Exhibit
99.1
STANTEC
INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
For the
Years Ended December 31, 2007, and 2006
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Table
of Contents
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MANAGEMENT’S
DISCUSSION AND ANALYSIS
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Page
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Caution
Regarding Forward-Looking Statements
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M-1
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Vision,
Core Business, and Strategy
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M-2
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Key
Performance Drivers and Capabilities
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M-5
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Results
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M-7
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Overall
performance
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M-7
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Acquisitions
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M-9
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Selected
annual information
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M-10
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Results
of operations
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M-11
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Fourth
quarter results and quarterly trends
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M-20
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Liquidity
and capital resources
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M-23
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Other
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M-25
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Outlook
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M-27
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Critical
Accounting Estimates, Developments, and Measures
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M-29
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Risk
Factors
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M-34
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Controls
and Procedures
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M-42
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Corporate
Governance
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M-42
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CONSOLIDATED
FINANCIAL STATEMENTS
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Management
Report
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F-1
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Independent
Auditors’ Report on Financial Statements
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F-2
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Independent
Auditors’ Report on Internal Controls
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F-3
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Consolidated
Balance Sheets
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F-4
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Consolidated
Statements of Income
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F-5
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Consolidated
Statements of Shareholder’s Equity and Comprehensive
Income
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F-6
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Consolidated
Statements of Cash Flows
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F-7
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Notes
to the Consolidated Financial Statements
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F-8
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MANAGEMENT’S
DISCUSSION AND ANALYSIS
February
20, 2008
This
discussion and analysis of Stantec Inc.’s operations and financial position,
dated February 20, 2008, should be read in conjunction with the Company’s 2007
audited consolidated financial statements and related notes. Our 2007 audited
consolidated financial statements are prepared in accordance with generally
accepted accounting principles (GAAP) in Canada, which differ in certain
respects from GAAP in the United States. Note 22 of the audited consolidated
financial statements summarizes the principal differences between Canadian GAAP
and US GAAP that affect our financial statements. Unless otherwise indicated,
all amounts shown below are in Canadian dollars. Additional information
regarding the Company, including our Annual Information Form, is available on
SEDAR at www.sedar.com. Such additional information is not incorporated by
reference and should not be deemed to be made part of this Management’s
Discussion and Analysis.
During
the second quarter of 2006, our shareholders approved the subdivision of our
common shares on a two-for-one basis. All references to common shares, per share
amounts, and stock-based compensation plans in this Management’s Discussion and
Analysis have been restated to reflect the stock split on a retroactive
basis.
CAUTION
REGARDING FORWARD-LOOKING STATEMENTS
Our
communications often include forward-looking statements within the meaning of
the U.S. Private Securities Litigation Reform Act and Canadian securities law.
Forward-looking statements are disclosures regarding possible events,
conditions, or results of operations that are based on assumptions about future
economic conditions and courses of action and include future-oriented financial
information.
Statements
of this type are contained in this report, including the discussion of our goals
in the Visions, Core Business, and Strategy section and of our annual and
long-term targets and expectations for our practice areas in the Results and
Outlook sections, and may be contained in filings with securities regulators or
in other communications. Forward-looking statements may involve, but are not
limited to, comments with respect to our objectives for 2008 and beyond, our
strategies or future actions, our targets, our expectations for our financial
condition or share price, or the results of or outlook for our operations or for
the Canadian or US economies.
We
provide a financial outlook (a type of forward-looking statement) for our
business in the Vision, Core Business, and Strategy; Results; and Outlook
sections of this report in order to describe management expectations and targets
by which we measure our success. Readers are cautioned that this information may
not be appropriate for other purposes.
By their
nature, forward-looking statements and financial outlooks require us to make
assumptions and are subject to inherent risks and uncertainties. Assumptions
about the performance of the Canadian and US economies in 2008 and how this
performance will affect our business are material factors we consider in
determining our forward-looking statements and are discussed in the Outlook
section. There is a significant risk that predictions and other forward-looking
statements will not prove to be accurate. We caution readers of this report not
to place undue reliance on our forward-looking statements since a number of
factors could cause actual future results, conditions, actions, or events to
differ materially from the targets, expectations, estimates, or intentions
expressed in these forward-looking statements.
Future
outcomes relating to forward-looking statements may be influenced by many
factors, including, but not limited to, global capital market activities;
fluctuations in interest rates or currency values; our ability to execute our
strategic plans or to complete or integrate acquisitions; critical accounting
estimates; the effects of war or terrorist activities; the effects of disease or
illness on local, national, or international economies; the effects of
disruptions to public infrastructure such as transportation or communications;
disruptions in power or water supply; industry or worldwide economic or
political conditions; regulatory or statutory developments; the effects of
competition in the geographic or business areas in which we operate; the actions
of management; or technological changes.
We
caution that the foregoing list is not exhaustive of all possible factors and
that other factors could adversely affect our results. The Risk Factors section
below provides additional information concerning key factors that could cause
actual results to differ materially from those projected in our forward-looking
statements. Investors and the public
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
1
should
carefully consider these factors, other uncertainties, and potential events as
well as the inherent uncertainty of forward-looking statements when relying on
these statements to make decisions with respect to our Company. The
forward-looking statements contained herein represent our expectations as of
February 20, 2008, and, accordingly, are subject to change after such date.
Except as may be required by law, we do not undertake to update any
forward-looking statement, whether written or verbal, that may be made from time
to time.
VISION,
CORE BUSINESS, AND STRATEGY
Our
Company provides professional consulting services in planning, engineering,
architecture, interior design, landscape architecture, surveying and geomatics,
environmental sciences, project management, and project economics for
infrastructure and facilities projects. By integrating our expertise in these
areas across North America and the Caribbean, we are able to work as one team
providing our clients with a vast number of project solutions. This integrated
approach also enables us to execute our “Global Expertise. Local Delivery.”
operating philosophy. We support the services we deliver through local offices
with the knowledge and skills of our entire organization. Through
multidiscipline service delivery, we also support clients throughout the project
life cycle—from the initial conceptual planning to project completion and
beyond.
Our goal
is to become a top 10 global design and consulting services firm, and our focus
is providing professional services in the infrastructure and facilities market
principally on a fee-for-service basis. To achieve our objective, we must expand
the depth and breadth of our services, which will result in growth. We intend to
continue to pursue a prudent growth plan.
Looking
ahead, we plan to gradually and systematically expand our geographic reach
outside North America in markets that are best suited and receptive to our
services as these services evolve and mature. International work currently
accounts for 1% of our business. By 2018 we target to generate up to 20% of our
revenue from our international work, most likely by expanding to the United
Kingdom, Australia, and New Zealand.
Our
business strategy is based on mitigating risk by
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Diversifying
our operations through a focused, three-dimensional business
model
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Serving
many clients on many projects
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Taking
on little or no construction risk
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Positioning
ourselves among the top-three service providers in our geographic regions
and practice areas
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Our
focused, three-dimensional business model allows us to manage risk while
continuing to increase our revenue and earnings. The model is based
on
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Diversifying
our operations across several geographic
regions
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Specializing
in distinct but complementary practice
areas
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Providing
services in all five phases of the infrastructure and facilities project
life cycle (planning, design, construction, maintenance, and
decommissioning)
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Through
our “One Team. Infinite Solutions.” and “Global Expertise. Local Delivery.”
operating philosophy and approach to our business and service delivery, we have
one reportable GAAP segment—Consulting Services—which is an aggregate of our
operating segments. Our operating segments are based on our regional geographic
areas, and our chief operating decision maker (chief executive officer) assesses
our Company’s performance based on financial information available from these
geographic areas. In addition, we have practice areas that provide strategic
direction, mentoring, and technical support across all of our geographic
regions.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
2
The
following discussion outlines the three main components of our business
model.
