Earnings Call
Stantec Inc (STN)
Earnings Call Transcript - STN Q3 2020
Operator, Operator
Welcome to Stantec's Third Quarter 2020 Earnings Results Conference Call. On the call today are Gord Johnston, President and Chief Executive Officer; Theresa Jang, Executive Vice President and Chief Financial Officer. Stantec those dialing in to view the slide presentation, which is available in the Investors section of stantec.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 20-second delay between the call and the webcast. All information provided during this conference call is subject to the forward-looking statement qualification set out on slide two, detailed in Stantec's Management Discussion and Analysis and incorporated in full for the purposes of today's call. All amounts discussed in today's call are expressed in Canadian dollars and are generally rounded. And with that, I'm pleased to turn the call over to Mr. Gord Johnston.
Gord Johnston, CEO
Well, good morning and thank you for joining us. I'll begin our call today with a review of our third quarter performance. Theresa will then delve deeper into the financial results, review our 2020 outlook and provide our 2021 targets. I'll then return to provide 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 initiatives, ongoing staffing management and controls on discretionary spending, drove a strong 17.3% adjusted EBITDA margin, a 5.1% year-over-year increase in adjusted diluted EPS and a 5.4% increase in adjusted net income, in light of net revenue and gross margin retractions. Backlog grew organically in Q3 to a record high of $4.8 billion and our balance sheet continued to strengthen. Subsequent to the quarter, we closed on our $300 million bond offering on very attractive terms. Theresa will discuss it in more detail in the resection of the presentation. At the end of the presentation today, I'll review how our core value creators of 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 million to $915 million. Revenue retracted organically 4.7% in the quarter. Year-to-date, net revenue is holding up very well despite the COVID-19 pandemic with an organic retraction of only 1%. Water demonstrated a 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 M7 framework awards in the U.K. and a multi-year 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 multi-billion-dollar pure water initiative, which will supply sustainable water to the city's 1.4 million residents. Environmental Services continues to perform well and slightly ahead of expectations. Essentially, all of our Environmental Services connected 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 our Northwest territories, Manitoba, and Alberta grew in scope during the quarter. Energy Resources had a strong quarter even in 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 earlier in the year, it's picked up and we were recently awarded large-scale solar projects in Canada, the U.S., and Australia. In general, given the critical nature of power generation and transmission infrastructure, the utility market has not slowed. We're seeing strong growth in electrical transmission opportunities, especially in the U.S. due to resiliency programs, the growth of renewables, and power trend mitigation. Infrastructure revenues retracted in the quarter, primarily due to several large rail transit projects in the United States, which are beginning to wind down. At the same time, the ramp-up of some of our other big transportation projects has been a bit slower than normal. We expect our Transportation business to benefit from various infrastructure programs as they're announced around the world. 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 the Edmonton Valley Line West LRT was announced just last week. The commercial airport and hospitality sectors in our Buildings business continue to be impacted by the pandemic, although we can work for e-commerce clients. We've also seen a significant increase in the pursuit of activity in the healthcare sector, and we were recently named the lead designer of the preferred performing team for the $1.4 billion Footscray Hospital in Melbourne, Australia. Our public sector in Buildings remains greater than 50%, which is higher than many of our peers. We're seeing a trend toward greater exposure to publicly funded projects in our Buildings business, which should bolster future resiliency. While Q3 2020, net revenue in the U.S. retracted slightly more than anticipated compared with Q2, we're seeing continued growth in water and strong performance in Environmental Services. The pandemic has had an unfavorable impact on Buildings, contributing to a lower ramp-up of major Transportation projects. Gross margin as a percentage of revenue decreased 1.7% in the quarter to 52.9%. This reflects a shift in our project mix, primarily driven by the major project in our Transportation segment. 