ultimate EBITDA line. So with that picking up steam next year as well as just where we are in the stage of our and there's a number of large transportation projects that are winding down in that lower gross margin range. That's the dynamic we're seeing that's going to keep our gross margin around where it is currently. And we're going work really hard to bring it up. I think there is some opportunity to improve our gross margin.
But we're not seeing, as you can see from the range we put out there, we're not seeing it rise back to that 53% to 55%, which has historically been the gross margin range we targeted.
Okay. And then I don't know who would like
to take this one, but I guess there's
a couple of pieces around the question around know, occupancy. And I guess, you know, first of all, Gord, I'm curious about your thoughts around, you know, how you've seen the organization change as you've gone through COVID and how you think about, you know, folks in an office setting and and what that does to your footprint. But then what does that do to the rest of your buildings business, and and how are you guys thinking about that business longer term? So, you know, on a cost side, it's a saving for you perhaps, but then it's also how offices get used in the future is maybe a little bit different as well.
Yeah. So I'll start on the with the overall occupancy side. We've seen, and I think our industry overall has seen, based on some of the
panels I've been on over the
last couple of weeks, that across the board, we're seeing that utilization numbers are holding up reasonably well, but that there's some concern about the amount of productivity per billable hour. So there is some benefit to having people together in the offices. There certainly is some business from a project perspective, particularly as you think about junior and intermediate staff. The ability to walk by someone's office and ask a question and then continue to work in a more efficient manner. So there is some benefit to that.
So but as we think about overall occupancy, we've been surveying our staff. We've been talking to others in the industry. And we as we think about occupancy going forward, we begin to think about certainly a percentage of people in the office full time, a percentage of people and that would be the majority likely, a percentage that would be in and out, a couple of days in the office, a couple of days at home perhaps, and then a smaller percentage that would work from home exclusively. So we are thinking about that as we think about our longer term footprint. We're not coming out and making any bold statements like we've seen from others in the tech sector that nobody's coming back to the office or much less than 50% will ever come back to the office because we don't think that's the reality in the long term.
But that said, you asked about the impact it might have on our business, our buildings business in particular. We do have a workforce group in our buildings business that is certainly advising us as well as a number of our clients on these sorts of decisions and how they might reconfigure an office. Perhaps if there's folks coming into the office three days three or four days a week and at home, others, maybe those individuals should not expect to have a dedicated workspace for them. So they're looking at how do we move from a perspective where there's dedicated workspaces for people to some shared or hoteling type space. In terms of how you think how that might impact our own buildings business, certainly, is the commercial, the office space segment of our buildings business has been the most impacted due to the downturn in the pandemic, that in our hospitality group where we're designing new multi storey hotels and those sorts of things.
But as we've talked about, we have seen a bit of a pivot due to some of the activity, the way people are responding differently. E commerce work is up. We're seeing health care work is up. But as you saw in Q3, our buildings business did retract organically, again, as they did in Q2. So while that pivot is occurring, the health care work that we're seeing in particular, there's a lot of health care work, big projects coming out in Australia and in Canada, in particular.
That work is starting to ramp up. You saw we announced the foot spray. But I think the rapid decline that we saw in commercial and hospitality hasn't been yet offset by the increase that we're seeing in health care, e commerce and so on. So we're watching it pretty carefully, matching our workforce to the type of work that's available. Okay.
Thanks. That's helpful. I'll turn it over. Thanks, Chris.
Thank you. Our next question today comes from Jacob Dash of CIBC. Please go ahead. Your line is open.
Good morning. And I'm going
to apologize upfront. I think I've got a fairly static line here to open the questions. My first question, it just goes back to the EBITDA margin target. And maybe you can talk a bit about in a post COVID world, where you actually see EBITDA margins normalizing?
Sure, Jacob. I mean, it's I think the reality is it's it's hard to say, what a post COVID margin looks like. You know, I I think where we have been in our strategic planning is thinking about and and and mapping out opportunities to to look for EBITDA margin improvement. And and and we still believe that those opportunities exist. It feels a little bit like the goalposts have moved for us through the pandemic, whether it be shifts in I pointed to employee group benefits.