Geographic
Diversification
Currently,
we operate in three main regions in North America—Canada, the US East, and the
US West. We also have a small presence in the Caribbean and a project presence
in several international locations. Our goal is to position our Company among
the top three service providers in each of our regions. Based on our services
mix, this generally means achieving a market penetration of 100 employees or $10
million in revenue per 1 million in population. We realize this objective in our
existing regions primarily by adding services through organic growth and
strategic hiring supplemented by acquisitions. We achieve our target in new
regions principally by acquiring and integrating firms that complement our
organization supplemented by organic growth and strategic hiring.
Practice
Area Specialization
Currently,
we provide services in five specialized and distinct practice area
groupings—Buildings, Environment, Industrial, Transportation, and Urban Land.
Focusing on this combination of project services helps differentiate us from our
competitors, allowing us to enhance our presence in new geographic regions and
markets and to establish and maintain long-term client relationships. Our
strategy for strengthening this element of our business model is to expand the
depth of our expertise in our current practice areas and to selectively add
complementary new practice areas to our operations.
Buildings. We provide
architectural and engineering design solutions to both private and public sector
clients in a wide range of market sectors across North America through two
specialist practice areas: 1) Architecture and 2) Buildings Engineering. Our
focus is on the architectural and engineering design of buildings from
preconception to postcompletion in the health care, retail/commercial,
education, sports/recreation, and airports market sectors. Our core
services include project and program definition, facilities planning,
architectural design, interior design, and structural, mechanical, electrical,
and acoustical engineering for both new construction and existing buildings. For
existing buildings, we offer expertise in performance engineering, building
operating systems (including analysis of exterior envelope, air quality,
lighting, and energy efficiency), and ongoing tenant improvements. Over the
past few years, our Buildings practice area has also established an
industry-wide reputation for leadership in sustainable and integrated
design.
In 2007
the Buildings practice area grew through the acquisition of architecture firms
in British Columbia and Ontario in Canada and in California in the United
States. Going forward, our focus in 2008 and over the next 10 years will be on
continuing to build the Buildings practice area, starting with our architecture
practice, in the United States and also internationally.
Environment. We provide
solutions for water supply and wastewater disposal for communities and industry;
planning and permitting infrastructure projects; ecosystem restorations; and
soil-structure interaction evaluations through four specialist practice areas:
1) Environmental Infrastructure, 2) Environmental Management, 3) Environmental
Remediation, and 4) Geotechnical Engineering. Our core services in these areas
include water supply, treatment, storage, and distribution; wastewater
collection, pumping, treatment, and disposal; watershed management;
environmental site management and remediation; environmental assessment,
documentation, and permitting; ecosystem restoration planning and design;
subsurface investigation and characterization; and geotechnical
engineering.
In 2007
we expanded our Environment practice area through organic growth in our existing
geographic locations as well as through the addition of firms (in the fourth
quarter of 2007 and at the beginning of 2008) with offices in Maine, New York,
Georgia, Indiana, Kentucky, Missouri, Ohio, Pennsylvania, West Virginia,
Tennessee, and New Brunswick. In particular, these additions strengthened our
capabilities in wastewater collection and disposal, ecosystem restoration, and
flood control. We also added a geotechnical engineering capability focused on
major civil works, such as dams and levees, bridge foundations, highways, and
waterfront structures, as well as an environmental remediation capability
focused on services for the energy, manufacturing, chemical, pulp and paper, and
transportation industries. In 2008 we will focus on strengthening the
Environment practice area by continuing to grow our profile and market share
throughout North America, particularly in central Canada, the US Southeast, and
California. Over the next 10 years, our goal will be to continue to improve our
presence in the environment market in the United States, along with targeting
international expansion.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
3
Industrial. We provide
industrial solutions to clients in the bio/pharmaceutical, power generation,
utilities, mining, automotive, chemical, consumer products, forestry, food and
beverage, pulp and paper, and general manufacturing sectors. Our core services
include planning, engineering, and project management, which we deliver through
five specialist practice areas: 1) Manufacturing, 2) Power, 3) Resources, 4)
Bio/Pharmaceuticals, and 5) Program & Project Management. We also provide
specialty services in occupational health and safety, system integration,
instrumentation and control, electrical energy and power management, facility
planning and design, industrial engineering, logistics, materials handling, and
commissioning.
In 2007
we strengthened the services this practice area provides for the power and
utilities, oil and gas, pulp and paper, food and beverage, mining, and composite
wood products sectors through the acquisition of the Neill and Gunter companies
in Atlantic Canada and the northeastern United States. We are now a midtier
consultant in several of these industries across North America.
To meet
our growth objectives going forward and to allow for more focus in some sectors,
we reorganized this practice area as of January 1, 2008. The name of the
practice area was changed from Industrial & Project Management to
Industrial. This change was made to reflect the fact that we provide project
management services throughout our organization; these services are not limited
to the Industrial practice area. In 2008 we will also focus on strengthening our
presence in the power transmission and renewable energy markets as well as
pursuing more opportunities in the food and beverage and electronics
industries.
Our goal
for the next 10 years is to further position our industrial practice as the
largest of the midtier consultants with the ability to undertake most projects
in the industrial sector with the exception of large turnkey oil and gas
projects.
Transportation. We offer
solutions for the safe and efficient movement of people and goods, primarily to
public sector clients, through one specialist practice area: Transportation. Our
core services include project management, planning, engineering, construction
administration, and infrastructure management related to the transportation
sector. We prepare transportation master plans for communities; conduct
transportation investment studies; plan and design airport, transit, rail, and
highway facilities; provide administration and support services for the
construction of specific projects; and provide ongoing management planning for
the safe and efficient upkeep of transportation facilities. Our broad range of
expertise is illustrated by our ability to 1) provide specialized services such
as state-of-the-art simulation modeling; 2) evaluate the effectiveness of
alternative transportation demand and supply management techniques; 3) prepare
investment grade revenue studies for funding transportation projects; 4) provide
public consultation and environmental assessment skills to build broad public
support for infrastructure plans; and 5) design and implement integrated
infrastructure/asset management systems for all types of transportation
infrastructure.
In 2007
we enhanced our presence in the transportation market in the US East through the
acquisition of Vollmer Associates LLP based in New York City.
To
improve the integration of our services in this practice area, we merged the two
former specialist practice areas of Transportation and Infrastructure Management
& Pavement Engineering into one specialist practice area effective January
1, 2008. In 2008 we will also focus on pursuing opportunities for growth in the
US West. Our goal over the next 10 years is to strengthen our Transportation
practice area by expanding primarily in growing urban areas across North America
and by adding more specialized skill sets.
Urban Land. We provide
planning, landscape architecture, surveying, engineering, and project
management solutions, principally for the land development and real estate
industries, through three specialist practice areas: 1) Planning & Landscape
Architecture, 2) Urban Land Engineering, and 3) Surveys/Geomatics. Our core
services include, or relate to, the development of conceptual and master
plans, development approvals and entitlement, infrastructure design,
transportation planning, traffic engineering, landscape
architecture, construction review, and a wide variety of surveying and
geomatics services to support the land development industry and other practice
areas.