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 IIT 3 North Street North York widening project in Pennsylvania. In Canada, Q3 net revenues were slightly ahead of Q2, consistent with our outlook. While Canada experienced a 5.3% organic retraction compared with Q3 '19, we're seeing growth in our Energy & Resources business, largely due to midstream pipeline work, and in our Transportation sector. Environmental Services performance has remained consistent year-over-year, and the COVID-19 pandemic was more pronounced in Buildings and community development. Gross margin decreased 1.8% as a percent 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 water infrastructure projects in both Alberta and Quebec and a new integrated academic 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 U.K. and Australian water business, our work in New Zealand's transportation sector, and progressive recovery in core markets in our U.K. infrastructure business all contributed to a strong showing in our global operations in Q3. The impact of COVID-19 was more pronounced in our U.K. and Australia Buildings 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 several 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 Footscray Hospital project. We were also selected by the European Commission to support the development of a continental generation and transmission master fund to meet Africa's growing power needs. Backlog expanded in Q3 to a record $4.8 billion, representing approximately 12 months of work. Backlog grew 12.7% since the end of 2019, of which 10.6% is organic growth. Since Q2, backlog had grown organically by 3.2%. Our book-to-burn ratio for Q3 2020 was 1.1 compared to 1.0 for Q3 2019, and it is greater than one across each of our five business operating units. Overall, our sales pipeline remains healthy after the brief activity we saw in Q1. The number of new pursuits in our pipeline has returned to more typical levels. Not surprisingly, we're seeing more opportunities in the public sector than in the private sector. I'll turn the call over to Theresa now for a review of our financial performance and our outlook.
Theresa Jang, CFO
Thank you, Gord, and good morning, everyone. Adjusted net income from continuing operations increased 5% to $70 million in the third quarter or 7.6% as a percentage of net revenue. Adjusted earnings per share increased 5% to $0.62 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 $479 million. As a percentage of net revenue, gross margin was 52.3%. The pandemic disrupted our and our clients' operations to a degree, causing some inefficiencies in project execution, as demonstrated by our solar adjusted EBITDA margin of 17.3%. We're managing the business carefully and we've taken steps to mitigate COVID-19's impact on organic growth and gross margins. Our balance sheet remains strong. At September 30, net debt to adjusted EBITDA was below our targeted range at 0.8 times. Day sales outstanding was 82 days at quarter-end compared with our target of 90 days. This remains unchanged since Q2 and we are not seeing any notable impact due to the pandemic. Moving on to liquidity and capital allocation. We generated $124 million in free cash flow for the quarter, a 31% increase compared with Q3 2019. Sequentially, our free cash flow has improved every quarter for the past four quarters on a trailing 12-month basis. On October 8, we closed our inaugural bond offering, issuing $300 million in senior notes for a 10-year term with an interest rate of 2.048%. The $300 million facility is currently largely undrawn, giving us significant dry powder to weather the pandemic and 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-19 pandemic will likely delay the achievement of our targets within the original timeframe. At this time, we're unable to provide a revised timeline with a high degree of confidence. Today, we're reiterating our outlook for 2020 as set out in August. We're also providing our target for 2021. New targets assume a continued gradual global recovery, which may not be uniform across geographies, experience, and severe worsening of the pandemic. In terms of our revenue expectations in the U.S., we expect the step-down results of Q2 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 U.S. net revenues to be comparable to, although slightly below 2019 in native currency. We expect the same seasonal dynamic to take place in Canada, which will result in Q4 2020 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 to last year. In Global, we expect Q4 2020 net revenues will be down slightly relative to Q3. Our U.K. Buildings practice appears to be more impacted by pandemic-related headwinds than anticipated. However, we have seen strong performance from our Water business in the U.K. and Australia and our Transportation sector in New Zealand, which has largely offset the impact of project slowdowns in the private sector for our other businesses. We expect this to result in 2020 revenue being comparable to, although slightly below, 2019. Taken together, we expect 2020 net revenue to be better comparable to, although slightly below, 2019. Adjusted net income and adjusted EPS are expected to be comparable with 2019 as a result of lower admin and marketing costs and lower interest costs. Similar to 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 remains strong, and we continue to have ample liquidity. Our capital allocation priorities have not changed. Our M&A activity has been reengaged and we're committed to returning capital to our shareholders through the payment of dividends, 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 lower to mid-single-digit organic net revenue growth. We anticipate net revenue growth in the U.S. in low single digits. While we believe we're well-positioned to benefit from stimulus spending, we haven't yet incorporated any potential upside to this into our revenue expectations, including uncertainty around the timing of such legislation being passed. I should also note that our estimate for 2021 assumes an exchange rate of 0.76, reflecting a weaker U.S. 