That's a step change in increase in in cost that, you know, has, of course, you know, being a a people company is is pretty significant. And so it's it's things like that that it's hard for us to know where that settles out, whether this is kind of a new normal level of cost that we, you know, are are expecting to bear or not. And and so there's there's a bit of back and forth on on this. So, again, hard hard to really pin down where we think it's going land post pandemic. But certainly, our efforts are around continuing to strengthen our EBITDA margin, very focused on it.
But really, got that for 2021. The range that we put out is a realistic outcome and function of what we're seeing from a gross margin and then an overall cost perspective. And so where that takes us beyond the pandemic is really tough to say at this point.
Okay.
Yeah. I guess my view, you know what?
I think if I
heard your comments correct, you know, mix is playing into this as well, and I thought, you know, a normalization of mix unless you think there's a step change there as well post COVID, would have an impact.
I don't know if that's the case. So, yeah, I'll just I'll just interject. I don't I don't I mean, project risk will always be a a a factor for sure. But whether that always that means that permanently, there's a step change down, I don't think we would say that, that's the case. I think we're in an interesting period right now where we've got this one large project that is clearly having an impact on gross margin.
I don't know that we would anticipate anything of that size and with that to have that kind of a margin profile as we go out into the future.
My last question here is just on the organic growth. And when I look across business lines, clearly, Water stands out with very strong organic growth in the quarter, the business lines negative. Can you talk a bit about what happened in the quarter and how sustainable this is?
Yes. We were very pleased with that 3.2% organic growth, but just in Q3 and then over 10% year to date. Because particularly in the pandemic, that's a tough period. Initially, we saw in Q2 some of the opportunities retracting as our clients move home as well. But they're back now too.
So we're seeing our we track on daily basis the number of opportunities and the volume of the size of the opportunities that are in our sales pipeline. Those numbers are back to sort of more normal pre COVID type numbers. We're seeing a little bit more from the public sector than the private sector. It's interesting that the amount of work the amount of opportunities in our pipeline from a dollar value has never been this high before. And I think there's a couple of reasons for that.
One is that the number of opportunities has kind of returned to more normal sizes. A bit of it, though, too, could be that squeezing out the bottom, some of those opportunities aren't being awarded quite as quickly. But I think it's just it's positive for us to see, though, that the size of opportunities or the overall volume of opportunities in the pipeline is continues to rise. So I do think that from what we're seeing right now, Jacob, that the organic growth, the numbers that we've put up for 2021, they feel about right. And again, that's absent any significant stimulus because it's hard to predict the timing of that might occur.
I'll leave it there. Thank you very much. Thanks, Jacob.
Thank you. Our next question today comes from Benoit Poirier of Desjardins Bank. Please go ahead. Your line is open.
Yes. Good morning, everyone. Just to come back on the question on the mix that will impact 2021. I was wondering what drove the profitability downward of the large project that you just mentioned and whether there could be other projects that could impact the mix in 2021.
I think the big project that Theresa referred to is that big Trans Mountain pipeline, big job. We and we see while we've been ramping up over the last number of years, 2021 is the will be the major year where we'll spend the majority of our effort and receive the majority of the revenue. And so that's why I think that in 2021, that has sort of an outsized impact on pulling down gross margin a bit. The impact of that will be lesser in 2022 and 2023 just because the majority of the work will phase on. So that would be, I think, the bigger one, that a lot of it that would have the impact.
And again, it will be primarily in 2021, and then it should lessen in 2022. And we don't see anything of that size and lower margin profile currently in pipeline.
That's great Maybe
I'll just add one comment, Benoit, around Trans Mountain because I think it's important where it sort of gets a bit of attention because of its size and because of the impact it's having on our overall gross margin. But this is a project that we've talked about before that is really staffed with contract workers. So this is a project that we are able to kind of ramp up and down the days of workers, to suit the project. And it's not the case that, there is a choice to be made for us around competing projects, and we are deploying our efforts towards this one project to the detriment of another or at the choice of other projects that might have different margin profiles. This is purely incremental for us.