In 2007
we expanded our expertise in landscape architecture, engineering, and
surveys/geomatics in the Urban Land practice area through a number
of acquisitions in the US East. Our priority for this practice area in 2008
is to continue to diversify the services we provide for nonresidential
development sectors. In the next 10 years, we expect to expand the practice
area geographically in the fast-growing parts of the western and southern United
States, which will give us an increased presence in Texas, Arizona,
Florida, Georgia, and the Carolinas.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
4
Life
Cycle Solutions
The third
element of our business model is the provision of professional services in all
five phases of the project life cycle—planning, design, construction,
maintenance, and decommissioning. This inclusive approach enables us to deliver
services during periods of strong new capital project activity (i.e., design and
construction) as well as periods of lower new capital project expenditures
(i.e., maintenance and rehabilitation). Beginning with the planning and design
stages, we provide conceptual and detailed design services, conduct feasibility
studies, and prepare plans and specifications. During the construction phase, we
generally act as the owners’ representative, providing project management,
surveying, and resident engineering services. We focus principally on
fee-for-service type work and generally do not act as the contractor or take on
construction risk. Following project completion, during the maintenance phase,
we provide ongoing professional services for maintenance and rehabilitation
projects in areas such as facilities and infrastructure management, facilities
operations, and performance engineering. Finally, in the decommissioning phase,
we provide solutions and recommendations for taking facilities out of active
service.
Going
forward, our strategy is to continue to expand the scope of services we provide
in the initial planning stages and during maintenance, allowing us to establish
longer-term relationships with clients and to strengthen our full “cradle to
grave” approach.
Our
three-dimensional business model allows us to provide services to many clients
and for many projects, ensuring that we do not rely on a few large projects for
our revenue and that no single client or project accounts for more than 5% of
our business.
KEY
PERFORMANCE DRIVERS AND CAPABILITIES
Our
performance depends on our ability to attract and retain qualified people; make
the most of market opportunities; finance our growth; find, acquire, and
integrate firms and/or new employees into our operations; and achieve top-three
market penetration in the geographic areas we serve. Based on our success with
these drivers, we believe that we are well positioned to continue to be one of
the principal providers of professional design and consulting services in our
geographic regions.
People
Because
we are a professional services firm, the most important driver of our
performance is our people. Our employees create the project solutions we deliver
to clients. Consequently, to achieve our goal of becoming a top 10 global design
firm, we must grow our workforce through a combination of internal hiring and
acquisitions. We measure our success in this area by total staff numbers. In
2007 our employee numbers increased to approximately 7,800 from 6,000 in 2006.
As at December 31, 2007, our workforce was made up of about 4,100 professionals,
2,600 technical staff, and 1,100 support personnel. We expect our employee
numbers to continue to increase in 2008 and beyond.
To
attract and retain qualified staff, we offer opportunities to be part of “One
Team” working on challenging multidiscipline projects with some of the most
talented people in our industry. We are continually strengthening and supporting
our people-oriented, “One Team. Infinite Solutions.” culture. In 2007 we
completed a number of activities, including the expansion of our Career
Development Center with updated content and new in-house programs and training.
Launched in 2005, the center is the on-line source for all our learning,
coaching and mentoring, and professional and career development resources. It
provides access to programs and material on topics such as employee orientation,
integration (acquisition) training, people skills and leadership, project
management, risk mitigation, business development, and financial management,
among others. Going forward, we will continue to update and improve our learning
and career development programs in response to the needs of our
staff.
To
measure our success in attracting and retaining staff, we use tools such as
employee engagement surveys, ongoing requests for feedback, and exit interviews.
The results of these performance metrics help us develop programs and
initiatives for improving and maintaining staff engagement. We also track
turnover rates for our staff through our business information
system.
Our
“diversified portfolio” approach to business, operating in different regions and
practice areas, and our “One Team” philosophy, using and sharing the best
available staff resources across the Company, generally enable us to redeploy a
portion of our workforce when faced with changes in local, regional, or national
economies or practice area demand. Although there will always be some areas
where it will be difficult to find appropriate staff during
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
5
certain
periods, as we increase in size we become better able to address these issues by
mobilizing staff from other parts of the Company either through temporary
relocation or work sharing. We are continually improving our ability to work on
projects from multiple locations through standardized practices and systems,
project collaboration, and Web-based technology.
Market
Opportunities/Acquisition and Integration
We
believe that growth is necessary in order to enhance the depth and breadth of
our expertise, broaden our services, increase our shareholder value, provide
more opportunities for our employees, and lever our information technology
systems. Our strategy is to combine internal growth with the acquisition of
firms that believe in our vision and want to be part of our dynamic Company.
Since we became publicly traded on the Toronto Stock Exchange (TSX) in 1994 to
date, we have integrated a total of over 6,300 employees into the Stantec team
from throughout Canada, the United States, and the Caribbean. In 2007 we
completed 11 acquisitions, including four in Canada, which created a new
geographic subregion in the Atlantic area, and seven in the United States, which
expanded our business into Connecticut, Delaware, Indiana, Kentucky, Missouri,
Ohio, Pennsylvania, and West Virginia. We are confident that we can continue to
take advantage of acquisition opportunities because we operate in an industry
sector that includes more than 100,000 firms, most of which are small. According
to the Engineering
News-Record, the largest 500 engineering and architecture companies
headquartered in the United States—our principal competitors—generated over
US$70 billion in fees in 2007, about 80% of which was earned in North America
and the balance earned internationally. Our share of our current addressable
market is about 1%.
The
integration of acquired firms begins immediately following the acquisition
closing date and generally takes between six months and three years to complete.
It involves the implementation of our Company-wide information technology and
financial management systems as well as provision of “back office” support
services from our corporate and regional offices. This approach allows our new
staff to focus on their primary responsibility of continuing to serve clients
with minimal interruption while taking advantage of our systems and
expertise.
Our
acquisition and integration program is managed by a dedicated acquisition team
that supports, or is responsible for, the tasks of identifying and valuing
acquisition candidates, undertaking and coordinating due diligence, negotiating
and closing transactions, and integrating employees and systems following an
acquisition. This team is complemented and enhanced by other operational staff
as appropriate. We measure our success in integrating acquired employees through
a postintegration survey and use the survey results to address specific issues
and improve future integration activities.
Financing
Our
success also depends on our continuing ability to finance our growth plan.
Adequate financing gives us the flexibility to acquire firms that are
appropriate to our vision and complement our business model. Since we became
publicly traded on the TSX in 1994, we have grown our gross revenue at a
compound annual rate of 20.0%. To fund such growth, we require cash generated
from both internal and external sources. Historically, we have completed
acquisitions using mostly cash and notes while at opportune times raising
additional equity to replenish our cash reserves, pay down debt, or strengthen
our balance sheet. To date, we have issued additional shares for these purposes
on four occasions—in 1997, 2000, 2002, and 2005. Currently, we have a revolving
credit facility, due on August 31, 2010, that provides us with a line of credit
of $250 million. Such financing will help us continue to pursue our growth
plan.
Market
Penetration
Also key
to our success is achieving a certain level of market penetration in the
geographic areas we serve. Our goal is to be among the top three service
providers in each of our geographic regions and practice areas. With this level
of market presence, we are less likely to be affected by downturns in regional
economies. Top-three positioning also gives us increased opportunities to work
for the best clients, obtain the best projects, and attract and retain the best
employees in a region, and is important for building or maintaining the critical
mass of staff needed to generate consistent performance and to support regional
company infrastructure.