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 industry, and pipeline activity is anticipated to be at key 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. While we reengage in our M&A activity, we have not incorporated any acquisitions into our 2021 outlook as it is 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 projects and on several of our lower-margin, $14 billion 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 prepandemic levels. We do, however, anticipate an increase in non-discretionary costs, including insurance and employee group benefits associated with indirect labor. Additionally, we're increasing our investments to drive innovation in IT systems to support our growing U.S. Federal government projects. We expect 2021 net income to be equal to or greater than 6% of net revenue and we benefit from lower interest expense and depreciation and amortization. Return on invested capital is targeted to be equal to or greater than 9%. We expect to generate 40% of our earnings in Q1 and Q4 and 60% in Q2 and Q3. We continue to advance our strategic initiatives to optimize occupancy costs beyond those locations identified to date, which could result in the recording of asset impairments, non-cash charges that would not change our plans 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 potential benefits from further optimization. And again, I note, our targets do not include any 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 below 1.0 to 2.0 times and we're committed to maintaining our BBB credit rating. With that, I'll turn the call back over to Gord for his concluding remarks.
Gord Johnston, CEO
Thanks, Theresa. We continue to execute well on our strategic plan, which we laid out to our employees and the investment community in December of last year. I want to thank our employees for their continued commitment to serving our clients and helping them through the unprecedented disruption caused by the pandemic. Our results for the quarter are truly accretive to our goal. 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-19 and to ensure that we emerge from the pandemic in an even stronger competitive position. We're also implementing strategies to conduct M&A activities by leveraging local resources even more when travel is restricted. We'd utilize these strategies for the integration of Cashman, a small but strategic acquisition that we announced subsequent to the quarter. We remain confident in the resilience of our business model and our ability to navigate the ongoing challenges caused by the COVID-19 pandemic. Given everything that Stantec has done in the last year, including our 2019 reshaping initiatives aligned with our organizational structure, continued focus on discretionary cost management and the staffing strategies we've put in place, we feel very well positioned as we head into 2021. And with that, we'll open the call up to questions.
Operator, Operator
Our first question today comes from Chris Murray of ATB Capital Market. Please go ahead.
Chris Murray, Analyst
Could you provide more details about your 2021 guidance? Specifically, how do you expect gross margins to be affected? It seems that EBITDA margins may be lower than anticipated, so any insights on this would be helpful.
Theresa Jang, CFO
Sure. I think we understood your question regarding the 2021 gross margin and project mix. Is that correct?
Chris Murray, Analyst
That's correct.
Theresa Jang, CFO
I believe that in 2020, which is important to carry into 2021, we will see some compression in our gross margin compared to the historical range we have experienced. This is primarily due to a decline in productivity, which is challenging to quantify but appears to be happening on our end as well as with our clients. The duration of our work and our responsiveness to clients are factors, as well as the overall project mix, which has lowered our gross margin. We expect this trend to continue next year. The TransMountain project is relatively large compared to our other projects, but it still accounts for less than 5% of our total net revenues. As we have mentioned, no single project significantly influences our overall results; however, this particular contract has a lower gross margin. As we enter next year, this will be more noticeable and will reduce our gross margin further. It is worth noting that because of the nature of the work, where employees are primarily in the field, there are minimal administrative costs associated with that project. Therefore, the resulting EBITDA margin is comparable, if somewhat lower than our typical project work. The decrease in gross margin does not necessarily reflect what ultimately affects our EBITDA. We anticipate improvement in the coming year, while also considering that several large transportation projects are nearing completion, contributing to a static gross margin. Though we are striving to improve it, we recognize, as indicated by the range we provided, that we do not foresee a return to the historical gross margin range of 15% to 55%.