And I think from that perspective, I want to touch on that because I think it's important to understand that it is, from an incremental perspective, from a return on our working capital perspective, still positive for us. And so I don't want to leave the impression that this is a project that we shouldn't be doing because it's driving our gross margin. Gross margin is important as a metric, but there's so many other factors that we need to consider when we look at the work that we do and the earnings that we generate. And so from a return perspective, this one is a good project for us.
Okay. That's great color. And with respect to the potential impairment that you might take to in order to reassess the real estate or cost reduction initiative, I was just curious what would drive the decision. Is it purely function of organic growth, the efficient rate? And what could be the magnitude or the potential impact we might see in 2021?
Sure. So on the occupancy cost front, you'll recall that this is work that we pointed to in our strategic plan. And so this is something that we have been analyzing for some time now. And certainly, as we moved into the pandemic, it gave us some real live data as to what was possible from a reduction of our footprint. But as Gord said, there's I think we need to resist the urge to then set this as our new normal and empty out all of our office spaces to reduce occupancy costs.
We need to get an understanding of what is normal, what is long term, our our occupancy, what is that that's gonna look like. And so it, you know, it'll be driven by, the work that we had done pre pandemic around, you know, what what is the appropriate amount of square footage per employee? And we're building that with now some new information around what do we as an employer expect from having our employees in the office relative to what do our employees want, how much do they want to be in the office finding that right balance as well. And then are there places where we've got leases that are maybe coming to maturity within the next couple of years that we see an opportunity to exit now as opposed to later. So it's all of those dynamics that we're looking at.
What's the scale of it? It's really it's tough to say at this point. But I think it's fair to say that we believe that there is a significant opportunity there. And unfortunately, when you do these kinds of things, the accounting rules are kind of punitive. It needs to take a noncash charge right away.
But overall, it should you're doing it to improve your earning profile your cash flows. So we think it will be a good trade off to make. But we don't, at this point, have an order of magnitude for you.
Okay. Thank you very much for the time.
Thanks, Benoit.
Thank you. The next question today comes from Fredrik Sastien of Raymond James. Please go ahead.
Hi. Good morning to you both.
I'm a bit surprised by your relatively muted growth expectations for The U. S. Next year. Can you provide a bit more detail on what's behind that outlook?
A number of things that we're looking at, we do feel that there will be some infrastructure stimulus that will come forward and will continue to drive things. We're seeing some good activity still in the water space. We see some good activity in transportation, certainly power, some of the renewables we talked about, solar and so on. The building space is gonna be interesting next year there as we continue to talk about that pivot from commercial, that pivot from hospitality. We haven't seen as much of an uptick in opportunities in health care in The United States as we have in Canada and Australia and so on.
And so I think you'll see that from our perspective on next year that we're being a little cautious and a little cautiously cautiously optimistic perhaps on things that we haven't included acquisitions. We haven't included stimulus. And then I think that's just sort of the future is a little unwritten there still. And so we're taking a bit of a a cautious way to see attitude towards it.
No. That's good to hear. I think I think it is a prudent way to go. Speaking of NA, from from that standpoint, are you you know, given current conditions and, you know, a lot of moving parts out there, are there any regions or verticals that you're particularly attracted to right now?
You know, we we continue to to look for opportunities in in many of our verticals. We're you know, as we've as we've spoken about before in our strategic plan, we're really focused on continuing to grow in those noncyclical businesses, water, transportation, and so on. So I and and the buildings component that would be less cyclic, there'll be like the health care components and so on. So certainly, we're looking for activity in in those those groups. We continue to look good opportunities, I think still, for some infill in Canada.
We are looking in The U. S. And certainly, we haven't changed our geographic profile where we're looking outside of North America. Still looking at The U. K.
With a bit of a cautious look to Brexit in the short term, looking a bit at some of the Nordics, Western Europe a bit, and then certainly down in Australia and New Zealand.
Okay. Are you still up and are you still actively engaged in discussions with respect to M and A? And, obviously, there's that uncertainty around COVID, about timing of transactions and things like that. But are you still comfortable and happy with the number of discussions you're having right now?
Yes. A lot of the discussions interesting over the last little while that I think we previously provided some color to that we saw a slowdown in activity March, April time frame as people kind of looked inwards to manage their own business. The existing discussions the ongoing discussions that we were having were paused. But those have really been reinitiated over the last several months. And it's been, I think, also interesting to note that there's been a number of new firms that have initiated discussions with us over the last, really, month to six weeks.