One
metric we use to gauge our success with market penetration is staff numbers per
population in a region. Generally, we estimate that to be among the top three
service providers in any given location we require 100 or more employees serving
a population of 1 million people. To date, we calculate that we have a mature
market presence (100 or more employees per 1 million in population) in the
following provinces and states: Alberta, British Columbia, Manitoba, Maine, New
Brunswick, Nova Scotia, Saskatchewan, and Vermont.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
6
RESULTS
Overall
Performance
Highlights
for 2007
By
executing our business strategy in 2007, we generated strong results for the
fiscal year as well as growth in gross revenue, net income, and earnings per
share as follows:
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2007
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2006
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$
Change
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%
Change
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(In
millions of Canadian dollars,
except
per share amounts)
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||||||||||||||||
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Gross
revenue
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954.6 | 816.1 | 138.5 | 17.0 | % | |||||||||||
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Net
income
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69.3 | 60.2 | 9.1 | 15.1 | % | |||||||||||
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Earnings
per share – basic
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1.52 | 1.34 | 0.18 | 13.4 | % | |||||||||||
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Earnings
per share – diluted
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1.50 | 1.31 | 0.19 | 14.5 | % | |||||||||||
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Cash
flows from operating activities
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87.5 | 93.4 | (5.9 | ) | n/m | |||||||||||
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Cash
flows used in investing activities
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(135.2 | ) | (15.6 | ) | (119.6 | ) | n/m | |||||||||
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Cash
flows from (used in)
financing
activities
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33.9 | (77.4 | ) | 111.3 | n/m | |||||||||||
n/m = not
meaningful
In our
2006 Management’s Discussion and Analysis, we established various ranges of
expected performance for 2007. The following table presents the results we
achieved in 2007:
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Measure
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Expected
Range
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Result
Achieved
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Debt
to equity ratio (note1)
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At
or below 0.5 to 1
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0.19 P
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Return
on equity (note
2)
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At
or above 14%
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16.4% P
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Net
income as % of net revenue
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At
or above 6%
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8.3% P
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Gross
margin as % of net revenue
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Between
55 and 57%
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56.7% P
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Administrative
and marketing expenses
as
% of net revenue
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Between
40 and 42%
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42.3% Ï
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Effective
income tax rate
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Between
32 and 34%
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30.1% PP
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note
1: Debt to equity ratio is calculated as the sum of (1) long-term debt,
including current portion, plus bank indebtedness, minus cash divided by (2)
shareholders’ equity.
note
2: Return on equity is calculated as net income for the year divided by average
shareholders’ equity over each of the last four quarters.
PP Performed
better than target
P Met
target
Ï Did not meet
target
In 2007
we met or performed better than our targets for all items except administrative
and marketing expenses as a percentage of net revenue, which were 0.3% higher
than expected. This variance is explained in the Administrative and Marketing
Expenses section below.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
7
The
following highlights the major financial achievements and strategic activities
that occurred in 2007, as well as other factors that contributed to our
successful financial performance and strong overall financial
condition:
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|
·
|
A year of record results and
continued growth. In 2007 we posted record gross revenue, net
income, and basic and diluted earnings per
share.
|
|
|
§
|
Gross
revenue for 2007 was $954.6 million compared to $816.1
million in 2006 and $618.0 million in 2005. This result is in
line with our previous 10-year goal of achieving $1 billion in revenue in
2008. We expect to exceed this target in the current fiscal
year.
|
|
|
§
|
Net
income for 2007 was $69.3 million compared to $60.2
million in 2006 and $40.6 million in
2005.
|
|
|
§
|
Diluted
earnings per share for 2007 were $1.50 compared to $1.31 in 2006 and
$0.99 in 2005.
|
The
continuing strength of our results reflects the ability of our business model to
adapt to changing market conditions throughout North America. During the year,
weakness in the residential land market in the United States contributed to a
decrease in year-over-year revenue (excluding acquisitions) in our Urban Land
practice area compared to 2006. This decline was offset by an increase in
organic revenue in our other practice areas, particularly our Industrial and
Environment practice areas.
|
|
·
|
Growth through
acquisitions. Of the $138.5 million increase in gross revenue from
2006 to 2007, $109.1 million was due to acquisitions completed in 2006 and
2007. We completed 11 acquisitions in
2007.
|
|
|
·
|
Continued growth. On
January 2, 2008, we completed the acquisition of R.D. Zande and Rochester
Signal, Inc. On February 1, 2008, we completed the acquisition of SII
Holdings, Inc. (Secor). Together, these acquisitions add approximately
1,100 staff to our US operations and increase the depth of the service
offerings in our Environment and Transportation practice
areas.
|
|
|
·
|
Strong balance sheet.
Our balance sheet remains solid, with cash and cash equivalents of $14.2
million and a debt to equity ratio of 0.19. As at December 31, 2007,
$106.5 million of our $160 million credit facility was available for
future acquisitions, working capital needs, capital expenditures, and
general corporate purposes. During the year, we also negotiated an
extension of the due date of our credit facility to August 2010 and
renewed our normal course issuer bid with the TSX. Subsequent to December
31, 2007, we were successful in increasing the limit of our credit
facility from $160 million to $250 million to provide additional
flexibility for continued growth.
|
|
|
·
|
Additions to leadership.
During the year, we announced the appointment of Mark Jackson to the new
role of senior vice president and chief operating officer (COO). The COO
role was created to oversee the day-to-day management of our operations
and to assume the practice responsibilities previously held by our chief
executive officer (CEO). This change allows our CEO to focus more time on
acquisitions, investor relations, strategic planning, and overall Company
leadership in executing our plan to be a top 10 global design firm. Mark,
who previously was the practice area leader for our Environment practice
area, graduated from the University of Waterloo in 1975 with a bachelor of
applied science in civil
engineering.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
8
In 2007
Ivor Ruste joined the Company’s board of directors. Mr. Ruste is currently the
executive vice president and chief risk officer for EnCana Corporation
headquartered in Calgary, Alberta. From 1998 to 2006, he was the managing
partner of the Edmonton, Alberta, office of KPMG LLP, and just prior to joining
EnCana, he served as the Alberta regional managing partner and vice chair of the
KPMG Canadian board of directors.
|
|
·
|
Increased backlog.
Consolidated revenue backlog at the end of 2007
was $831 million compared to $685 million at the end of 2006 and
$588 million at the end of 2005. The outlook for 2008 remains
positive.
|
|
|
·
|
Strategic initiatives for
2018. During the year, we continued to develop our 2018 strategic
plan. Generally, we expect to continue growing our Company by expanding
geographically and adding new or complementary practice areas. As we
continue to evolve and mature, we will have a more significant presence
outside North America. By 2018 we target to generate up to 20% of our
revenue from international work.
|
Acquisitions
Total
consideration for acquisition activity was $150.0 million in 2007
and $18.5 million in 2006. In 2007 we completed the following
acquisitions:
|
|
·
|
In
March 2007, we acquired Nicolson Tamaki Architects Inc., which added 10
staff and supplemented our architecture services in British Columbia,
Canada.
|
|
|
·
|
In
April 2007, we acquired Vollmer Associates LLP (Vollmer), which added over
600 staff, established a major presence in New York City, and strengthened
our engineering, architecture, planning, landscape architecture, and
survey services in the transportation sector in the US
East.
|
|
|
·
|
In
April 2007, we acquired Land Use Consultants, Inc., adding approximately
20 staff to our existing office in Portland, Maine. This acquisition
expanded our landscape architecture and planning services in our northern
New England region.
|
|
|
·
|
In
May 2007, we acquired Geller DeVellis Inc., which added over 50 people to
our New England operations and strengthened our landscape architecture,
planning, and civil engineering design
capabilities.