Chris Murray, Analyst
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 occupancy. I'm curious about your thoughts around how you see the organization change as it's gone through COVID? And how you think about in an office setting and what that does to your footprint? But then what does that do to your Buildings business? And how are you guys thinking about that business longer term? So the cost side is a savings for you, perhaps. But then also, how offices get used in the future, maybe it's a little bit different as well.
Gord Johnston, CEO
Yes. I'll begin by discussing overall occupancy. We've noticed, and our industry has too, that utilization numbers are holding up reasonably well. However, there are concerns regarding productivity per billable hour. Having people in the office does offer some advantages, especially for junior and intermediate staff who benefit from the ability to ask quick questions and collaborate more efficiently. As we assess overall occupancy, we've been surveying our staff and communicating with others in the industry. Looking ahead, we're considering a mix of full-time office staff, those who come in a few days a week, and a smaller group who may work from home exclusively. We don't intend to make sweeping claims like those seen in the tech sector regarding office attendance. We believe the long-term reality will be more nuanced. Regarding our Buildings business, we have a workforce group advising us and clients on these decisions, such as how to reconfigure office spaces. If staff are coming in part-time, they may not need dedicated workspaces, prompting a shift toward shared or flexible workspaces. The commercial and office space segment of our Buildings business has been the most affected by the pandemic, while our Hospitality group focuses on developing new hotels. We've observed a shift in activities as e-commerce and healthcare projects see increased demand. Despite the uptick in healthcare work, particularly significant projects in Australia and Canada, the substantial decline in commercial and hospitality sectors has not yet been fully balanced by these gains. We are closely monitoring the situation and adjusting our workforce to align with available work.
Operator, Operator
Our next question today comes from Jacob Bout of CIBC. Please go ahead.
Jacob Bout, Analyst
I apologize upfront if I sound a bit static in line here. My first question just goes back to the EBITDA margin target. And maybe you can talk a bit about how in a post-COVID world, do you see EBITDA margins normalizing?
Theresa Jang, CFO
Sure, Jacob. I think the reality is, it's hard to say what a post-COVID margin looks like. I think where we have been in our strategic planning is thinking about and mapping out opportunities to look for EBITDA margin improvement and we still believe that those opportunities exist. I feel a little bit like the goalposts have moved for us, though, as to the pandemic, whether in the shift and yes I pointed to employee group benefits. That's a step change increase in cost that has, of course, being a people company, is pretty significant. And so it seems like 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 are expecting to bear or not. There's a bit of back and forth on this. So again, we're trying to align our expectations around where we think it's going to land post-pandemic. Certainly, our efforts are around strengthening our EBITDA margin, very focused on it. But we really felt 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 an overall cost perspective. Whether that takes us beyond the pandemic is really hard to say at this point.
Jacob Bout, Analyst
Okay. Yes. I guess from my view, I think if I heard your comments correctly, mix also played into this as well. And I thought it a normalization of mix, unless you think there's a step change there as well post-COVID will happen?
Theresa Jang, CFO
Yes, I'm not sure if that was the case. I'll just add that the project mix will definitely be a factor. However, I don't think we would say that it permanently affects the business case. We are currently in an interesting phase with a significant project that is noticeably impacting our gross margin. I don't believe we would expect anything of that scale and margin profile in the future.
Jacob Bout, Analyst
Yes. 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. All the other business lines are negative. Can you talk a bit about what happened in the quarter and how sustainable this is?
Gord Johnston, CEO
Yes. We're very pleased with the 3.2% organic growth shift in Q3 and then over 10% year-to-date. Particularly in the pandemic, that's a tough period we saw in Q2, with some opportunities retracting as our clients moved forward as well. But they're back now too. We're tracking on a 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 at 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 and our timing from dollar value has never been higher before. I think there are a couple of reasons for that. One is the number of opportunities has kind of returned to more normal sizes, a bit of a go-to, could be squeezing out the bottom. Some of those opportunities aren't being awarded quickly. But I think it's positive for us to see that the size of opportunities or the overall volume of opportunities in the pipeline continues to rise. We do believe that from what we're seeing right now, Jacob, that the organic growth number that we've put out for 2021 feels accurate. Again, that's absent any significant stimulus because it's hard to predict the timing of when that might occur.