And these were firms that we've been having some discussions with, just very, very cursory, but have really not that they've suffered during the COVID because a number of firms, as you know, are continuing to do just as well now as they were before. I But think they're just looking at ownership transition and having a little bit more time to think about some of these things. So I'd say that the discussions that we had ongoing pre COVID have continued, and we've initiated some additional new discussions over the last month to six weeks.
That's great color. Thank you very much.
Great. Thank you.
Thank you. Our next question now comes from Sabahat Khan of RBC Capital Markets. Please go ahead.
Just a little bit more on some of the commentary around specific end markets. I think part of The U. S. Market, you noted some water activity there as well. Can you maybe talk about it sounds like there's a bit of variance within the water market across geographies.
Can you provide a little bit color there on what you're seeing globally?
Sure. And and, Simone, can we talk about end markets just within The United States or sort of, you know, I like to maybe look at that from a larger perspective, talking about The UK, US, Canada, and and Australia. Is that sort of what what you're thinking?
Yeah. Just I think it was mentioned in The US, it seemed like it might be a little bit softer. But, yeah, just globally, just what you're seeing. It seems like UK is still doing well. I'm just curious.
Yeah. So, you know, looking at water overall, certainly, in the in The UK, water is a regulated industry in The UK. Continues to be driven by, you know, the EU directives. And it's interesting that those are unlikely to be relaxed in any way, you know, after Brexit. M7 is now well underway.
We're in fact aggressively hiring to continue to as we ramp up M7. Of course, that's difficult during a pandemic. But so we'll we've been very successful. We haven't seen a drop in 2020 in water in The UK. Australian diseases, we've got a couple of good framework awards ongoing in Australia, and I think that will continue to drive growth for us in the water industry through the remainder of 2020 and into 2021.
And in the in North America, you know, water, we've had organic growth in water for the last five, six quarters, strong growth. We saw it again in Q3, and we are projecting continued growth organic growth in water through 2020 as well. North America, there's a backlog of projects in the water space, very strong. And this because we're active in so many spaces and dominate really North America in a number of everything from coastal resilience type work to water wastewater treatment, big water conveyance, water resources projects. So we see continued good opportunities in water, really in all of our major geographies for the remainder of 2020 and into 2021.
Got it. And then I guess just on the 2021 commentary that you provided, appreciating the fact that M and A is not included in there. I guess, you maybe comment on maybe the scale or size of potential transactions that you're currently engaged with? Just trying to see if there is potentially some needle moving opportunities in the pipeline. You know, in a clear sense, a little uncertain in the backdrop, but what in kind of conversations are you having?
Is it larger players or smaller players?
Yeah. You know, we we haven't really changed our philosophy there, which is still to target those, you know, small to mid smaller to midsized firms, kind of less than a thousand people. You know, that that's really it's our area of focus. You know, that said that there will be larger ones that come, I think, in 2021. We'll have a we'll have a look at them, but our primary area of focus is still on that small to midsize, less than a thousand people type of space.
And then I think you made some comment or just some commentary earlier that the health care work is picking up in some markets and not in The US. That was somewhat surprising. Can you maybe share some color on why that region might be a little bit different on that front?
Yeah. And it's there's a lot of ongoing discussions still in The US, but we've just seen less pursuit activity over the last quarter, one years in The U. S. Than we have in Canada and Australia in particular. I do think that we'll see it coming back.
Perhaps there's some of these larger projects where we're waiting to learn more about the impact of any potential stimulus that might be coming forward. US also has more private health care sort of operations down there. So we may be waiting just to see a little bit more how some of these things shake out over the next quarter or so. There is still great opportunity there. It's just that over the last quarter, quarter and half, we've seen less opportunities come to market in The U.
S. Than we have in other locations.
Okay. Great. And then just last one for me. I think you mentioned earlier on this larger project, which it sounds like is a TMX. The gross margin might be lower, but there's less SG and A or discretionary costs associated with it.
Can you maybe talk about what's driving that? Is it just the nature of the work you're doing there that's resulting in lower SG and A?