|
|
|
·
|
In
August 2007, we acquired Trico Engineering Consultants, Inc (Trico
Engineering), adding approximately 130 staff. This acquisition
complemented our presence in Charleston, South Carolina, expanded the
depth of our services throughout the southeastern United States, and
strengthened our civil engineering, surveying, landscape architecture, and
planning capabilities.
|
|
|
·
|
In
September 2007, we acquired Chong Partners Architecture, Inc. (Chong
Partners), which added approximately 175 staff. The acquisition of this
firm, headquartered in San Francisco, California, with additional offices
in Sacramento and San Diego, enhanced our modest existing architecture
presence in the United States, particularly in California, and provided a
foundation for further expansion of our US architecture
practice.
|
|
|
·
|
In
October 2007, we acquired Woodlot Alternatives, Inc., which added
approximately 65 staff to our Maine and New England operations. Woodlot
Alternatives, Inc. specialized in natural resource assessment, permitting,
and environmental engineering.
|
|
|
·
|
In
October 2007, we acquired Neill and Gunter, Incorporated; Neill and Gunter
Limited; and Neill and Gunter (Nova Scotia) Limited (the Neill and Gunter
companies), which added approximately 650 staff. The acquisition of these
companies brought greater depth to our industrial practice, enhanced our
operations in New England, and provided access to a new market in Atlantic
Canada.
|
|
|
·
|
In
November 2007, we acquired Moore Paterson Architects Inc., adding 17
staff. This firm provided architecture, planning, and project management
services on Vancouver Island and the Lower Mainland of British
Columbia.
|
|
|
·
|
In
November 2007, we acquired Murphy Hilgers Architects Inc., Brentcliffe
Financial Service Inc., and Dekko Studio Inc., which added approximately
55 staff. The acquisition of these firms expanded our operations in
Toronto, Ontario, and provided further depth to our expertise in designing
health care, judicial, and retail/commercial
facilities.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
9
|
|
·
|
In
December 2007, we acquired Fuller, Mossbarger, Scott & May Engineers,
Inc. (FMSM) and Leestown Leasing, L.L.C., which added 300 staff; created a
presence in Kentucky, Ohio, Missouri, and Indiana; and brought a
geotechnical engineering capability to our
Company.
|
As a
result of our investment in our enterprise management system in 2003 as well as
subsequent enhancements, we were able to begin quickly integrating these
acquisitions during 2007. We will continue our integration activities in
2008.
Selected
Annual Information
We have
demonstrated strong, sustainable financial growth in the last three years as
highlighted in the trending of the annual information below:
|
Selected
Annual Information
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
millions of Canadian dollars, except per share and share
amounts)
|
||||||||||||
|
Gross
revenue (note
1)
|
954.6 | 816.1 | 618.0 | |||||||||
|
Net
income
|
69.3 | 60.2 | 40.6 | |||||||||
|
Earnings
per share – basic
|
1.52 | 1.34 | 1.02 | |||||||||
|
Earnings
per share – diluted
|
1.50 | 1.31 | 0.99 | |||||||||
|
Cash
dividends declared per common share
|
Nil
|
Nil
|
Nil
|
|||||||||
|
Total
assets
|
813.6 | 634.5 | 628.8 | |||||||||
|
Total
long-term debt
|
96.1 | 16.2 | 86.7 | |||||||||
|
Outstanding
common shares – as at December 31
|
45,698,143 | 45,201,785 | 44,626,262 | |||||||||
|
Outstanding
common shares – as at February 20, 2008
|
45,637,125
|
|||||||||||
|
Outstanding
share options – as at December 31
|
1,751,022 | 1,702,784 | 1,876,528 | |||||||||
|
Outstanding
share options – as at February 20, 2008
|
1,691,494
|
|||||||||||
note
1: The term gross revenue is defined in the Critical Accounting Estimates,
Developments, and Measures section of this Management’s Discussion and
Analysis.
note
2: Certain comparative figures have been reclassified to conform to the
presentation adopted for the current year.
The 11
acquisitions completed in 2007, the three completed in 2006, and the three
completed in 2005 contributed to our year-over-year growth in gross revenue, net
income, and basic and diluted earnings per share. As well, internal growth
contributed $47.1 million to the $138.5 million increase in gross revenue in
2007 compared to 2006.
Balance Sheet. Our balance
sheet remained strong in 2007 as shareholders’ equity increased $31.8 million as
further described in the Shareholders’ Equity section below. Our total assets
increased by $179.1 million from 2006 to 2007. This increase was mainly due to
an increase of $81.4 million in goodwill, $65.0 million in accounts receivable
and in costs and estimated earnings in excess of billings, $23.1 million in
property and equipment, and $9.5 million in intangible assets. These items
increased due to internal growth and growth from acquisitions during the
year.
During
the third quarter of 2007, we conducted our annual goodwill impairment review.
The review concluded that there was no impairment of goodwill.
Our total
assets increased by $5.7 million from 2005 to 2006. A $15.8 million decrease in
current assets was offset by a $21.5 million increase in non-current assets. The
decrease in current assets was mainly due to a reduction in restricted cash used
to fund acquisitions in 2006, the repayment of acquired debt, and the payment of
promissory notes for acquisitions completed in prior years. The increase in
non-current assets was mainly due to an $8.8 million increase in goodwill and a
$6.5 million increase in property and equipment resulting from internal growth
and growth through acquisitions during the year.
Our total
liabilities increased by $147.3 million from 2006 to 2007 mainly due to a $43.9
million increase in our revolving credit facility from $8.2 million at December
31, 2006, to $52.1 million at December 31, 2007, in order to finance the
acquisitions completed in 2007. In addition, accounts payable and accrued
liabilities increased $47.9 million from 2006 to 2007 due to internal growth and
growth through acquisitions during the year.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
10
Our total
liabilities decreased $57.2 million from 2005 to 2006 mainly due to the
reduction of our revolving credit facility from $79.0 million at December 31,
2005, to $8.2 million at December 31, 2006. We were able to repay our credit
facility from cash generated from operations during the year.
Results
of Operations
Our
Company operates in one reportable segment—Consulting Services. We provide
knowledge-based solutions for infrastructure and facilities projects through
value-added professional services principally under fee-for-service agreements
with clients.