Operator, Operator
Our next question today comes from Benoit Poirier of Desjardins. Please go ahead.
Benoit Poirier, Analyst
Just to come back on the question on the mix that will impact 2021. I was wondering what drove the process; will we see downward of the large project that you just mentioned and whether there could be other projects that could impact the mix in 2021?
Gord Johnston, CEO
No. I think the big project that Theresa referred to is a major transit pipeline. We see while we've been ramping up over the last number of years, 2021 will be the year where we'll expand the majority of our effort and receive the majority of the revenue. So that's why I think for 2021, that has 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. We don't see anything of that size and lower-margin profile currently in the pipeline.
Theresa Jang, CFO
Maybe one comment, Benoit, around the project. I think it's important we get a bit of attention because of its size and because of the impact it's having on our overall gross margin. This is a project, as we talked about before, that is mainly sold to contract workers. This is a project where we are able to ramp up and down the basis of work that consumes the project. It's not the case that there's a choice to be made for us around competing projects. We are deploying our staff toward this one project without the detriment of another or the choice of other projects that might have a different margin profile. This is purely incremental for us. From that perspective, I want to emphasize 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 a positive project for us. So I don't want to create the impression that this is a project we shouldn't be doing because of its impact on our gross margin. Gross margin is an important metric, but there are so many other factors that we need to consider when we look at the work we do and the earnings we generate.
Benoit Poirier, Analyst
Okay. That's great color, and with respect to the potential impairment that you might take in order to reassess the real estate or cost-reduction initiative, I was just curious what would drive the decision? Is it purely a function of organic growth utilization rate? And what could be the magnitude or the potential impact we might see in 2021?
Theresa Jang, CFO
Certainly. Regarding the trend in occupancy costs, this is an effort we've outlined in our strategic plan and have been examining for some time. The pandemic provided us with valuable data on the feasibility of reducing our office space. However, as Gord mentioned, we need to avoid the temptation to assume this is the new normal and completely vacate our office locations to cut costs. It's essential to determine what is considered normal, our long-term occupancy needs, and what that will entail. This understanding will stem from our pre-pandemic work on the appropriate square footage per employee, combined with new insights into what we require as an employer versus what our employees prefer. We are also evaluating upcoming lease expirations in the next few years that could allow for an earlier exit. All these factors are being taken into account. It's difficult to determine the scale of this at this point, but we believe there is a significant opportunity. It’s important to note that making these changes can involve accounting rules that impact the immediate non-cash charges. Ultimately, the intent is to enhance your earnings and cash flows, so we feel it will be a worthwhile trade-off, although we cannot provide a specific magnitude at this time.
Operator, Operator
The next question today comes from an unidentified analyst of Raymond James. Please go ahead.
Unidentified Analyst, Analyst
I'm a bit surprised by your relatively muted growth expectations for the U.S. next year. Can you provide a bit more details on what's behind that outlook?
Gord Johnston, CEO
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 here. We're seeing good activity still in the Water space. We see strong activity in Transportation, certainly power, some of the renewables, solar. The Buildings space is going to be interesting next year as we continue to talk about that pivot from commercial and hospitality. We haven't seen as much of an uptick in opportunities in healthcare in the United States as we have in Canada and Australia. I think you'll see that from our perspective, we are being a little cautious and perhaps cautiously optimistic on things. We haven't included acquisitions or the stimulus in our outlook. But I think that's just sort of the future is a little unwritten at this point. So we're taking a bit of a cautious wait-and-see attitude toward it.
Unidentified Analyst, Analyst
Clear. I think it is a prudent way to go. Speaking of M&A from that standpoint, are there given current conditions and a lot of moving parts out there, are there any regions or verticals that you're particularly attracted to right now?