Yeah. So, you know, as Teresa mentioned, that the vast majority of of the individuals that we have working for us on the job are contractors. And so really, they're they'll typically, they won't see the inside of a SanTech office. These are folks who are hired specifically to be on-site working on that project. So a lot of the admin, there's really no marketing costs.
For those folks who aren't involved in working on other proposals, they often will bill a day rate for the work that they do there. So there's really good to know administrative times, certainly marketing time, and expenses are covered. So there's really none of those discretionary admin and marketing costs that are, for the most part, that we would see with other operations. So very well, the gross margin on the work is lower. Really, there's you can never say none, but there's very, very limited admin and marketing costs.
And so on the flip side, their utilization rates are virtually 100%.
Okay. Great. Thanks very much for the color.
Great. Thank you.
Thank you. Our next question today comes from Mona Azir of Laurentian Bank. Please go ahead. Good morning, and thank you for taking my questions. On prior conference calls on the back of COVID, you stated that there were some pricing concessions put in place.
And I believe the majority of those were short term in nature, three to six months. I'm just wondering if they have come off at all? Or are there further concessions? And I'm just wondering related to that, if you've seen increased competition or pricing pressure. Yes.
Thanks, Lauren. So certainly, some of those that were of shorter duration have come off. Others will stick for a bit longer. But we factored all that into our forecast for the remainder of this year and next outlook for next year as well. In terms of what we're seeing going forward, this is always a price competitive market.
But we haven't seen some of the pricing pressures from a competitive environment that we saw early on in the pandemic, we've seen a bit of lessening of that. You'll see from other firms that you look at in the space, these companies are still doing fairly well. So the need to continually beat each other up and continue to drive prices down to secure additional market share has become less of a concern of people as the pandemic has proceeded. That said, as I say, it's always a competitive market. But a lot of that pricing pressure that we saw the first couple of months of as people moved home really has come off to a degree.
That's very helpful. And then just secondly on M and A, I know you did speak to a number of questions on this. We have not seen a number of transactions within the space. I think Teshemont was kind of one of the only ones in my coverage universe. I'm just wondering, you mentioned the various geographies that you continue to target, UK, Nordics, Australia.
I just wanted to confirm that there's not a higher probability of M and A in Canada or The US just given location and proximity, with travel restrictions. And then, on that, I'm just wondering if you're comfortable with the ability to do due diligence on a far you know, the financials for the companies that you're targeting and related integration.
Yeah. So in terms of where we're looking, you know, what's really important to us is that where we're looking for a firm, we have a solid presence from a Stantec perspective. We have people that understand what it takes to go through due diligence to source the firm, what does the cultural fit look like. And we feel very comfortable with the leadership that we have in place in in The UK, Western Europe, Australia, New Zealand, in addition to the leadership we have in place in Canada and The United States. So as long as we're in a location where we have that strong leadership, I think we feel very comfortable continuing to move forward.
And we are having ongoing discussions really in all of those geographies that you mentioned. And so from the perspective of conducting due diligence and so on, again, our leaders in these various areas, whether you're doing project due diligence, HR, accounting, taxation, we'll have people on the ground, but we'll always be in contact with sort of our the group of people that lead that initiative just to ensure that we're asking the right questions, we're pushing forward with due diligence appropriately. So I don't really see that these travel restrictions at this point are really significantly inhibiting our ability to move forward with our M and A discussions.
Okay. That's very helpful. And just lastly for me, I appreciate you providing 2021 guidance, particularly in such challenging times. I understand there are a number of questions surrounding the outlook, but this is just more of a clarification. Just given you stated that organic the organic growth target is kind of feeling right, but then you're also somewhat cautious.
Just for my own purposes, would it be fair to say that you would characterize the overall guidance as being realistic based on how things are sitting right now or perhaps somewhat conservative?
You know, we we feel good about it, Mona. I think we feel that it's it's realistic based on what we know now. And, you know, we we do feel comfortable with with where we are. We didn't want to put out sort of our targets that we thought were unachievable because then that will cause us issues all of next year. So I think these are realistic numbers that we feel reflect our how we're thinking about the environment at this point.
Perfect. That's great. Thank you. Congrats on the performance.
Great. Thanks, Mohan.