The
following table summarizes our key operating results on a percentage of net
revenue basis and the percentage increase in the dollar amount of these results
from year to year:
|
Percentage
of Net Revenue
|
Percentage
Increase*
|
|||||||||||||||||||
|
2007
|
2006
|
2005
|
2007
vs. 2006
|
2006
vs. 2005
|
||||||||||||||||
|
Gross
revenue
|
114.9 | % | 115.3 | % | 117.8 | % | 17.0 | % | 32.1 | % | ||||||||||
|
Net
revenue
|
100.0 | % | 100.0 | % | 100.0 | % | 17.4 | % | 35.0 | % | ||||||||||
|
Direct
payroll costs
|
43.3 | % | 43.0 | % | 44.7 | % | 18.2 | % | 29.9 | % | ||||||||||
|
Gross
margin
|
56.7 | % | 57.0 | % | 55.3 | % | 16.7 | % | 39.1 | % | ||||||||||
|
Administrative
and marketing expenses
|
42.3 | % | 41.3 | % | 40.6 | % | 20.3 | % | 37.1 | % | ||||||||||
|
Depreciation
of property and equipment
|
2.3 | % | 2.2 | % | 2.4 | % | 22.4 | % | 26.0 | % | ||||||||||
|
Amortization
of intangible assets
|
0.5 | % | 0.9 | % | 0.5 | % | (39.3 | %) | 141.2 | % | ||||||||||
|
Net
interest expense
|
0.2 | % | 0.3 | % | 0.1 | % | (15.8 | %) | 231.3 | % | ||||||||||
|
Share
of income from associated
|
||||||||||||||||||||
|
companies
|
0.0 | % | (0.1 | %) | 0.0 | % | 50.0 | % | 52.4 | % | ||||||||||
|
Foreign
exchange gains
|
(0.3 | %) | 0.0 | % | (0.1 | %) | n/m | (83.5 | %) | |||||||||||
|
Other
income
|
(0.2 | %) | (0.2 | %) | (0.1 | %) | (20.0 | %) | 319.8 | % | ||||||||||
|
Income
before income taxes
|
11.9 | % | 12.6 | % | 11.9 | % | 10.9 | % | 43.1 | % | ||||||||||
|
Income
taxes
|
3.6 | % | 4.1 | % | 4.2 | % | 2.1 | % | 33.7 | % | ||||||||||
|
Net
income
|
8.3 | % | 8.5 | % | 7.7 | % | 15.1 | % | 48.2 | % | ||||||||||
|
*
% increase calculated based on the dollar change from the comparable
period
|
||||||||||||||||||||
|
n/m
= not meaningful
|
||||||||||||||||||||
Our gross
and net revenue grew at a lower rate during 2007 than during 2006 mainly due to
the smaller size of the acquisitions that occurred in the second half of 2005
and in the first two quarters of 2006. In particular, the acquisition of the
Keith Companies, Inc. (Keith) completed in September 2005 added over 850 people
to our Company. In 2007 administrative and marketing expenses grew at greater
rates than the rate of growth in revenue as further explained in the
Administrative and Marketing Expenses section below. This was offset by declines
in the amortization of intangible assets and net interest expense, which are
further explained in their respective sections.
Gross
and Net Revenue
The
following table summarizes the impact of acquisitions, internal growth, and
foreign exchange on our gross and net revenue for 2007 compared to 2006 and for
2006 compared to 2005. For definitions of gross and net revenue, refer to the
Definition of Non-GAAP Measures in the Critical Accounting Estimates,
Developments, and Measures section of this discussion and analysis. Revenue
earned by acquired companies in the first 12 months after the acquisition is
reported as revenue from acquisitions.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
11
|
Gross
Revenue
|
2007
vs. 2006
|
2006
vs. 2005
|
||||||
|
(In
millions of Canadian dollars)
|
||||||||
|
Increase
(decrease) due to:
|
||||||||
|
Acquisitions
growth
|
109.1 | 165.4 | ||||||
|
Internal
growth
|
47.1 | 46.7 | ||||||
|
Impact
of foreign exchange rates on revenue earned
by foreign subsidiaries
|
(17.7 | ) | (14.0 | ) | ||||
|
Total
increase over prior year
|
138.5 | 198.1 | ||||||
|
Net
Revenue
|
2007
vs. 2006
|
2006
vs. 2005
|
||||||
|
(In
millions of Canadian dollars)
|
||||||||
|
Increase
(decrease) due to:
|
||||||||
|
Acquisitions
growth
|
92.0 | 148.7 | ||||||
|
Internal
growth
|
46.5 | 46.8 | ||||||
|
Impact
of foreign exchange rates on revenue earned
by foreign subsidiaries
|
(15.5 | ) | (12.2 | ) | ||||
|
Total
increase over prior year
|
123.0 | 183.3 | ||||||
Gross
revenue earned in Canada during 2007 increased to $539.3 million from $461.3
million in 2006 and $380.5 million in 2005. Gross revenue generated in the
United States in 2007 increased to $405.2 million compared to $348.0 million in
2006 and $233.4 million in 2005. Gross revenue earned outside Canada and the
United States in 2007 was $10.1 million compared to $6.8 million in 2006 and
$4.1 million in 2005. The increase in revenues in both our US- and
Canadian-based operations was positively impacted by the acquisitions completed
in 2007 and 2006.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
12
The
following table summarizes our gross revenue by practice area for 2007,
2006, and 2005:
|
%
of
|
%
of
|
%
of
|
||||||||||||||||||||||||||||||
|
Consulting
|
Consulting
|
Consulting
|
||||||||||||||||||||||||||||||
|
Services
|
%
Change
|
Services
|
%
Change
|
Services
|
||||||||||||||||||||||||||||
|
Practice
Area Gross
|
Gross
|
2007
vs.
|
Gross
|
2006
vs.
|
Gross
|
|||||||||||||||||||||||||||
|
Revenue
|
2007
|
Revenue
|
2006
|
2006
|
Revenue
|
2005
|
2005
|
Revenue
|
||||||||||||||||||||||||
|
(millions
of C$)
|
(millions
of C$)
|
(millions
of C$)
|
||||||||||||||||||||||||||||||
|
Buildings
|
211.8 | 22.2 | % | 15.0 | % | 184.2 | 22.6 | % | 25.0 | % | 147.4 | 23.9 | % | |||||||||||||||||||
|
Environment
|
175.9 | 18.4 | % | 17.7 | % | 149.4 | 18.3 | % | 44.5 | % | 103.4 | 16.7 | % | |||||||||||||||||||
|
Industrial
|
139.0 | 14.6 | % | 46.6 | % | 94.8 | 11.6 | % | 39.8 | % | 67.8 | 11.0 | % | |||||||||||||||||||
|
Transportation
|
143.1 | 15.0 | % | 35.0 | % | 106.0 | 13.0 | % | 17.0 | % | 90.6 | 14.6 | % | |||||||||||||||||||
|
Urban
Land
|
284.8 | 29.8 | % | 1.1 | % | 281.7 | 34.5 | % | 34.9 | % | 208.8 | 33.8 | % | |||||||||||||||||||
|
Total
Consulting Services
|
954.6 | 100.0 | % | 17.0 | % | 816.1 | 100.0 | % | 32.1 | % | 618.0 | 100.0 | % | |||||||||||||||||||
As
indicated above, our gross revenue was impacted by acquisitions, net internal
growth, and the effect of foreign exchange rates on revenue earned by our
foreign subsidiaries. The impact of these factors on gross revenue earned by
practice area is summarized below:
|
2007
Compared to 2006
|
||||||||||||||||
|
Change
Due
|
Change
Due
|
Change
Due
|
||||||||||||||
|
to
|
to
Internal
|
to
Foreign
|
||||||||||||||
|
Practice
Area Gross Revenue
|
Total
Change
|
Acquisitions
|
Growth
|
Exchange
|
||||||||||||
|
(In
millions of Canadian dollars)
|
||||||||||||||||
|
Buildings
|
27.6 | 17.2 | 11.7 | (1.3 | ) | |||||||||||
|
Environment
|
26.5 | 13.1 | 17.5 | (4.1 | ) | |||||||||||
|
Industrial
|
44.2 | 11.8 | 33.8 | (1.4 | ) | |||||||||||
|
Transportation
|
37.1 | 35.8 | 4.2 | (2.9 | ) | |||||||||||
|
Urban
Land
|
3.1 | 31.2 | (20.1 | ) | (8.0 | ) | ||||||||||
|
Total
Consulting Services
|
138.5 | 109.1 | 47.1 | (17.7 | ) | |||||||||||
|
2006
Compared to 2005
|
||||||||||||||||
|
Change
Due
|
Change
Due
|
Change
Due
|
||||||||||||||
|
to
|
to
Internal
|
to
Foreign
|
||||||||||||||
| Total Change |
Acquisitions
|
Growth
|
Exchange
|
|||||||||||||
|
(In
millions of Canadian dollars)
|
||||||||||||||||
|
Buildings
|
36.8 | 38.7 | (0.3 | ) | (1.6 | ) | ||||||||||
|
Environment
|
46.0 | 32.6 | 15.7 | (2.3 | ) | |||||||||||
|
Industrial
|
27.0 | 8.9 | 19.9 | (1.8 | ) | |||||||||||
|
Transportation
|
15.4 | 11.7 | 6.6 | (2.9 | ) | |||||||||||
|
Urban
Land
|
72.9 | 73.5 | 4.7 | (5.3 | ) | |||||||||||
|
Total
Consulting Services
|
198.1 | 165.4 | 46.7 | (14.0 | ) | |||||||||||
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
13
The
following summarizes the acquisitions completed from 2006 to 2007 that affected
the acquisition growth of each of our practice areas:
|
|
·
|
Buildings:
Carinci Burt Rogers Engineering, Inc. (March 2006); Dufresne-Henry, Inc.