Gord Johnston, CEO
We continue to look for opportunities in many of our verticals. As we've spoken about before in our strategic plan, we're really focused on continuing to grow in those non-cyclic businesses: Water, Transportation, and so on. The Buildings component, there would be less cyclical, particularly the healthcare components and so on. We're looking for activity in those groups. We are still looking for infill opportunities in Canada. We are looking in the U.S. and we haven't changed our geographic profile while looking outside North America, still considering the U.K. with a cautious look toward Brexit in the short term, and certainly in the Nordics, Western Europe, and then down in Australia and New Zealand.
Unidentified Analyst, Analyst
Okay. Are you still actively engaged in discussions, especially around M&A? Obviously, there's that uncertainty around COVID, the timing of transactions, and things like that. Are you still comfortable and happy with the number of discussions you're having right now?
Gord Johnston, CEO
Yeah. A lot of the discussions over the last little while, I think we previously provided some color on that. We saw a slowdown in activity in March and April as people would kind of look inwards to manage their own business. Ongoing discussions we were having were paused, but those have really been reinitiated in the last several months. It's interesting to note that there have been a number of new firms that have initiated discussions with us over the last few months, firms that we've had some cursory discussions with; it’s not that they suffered during COVID. These firms are continuing to do just as well now as they were before, but I think they are just looking at opportunities and having more time to think about things. The discussions that we have ongoing pre-COVID have continued, and we've initiated additional discussions in the last month to six weeks.
Operator, Operator
Our next question comes from Sabahat Khan of RBC Capital Markets. Please go ahead.
Sabahat Khan, Analyst
Great. 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 how much there is a bit of a variance within the Water market across geographies? Can you provide a little bit of color there on what you're seeing globally?
Gord Johnston, CEO
Sure. When you talk about end markets, are you talking within the United States or are you looking at the larger perspective, taking into consideration the U.K., U.S., Canada, and Australia?
Sabahat Khan, Analyst
Yes, just I think it was mentioned in the U.S., it seemed like it might be a little bit softer. Just curious, yes.
Gord Johnston, CEO
Yes. When looking at Water overall, certainly in the U.K., water is a regulated industry in the U.K. It continues to be driven by the new directives. Interestingly, those are unlikely to be relaxed in any way after Brexit. M7 is now well underway. We're aggressively hiring to continue ramping up. I see, of course, that is difficult during a pandemic. We haven't seen a drop in 2020 because of Water in the U.K. Australia and New Zealand, we've got some good framework awards ongoing in Australia. I think that will continue to drive growth for us in the water industry through the remainder of 2020 and certainly into 2021. In North America, we've had organic growth in Water for the last five, six quarters of strong growth. We saw it again in Q3 and we are projecting continued organic growth in Water into 2021 as well. The North America backlog projects in the water space remain very strong. Because we're active in so many spaces and dominate in North America in multiple roles – everything from water resiliency to wastewater treatment, to big water conveyance, and a lot of resource projects. We expect continued good opportunities in Water across all our major geographies for the remainder of 2020 into 2021.
Sabahat Khan, Analyst
And then I guess just on the 2021 commentary you provided. I appreciate the fact that M&A is not included. I guess can you comment on the scale or size of potential transactions that you're currently engaged with? Trying to see if there's potentially some needle-moving opportunities in the pipeline. We understand it's still uncertain given the backdrop, but what kind of conversations are you having? Is it with larger players or smaller players typically?
Gord Johnston, CEO
Yes. We haven't really changed our philosophy in that regard, which is still to target those small to mid-sized firms, kind of less than 1,000 people. That said, there will be larger ones, but in 2021, we will be taking a look at them. Our primary area of focus is still on that smaller to mid-sized space, less than 1,000 people.
Sabahat Khan, Analyst
And then I think you made some comments earlier about the healthcare work picking up in some markets and not in the U.S. That's somewhat surprising. Can you shed some light on why that region might be a little different on that front?
Gord Johnston, CEO
Yes. There are ongoing discussions still in the U.S. But we've seen less pursuit activities over the last quarter or so. A quarter and a half in the U.S. than we have in Canada and Australia, in particular. I do believe that we'll see it coming back. Perhaps there are some larger projects where we are waiting to learn more about the impact of any potential stimulus that might be coming online. The U.S. also has more private healthcare operations down there. So we may be waiting for some of these things to shake out over the next quarter or so. There is still great opportunity there. It's just that over the last quarter or a quarter and a half, we've seen fewer opportunities come to market in the U.S. than we have in other locations.