Thank you. Our next question comes from Michael Turpaul from TD Securities. Please go ahead.
Thanks. Good morning. I wanted to go back to the discussion about the strategic initiative to look at optimization of occupancy costs. Therese, is this just in terms of timing, it sounds like you're sort of still in an evaluation or at an evaluation stage here. I know you said it's not included there's no benefits included in your 2021 guidance from this.
But what is the timing for, potentially coming to some conclusions through this process? And then how quickly could you expect to see some benefits, from that?
Well, I think based on where we are, you know, it'd realistic to think that in the next, you know, sort of three to six months, we'll we'll draw, draw to conclusion. And again, because the whole situation around work from home continues to be fluid, and we're trying to make a long term decision, it may take longer than we expected, but we're advancing. And we have three fifty locations around the world. So there's a lot of data to crunch through and a lot of thinking around what's the appropriate sizing that we want to put in place. So our expectation is that it would be in, I'd say, the three to six month period, but with the caveat that it could take longer just as things kind of change unexpectedly.
And if it is within that period in terms of sort of the decision making process, you know, I know it takes time to to get out of leases or to sort of rearrange things on that front. What would be a realistic expectation for when you would start to begin to see the benefits?
Well, you know, I think what's what's interesting about the way accounting rules work is that when you make a determination and you've established pretty firmly what your plans are around the use of that phase, you have to assess and take that impairment charge right away. And because you've taken that charge right away, you then start to see the benefits through lower occupancy costs, mostly through your depreciation and interest expense line items, but also to some extent in your G and A line item. You start to see that right away because you've now kind of unburdened yourself from that lease. So it is pretty immediate. The cash flow impact could be slightly lagged depending on when you're able to release or sell lease that space.
But from an earnings standpoint, you would start to see that pretty much right away.
Okay. That's helpful. And then second question, Gord, I think you were speaking earlier and you mentioned that you see the opportunity pipeline, the awards pipeline as being very strong. Just thinking back to the last quarterly release and call, there was some discussion about observing some slowdowns in current projects and new awards in the second half of twenty twenty. So I'm just trying to sort of reconcile the strength of that pipeline with the commentary last quarter about the pipeline pardon me, the new awards sort of activity slowing a bit.
I mean, the pipeline, I suppose, can be very robust. But are you confident sort of in the conversion of those opportunities to awards? Or are there still some pressures given the environment we're in in terms of that conversion?
Yes. We have seen sometimes some of the award process can take a little bit longer. But yet, you can see from the 3.2% increase in organic growth in our backlog in Q3, we have been converting those. So I think that we're getting back to a more normal cadence. Although it's still sometimes in an environment where all the clients are working at home, it can take a little longer to get all the paperwork done and move all this forward.
But again, really just the fact that our backlog increased organically by 3% in Q3, I think, sort of provides me some comfort that we are seeing that conversion from opportunities to backlog.
Okay. So has there been a that makes sense. But I'm just wondering, has there been an actual improvement from your perspective in terms of the I guess, relative to those comments you made last quarter about slowdowns of possible awards, like has situation sort of improved from your perspective?
No. And I think, Michael, it's interesting because my thought about over the next period of time is gonna be one of flexibility. Because I think if we looked at now The UK for the next month, when The UK has now gone into lockdown, I think we're gonna see now luckily, we've got all our AMP awards going, and the projects are underway. But for new awards in The U. K.
During a lockdown in the next couple months or next month, sorry, I think it might be a little bit slower. And conversely, if we look at Australia, where they just which is pretty active. Australia, New Zealand, our offices are open, we're back. Melbourne has reopened after their lockdown. I'd expect to see awards in the Melbourne area that perhaps have been a bit slower during lockdown speed up a little bit again.
So I think it's it's gonna be it's hard to make a broad brush statement at this point because the world is gonna be, I think, in this move forward, lurch backwards, move forward, lurch backwards. So it's gonna be so the words that we've been using internally is just be flexible and understand that some things are gonna happen faster, some things are gonna happen slower. But on balance, we feel like we're on the right track. Backlog is growing. Book to burn greater than one in each of our business operating units and quarters, that's pretty impressive.