(April 2006); Nicolson Tamaki Architects Inc. (March 2007); Vollmer
Associates LLP (April 2007); Chong Partners Architecture, Inc. (September
2007); Neill and Gunter companies (October 2007); Moore Paterson
Architects Inc. (November 2007); and Murphy Hilgers Architects Inc.,
Brentcliffe Financial Services Inc., and Dekko Studio
Inc. (November 2007)
|
|
|
·
|
Environment:
Dufresne-Henry, Inc. (April 2006); Vollmer Associates LLP (April 2007);
Trico Engineering Consultants Inc. (August 2007); Woodlot Alternatives,
Inc. (October, 2007); and Neill and Gunter companies (October
2007)
|
|
|
·
|
Industrial:
Dufresne-Henry, Inc. (April 2006) and Neill and Gunter companies (October
2007)
|
|
|
·
|
Transportation:
Dufresne-Henry, Inc. (April 2006); ACEx Technologies, Inc. (May 2006);
Vollmer Associates LLP (April 2007); and Neill and Gunter
companies (October 2007)
|
|
|
·
|
Urban
Land: Dufresne-Henry, Inc. (April 2006); Vollmer Associates LLP (April
2007); Land Use Consultants, Inc. (April 2007); Geller DeVellis Inc. (May
2007); and Trico Engineering Consultants Inc. (August
2007)
|
All of
our practice areas generate a portion of their gross revenue in the United
States. The strengthening of the Canadian dollar against the US dollar in 2007
compared to 2006 and in 2006 compared to 2005 had a negative impact on the
change in gross revenue by practice area year over year. The average exchange
rate for the Canadian dollar relative to the US dollar increased by
approximately 5.7% from 2006 to 2007 (US$0.88 to US$0.93) and by 6.0% from 2005
to 2006 (US$0.83 to US$0.88).
2007
versus 2006
Buildings. Gross revenue for
the Buildings practice area grew by 15.0% from 2006 to 2007. Of the $27.6
million increase in gross revenue in 2007, $17.2 million was due to
acquisitions, and $11.7 million was due to internal growth, offset by a foreign
exchange impact of $1.3 million. This year was, historically, the strongest year
for the Buildings practice area as it continued to secure significant projects
and to experience consistently high project volumes. Activity was especially
strong in western Canada in both the public and private sectors. For example, in
2007 we secured a contract to provide architecture; planning; landscape
architecture; and structural, mechanical, electrical, civil, and transportation
engineering services for the development of a 16.2-hectare (40-acre) greenfield
site for a new 300-bed acute care hospital in Grand Prairie, Alberta. We also
completed an award-winning design of an expansion of the Vancouver International
Airport in British Columbia. With a growing presence and project volumes in the
United States, we were awarded an assignment to provide design solutions for a
renovation of the Sheraton New York Hotel and Towers in New York City. To assist
in meeting increased demand for staff, the practice area continued to make use
of work-sharing initiatives across the Company in 2007.
We
believe that the outlook for our Buildings practice area remains optimistic.
With top-tier architecture and buildings engineering practices in Canada, we
expect to enhance our architecture presence in the United States, particularly
in California, through the integration of Chong. We also expect this
acquisition to be a catalyst for future expansion of our US operations in both
architecture and buildings engineering.
Environment. Gross revenue for
the Environment practice area grew by 17.7% from 2006 to 2007. Of the $26.5
million increase in gross revenue in 2007, $13.1 million was due to
acquisitions, and $17.5 million was due to internal growth, offset by a foreign
exchange impact of $4.1 million. The strength demonstrated by the Environment
practice area in 2007 was primarily due to the strong economy in western Canada,
the procurement of additional work in the public sector in eastern Canada, and
development as a top-tier provider of environmental infrastructure expertise in
certain areas of Canada and the United States, which gave us the ability to
secure larger and more complex projects. For example, in 2007 we completed the
design work for the Seymour-Capilano Water Filtration Plant in North Vancouver,
British Columbia, which will be the largest greenfield water treatment facility
in North
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
14
America.
The project has achieved Leadership in Energy and Environmental Design Gold
certification. During the year, the practice area also continued to improve its
operating effectiveness in the US East in terms of client selection, project
management, and sales efficiency. Continuing concerns in the US West about the
inadequacy of existing water supplies due to drought conditions, as well as
legal and regulatory activities, translated into new projects in the areas of
water supply master planning and water supply facility development, including
groundwater, surface water, and recycled water systems.
As
backlog continues to grow, the outlook for this practice area for 2008 remains
optimistic. With the acquisition of Woodlot Alternatives, Inc. and FMSM in 2007
and of R.D. Zande in January 2008, we established a top-tier presence in the US
East in ecosystem restoration capabilities, permitting and compliance for energy
projects, integrated watershed management, and urban wet weather infrastructure
engineering. The integration of FMSM also brings a new practice in geotechnical
engineering specializing in complex subsurface investigation, bridge foundation
analysis, and dam and levee design for clients such as the U.S. Army Corps of
Engineers. In addition, we believe that opportunities for this practice area
will remain positive into 2008 due to the continuing need to rehabilitate or
replace aging and inadequate infrastructure, population growth in the United
States, and the ongoing regulation of communities’ wet weather storm
discharges.
Industrial. Gross revenue for
the Industrial practice area grew by 46.6% from 2006 to 2007. Of the $44.2
million increase in gross revenue in 2007, $11.8 million was due to
acquisitions, and $33.8 million was due to internal growth, offset by a foreign
exchange impact of $1.4 million. The strong internal growth was primarily
due to projects secured as a result of the strong economy in Canada, especially
in western Canada. In 2007 the Industrial practice area continued to
provide services for the development of facilities and infrastructure in support
of major projects in British Columbia and Alberta. For example, we continued to
work with an international pipeline company, providing engineering design
services for major tank terminal facilities. We also secured an assignment to
develop facilities and infrastructure for the Athabasca Upgrader in northern
Alberta for Total E&P Canada Ltd. In addition, we were selected as one of
six firms to complete various projects for the Department of National Defence
across Canada over the next five years. This agreement is starting to translate
into assignments for our Company. For example, in Q4 07 we secured an assignment
to complete the preliminary design and planning of the C-17 hanger at Canadian
Forces Base Trenton in Ontario. The revenue from our bio/pharmaceuticals
practice continued to grow in 2007 as we completed our work on the development
of a world-class oral solid dosage manufacturing facility for Wyeth
Pharmaceuticals in Puerto Rico.