Sabahat Khan, Analyst
Okay. Good. And then just the last one for me. I think you mentioned earlier on the barge project, which it sounds like the gross margin might be lower, but there are fewer SG&A or discretionary costs associated with it. Can you talk about what's driving that? Is it just the nature of the work you're doing there that's resulting in lower SG&A?
Gord Johnston, CEO
Yes. So Theresa mentioned that the vast majority of the individuals that we have working for us on that job are contractors. They typically won’t see the inside of a Stantec office. These are folks who are hired specifically to be on-site and working on that project. So a lot of the admin, there's really no marketing costs for those folks who are involved. When we're working on other proposals, they often will build a day rate for the work that they do. Thus, there's really limited to no administrative time, certainly no marketing time associated with this work on that job. So while the gross margin on the work is lower, we see virtually none of those discretionary admin and marketing costs where we typically do with other operations. So very well, the gross margin on the work is lower, but we have virtually no costs, in the competitive sense, maintaining a steady workforce without incurring many costs.
Operator, Operator
Our next question comes from Mona Nazir of Laurentian Bank. Please go ahead.
Mona Nazir, Analyst
Good morning, and thank you for taking my questions. Prior conference calls, on the back of COVID, you stated that there were some pricing concessions put in place. I believe the majority of those are short term in nature, three to six months. I'm just wondering if they have come out at all? Or are there further concessions? And I'm just wondering, related to that, if you see increased competition or pricing pressure?
Gord Johnston, CEO
Yes. Thanks, Mona. Certainly, some of those shorter-duration concessions have come off. Others will stay for a bit longer. We factored all of that into our forecast for the remainder of this year and for next year. In terms of what we're seeing going forward, this is always a price-competitive market. 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 a lessening of that. You'll see from other firms that you might look at in this space, they are still doing very well. The need to continually undercut prices to secure additional market share has become less of a concern as the pandemic has proceeded. That said, as I said, it's always a competitive market. But a lot of that pricing pressure that we observed in the first couple of months, as people moved forward, really has come off to a degree.
Mona Nazir, Analyst
That's very helpful. And then secondly, on M&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 Tesla is kind of one of the only ones in my covered universe. I'm just wondering, you mentioned the various geographies that you continue to target, U.K., Nordics, and Australia. I just wanted to confirm that there's not a higher probability of M&A in Canada or the U.S. just given the location and proximity, travel restrictions. And then on that, I'm just wondering if you're comfortable with the ability to do due diligence from the financials for the companies that you're targeting and related integration.
Gord Johnston, CEO
Yes. So look, in terms of where we're looking, 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 and to source the firm, what the cultural set looks like. We feel very comfortable with the leadership we have in place in the U.K., Western Europe, Australia, and New Zealand, in addition to the leadership we have in Canada and the United States. Therefore, as long as we're in a location where we have that strong leadership, we feel comfortable continuing to move forward. We are having discussions in all of those geographies that you mentioned. From the perspective of conducting due diligence, we have leaders on the ground for HR, accounting, taxation, etc., that will facilitate our diligence activities, ensuring we ask the right questions and that we conduct due diligence appropriately. I don't see these travel restrictions significantly inhibiting our ability to move forward with our M&A discussions.
Mona Nazir, Analyst
Okay. That's very helpful. And just lastly, for me, I appreciate you providing 2021 guidance, particularly in challenging times. I understand that there are several questions surrounding the outlook, but this is more of a clarification. Given you stated that organic growth targets kind of feel 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?
Gord Johnston, CEO
We feel good about it, Mona. I think we feel that it's realistic based on what we know now. We do feel comfortable with where we are. We didn't want to put out a target that we thought was unachievable because then that would cause issues for the rest of the year. So I think these are realistic numbers that reflect how we're thinking about the environment at this point.