But it's the future ahead, just in the same way as we've talked about 2021. And I think we're just being a bit cautious to make any broad statements because the world is in a bit of an unknown place, though.
Right. That makes sense. I appreciate the fluidity and the fact that regions differ. So that makes complete sense. Just a final question for me.
In the discussion around the 2021 outlook, there was commentary about looking at a meaningful increase in cost of employee group benefits, and I apologize if I missed this, but can you just explain to me and and provide a little more detail on on what's behind that, what's driving that?
Yeah. You know, I I think what we're seeing is through the pandemic, it was interesting because initially people went home and and kinda stopped doing everything. But as time wore on, the the use of, employee benefits has really, increased pretty pretty at a pretty high rate. And so people are, you know, going to physio, getting, you know, getting their necks and chests. They're going getting lavages.
They're getting all these things taken care of. And they're, importantly, you know, taking advantage of whether it's counseling, that's the promotional support that's offered through employee programs. And that is, of course, why those programs exist. But I believe what we're seeing now is the pricing into the programs for next year that's reflective of assumed higher usage. And as I said, as a people company, that can have quite a dramatic effect on us when the cost of those benefit programs increase.
And so that's what we're seeing, and that's what is factored into what I think whether it's permanent or not, I have no idea. But I know for next year, we are seeing a significant increase.
Okay. That makes sense. Thanks very much.
Thanks.
Thank you. Our next question comes from Maxim Sytchev from National Bank Financial. Please go ahead.
Good morning.
Good morning, guys.
Just wanted to circle back to, Gord, your commentary around book to bill, being above one. As we have the backlog, which is strong then organic growth on the revenue side, obviously, a bit. How should we think about sort of the change in the burn rate or there's literally none of just timing, which is kind of impacting things. So I guess my question is how quickly can we see organic growth actually coming back into the problem territory given the macro trends?
Yes. So we have seen that some of these projects are stretching out a little bit longer than they had. And so we as we look into 2021 and our sort of low to mid single digit organic growth assumptions that we put forward there, that's sort of as we've spoken with our leaders in the various business lines in the different geographies, that's sort of a number that everyone feels pretty comfortable about. Certainly, we see a group like water probably at the higher end of that than other groups in different positioning in the organic growth spread. But so I think we feel pretty good, Max, about that low to mid single digit organic growth in 2021 based on what we see in the pipeline and based on what we've got in backlog.
Right. But I guess, I mean, we cross there by kind of Q1 or Q2 is going to be sort of the first quarter where you see sort of positive comps?
I think that as part of what we typically see from a seasonality perspective, Q1 is always a little bit slower because certainly up here in the North, we don't have a lot of field programs moving in and things. I think while we and Nolan, of course, said that Q1 'twenty was still pre pandemic, so that's going to be a higher comp. Where we get into Q2, we're looking at a post pandemic. So we're going to see while the revenues might be react as we would expect from a seasonal perspective, from an organic growth perspective, as we look at Q2 'twenty one, we're still comparing to that higher Q1 'twenty pre pandemic comp. So I think we'll probably see it numerically reflects much better in Q2 because we're ramping up and coming off a lower post pandemic comp.
Yes. No, that makes sense. And then lastly, just given sort of the moving parts in the building side, do you feel that the headcount that you have in that division specifically is sort of appropriate, given, the revenue opportunities that you guys are seeing on the horizon? I guess my question is if if you have to, you know, sort of contemplate further stuff.
Yeah. That that group, has been managed extremely well through through the pandemic, and we've been matching headcount at different levels in the organization to available work, throughout. So I think we'll continue managing it very judiciously, as we have. But I I don't see the need for any any, you know, more significant headcount reductions because it's been run very well throughout the pandemic.
Right. Okay. Excellent. Thank you so much. That's it for me.
Great. Thanks, Max.
Thank you. That will now conclude the question and answer session. I'd like to hand back to our speakers today for any additional or closing remarks.
Well, thanks, everyone, for joining us on the call today. We look forward to continuing to speak with you about our future progress. Have a great day, and stay healthy.
Thanks very much. Thanks, everyone. Thank you. That will now conclude today's conference call. Thank you for your participation, ladies and gentlemen.
You may now disconnect.