Operator, Operator
Our next question comes from Michael Tupholme from TD Securities. Please go ahead.
Michael Tupholme, Analyst
I wanted to return to the discussion on the strategic initiative regarding the optimization of occupancy costs. Theresa, are you still in the evaluation stage? It seems this isn't included in your 2021 guidance. What is the timeline for reaching conclusions in this process, and how soon could we see benefits from it?
Theresa Jang, CFO
Well, I think based on where we are, it'd be realistic to think that in the next three to six months, we would draw to a conclusion. And again, given the fluidity of the whole situation around working from home, it may take longer than expected. We have 350 locations around the world, so there's a lot of data to crunch through and a lot of thinking around the appropriate pricing. Our expectation is that it would be in the three to six-month period, but with a caveat that it could take longer as things change.
Michael Tupholme, Analyst
If it is within that period in terms of the decision-making process, I know it takes time 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?
Theresa Jang, CFO
Well, what's interesting about the way the accounting rules work is that when you make a determination, if you establish a pretty firm plan around the use of that space, you have to assess it and take that impairment charge right away. Once you take that charge, you start to see benefits through lower occupancy costs primarily on the depreciation and interest expense line items, but also just on your G&A line items. We start to see that right away because you've now unburdened yourself from that lease. The cash flow impact could be slightly lagged depending on when you're able to release or sublease that space. From an earnings standpoint, you would start to see that pretty much right away.
Michael Tupholme, Analyst
That's helpful. And then second question, Gord, I think you were speaking earlier, you mentioned that you see the opportunity pipeline, the awards pipeline as being very strong. Just thinking back to the last quarterly releases call, there was some discussion about observing slowdowns in current projects and awards in the second half of 2020. So I'm trying to reconcile the strength of that pipeline with the commentary last quarter about the new awards and activity slowing a bit. I mean the pipeline is supposed to be very robust, but are you confident in the conversion of those opportunities to awards? Or are there still some pressures given the environment in terms of that conversion?
Gord Johnston, CEO
Sometimes the award process could take a little bit longer. But yes, you can see from the 3.2% increase in organic growth in our backlog in Q3, we have been converting those. I think that we're getting back to a more normal cadence. However, I still worry that in an environment where clients are working from home it may take longer to get all the paperwork and move these things forward. But again, the fact that our backlog increased organically by 3% in Q3 gives us comfort that we are seeing conversion from opportunities to backlog.
Michael Tupholme, Analyst
Okay, I'm just wondering if there has been any improvement from your perspective regarding the comments made last quarter about slowdowns in hospital awards. Has that situation improved from your viewpoint?
Gord Johnston, CEO
I believe that flexibility will be essential in the upcoming period. Looking at the U.K., they have entered lockdown, which suggests that there will be slower new awards in the country over the next month as current projects continue. On the other hand, in Australia, where offices have just reopened, I anticipate that new awards will pick up pace in open areas. It's challenging to make broad statements because the global situation remains uncertain. Nevertheless, we feel positive about our direction; our backlog is increasing, and we have a book-to-burn ratio exceeding one in each operational unit this quarter. While this is encouraging, we are cautious about making sweeping statements due to the evolving circumstances.
Michael Tupholme, Analyst
That makes sense. I appreciate the fluidity and the fact that regions differ. So that makes sense. Just the final question for me. In the discussion around the 2021 outlook, there was some commentary about looking at a meaningful increase in the cost of employee group benefits. I apologize if I missed this, but can you explain what's behind that and what is driving that?
Theresa Jang, CFO
Yes. I think what we're seeing with the pandemic is, interestingly enough, initially, people went home and stopped utilizing things. But as time has gone on, the use of employee benefits has really increased at a high rate. People are using their health services more, getting treatments done that they might have put off. They are taking advantage of emotional support programs, which is the reason those programs exist. I believe what we're seeing now is the pricing into those programs for next year reflecting assumed higher usage. As a people company, that can have quite a dramatic effect on us when the cost of those vendor programs increase, and that’s what we're seeing. That's what is factored into our outlook for next year.