We expect
the growth in revenue for our Industrial practice area to continue into 2008 as
we integrate approximately 650 staff from the Neill and Gunter companies. With
the addition of these companies, we believe that the practice area will become a
stronger player in the power sector and be better positioned to take on larger
projects. The practice area continues to market its expertise to capture more
projects in the power transmission and distribution sector as well as
opportunities that may arise from an expected increase in construction activity
related to the focus on renewable and sustainable energy initiatives (i.e.,
ethanol, biomass, wind, and solar energy) in North America. The practice area
also continues to position itself in the energy and resources sector by pursuing
more of the support facilities and infrastructure segment of projects. In
addition, given the aging population in North America, we remain optimistic for
continued opportunities in the biopharmaceutical sector. Competition for
qualified staff, especially in western Canada, is expected to continue into
2008.
Transportation. Gross revenue
for the Transportation practice area grew by 35.0% from 2006 to 2007. Of the
$37.1 million increase in gross revenue in 2007, $35.8 million was due to
acquisitions, and $4.2 million was due to internal growth, offset by a foreign
exchange impact of $2.9 million. Through acquisitions and internal growth,
our Transportation practice area established a more significant presence in the
US East in 2007. In particular, the acquisition of Vollmer in Q2 07 assisted our
US East operations in securing new projects during the year. Partly fueled by
public concern over infrastructure deficiencies, funding for transportation
projects remained strong at all levels of government in 2007, which continued to
translate into contracts for our Company. For example, during the year, we
secured assignments to provide system integration analysis and planning services
for several light rail transit projects in the southern United States.
Highlights for our Canadian operations in 2007 were the completion of the
southeast leg of Anthony Henday Drive—Edmonton, Alberta’s ring road—and of
improvements to the TransCanada Highway through the challenging terrain of
Kicking Horse Canyon in British Columbia. Although some projects have been
delayed due to increases in construction costs, the outlook for our
Transportation practice area remains positive for 2008.
Urban Land. Gross revenue for
the Urban Land practice area grew by 1.1% from 2006 to 2007. Of the
$3.1 million increase in gross revenue in 2007, $31.2 million was due to
acquisitions, offset by a foreign exchange impact of $8.0 million and a
decline in revenue from internal growth of $20.1 million. We offer urban land
services primarily in three core regions—Alberta and Ontario in Canada and
California in the United States—and these operations accounted
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
15
for
approximately 68.8% of our urban land business in 2007. In addition, we have a
modest urban land presence in Arizona, Nevada, Utah, Colorado, North Carolina,
and Georgia and a small presence in other Canadian markets. Our recent
acquisitions in the US Northeast have increased our presence in New England and
the Tri-State (New York, New Jersey, and Connecticut) area, and the addition of
Trico has strengthened our presence in the southeastern United States and
expanded our services further into the coastal areas of the
Carolinas.
Revenue
for the Urban Land practice area in 2007 was impacted by a decline in housing
starts in various parts of the United States, particularly California, offset by
an increase in starts in Alberta, Canada. Single-family housing starts in the
United States declined in 2007 to the lowest level in the last 15 years.
Although acquisitions in 2007 added employees to the practice area, certain of
our urban land operations in the United States decreased their staff levels
during the year in reaction to the market conditions, resulting in less revenue
generated from these operations in 2007 compared to 2006.
The
National Association of Home Builders in the United States forecasts that US
single-family housing starts will continue to decline in 2008. To mitigate the
impact of this decline in activity, we continue to take advantage of
work-sharing opportunities by using US-based staff to complete Canadian
projects. In addition, we will continue to monitor our short-term backlog and
manage our staff levels to match the amount of work available.
2006
versus 2005
Buildings. Gross revenue for
the Buildings practice area grew by 25.0% from 2005 to 2006. Of the $36.8
million increase in gross revenue in 2006, $38.7 million was due to
acquisitions, offset by a decline in internal growth of $0.3 million and a
foreign exchange impact of $1.6 million. In 2006 the Buildings practice area
continued to secure larger projects and to experience higher project volumes. In
particular, the practice area was very active in western Canada, resulting in a
strong backlog. For example, in Q3 06 we secured a multimillion-dollar contract
to provide mechanical, electrical, and civil engineering services for the
development of an acute care hospital facility—the Legacy project—in Vancouver,
British Columbia. In addition, in 2006 we were awarded a multimillion-dollar
contract to design a three-module, campus-style facility for a banking
institution in Calgary, Alberta. To assist in meeting increased demand for
services in 2006, the practice area made use of work-sharing initiatives across
the Company.
Environment. Gross revenue for
the Environment practice area grew by 44.5% from 2005 to 2006. Of the $46.0
million increase in gross revenue in 2006, $32.6 million was due to
acquisitions, and $15.7 million was due to internal growth, offset by a foreign
exchange impact of $2.3 million. The Environment practice area remained strong
due to larger projects, higher labor utilization rates, and the strong economy
in western Canada.
Industrial. Gross revenue for
the Industrial practice area grew by 39.8% from 2005 to 2006. Of the $27.0
million increase in gross revenue in 2006, $8.9 million was due to acquisitions,
and $19.9 million was due to internal growth, offset by a foreign exchange
impact of $1.8 million. The revenue earned from the industrial practice acquired
from the Keith acquisition accounted for $8.1 million of the acquisition growth.
The internal growth in 2006 was primarily due to securing projects in the oil
sands sector in western Canada. For example, in 2006 we completed a
multimillion-dollar contract to provide services for the development of
facilities and infrastructure for the Fort Hills Oil Sands project in northern
Alberta.
Transportation. Gross revenue
for the Transportation practice area grew by 17.0% from 2005 to 2006. Of the
$15.4 million increase in gross revenue in 2006, $11.7 million was due to
acquisitions, and $6.6 million was due to internal growth, offset by a foreign
exchange impact of $2.9 million. The implementation of the six-year, US$286.4
billion Safe, Accountable, Flexible, Efficient Transportation Equity
Act: A Legacy for Users (SAFETEA-LU) signed on August 10, 2005, increased the
funds available for transportation projects, which started to translate into
contracts for our Company in 2006. For example, during the year, we renewed a
five-year, $11 million contract with the U.S. Department of Transportation to
conduct long-term pavement performance studies.
Urban Land. Gross revenue for
the Urban Land practice area grew by 34.9% from 2005 to 2006. Of the $72.9
million increase in gross revenue in 2006, $73.5 million was due to
acquisitions, and $4.7 million was due to internal growth, offset by a foreign
exchange impact of $5.3 million. The Keith and Dufresne-Henry, Inc. acquisitions
increased our presence in the urban land market in the United States. During
2006, we offered urban land services primarily in Alberta, southern Ontario, and
California and had a more modest presence in Arizona, Nevada, Utah, Colorado,
North Carolina, and Florida and a small presence in other Canadian and eastern
US markets. Our three core regions, which accounted for approximately 75% of our
business, were stable or experienced moderate declines in housing starts. Due to
our strong market position in these regions, the overall performance of our
Urban Land practice area was strong in 2006.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
16
Gross
Margin
For a
definition of gross margin, refer to the Definition of Non-GAAP Measures in the
Critical Accounting Estimates, Developments, and Measures section below. Gross margin decreased to
56.7% in 2007 from 57.0% in 2006 and increased from 55.3% in 2005 to 57.0% in
2006. Our gross margin for 2007 fell within the anticipated range of 55 to 57%
set out in our 2006 Annual Report. Fluctuations in gross margin from year to
year depend on the mix of projects in progress during any year. These
fluctuations reflect the nature of our business model, which is based on
diversifying our operations across geographic regions, practice areas, and all
phases of the infrastructure and facilities project life cycle. In addition, the
decline in our gross margin percentage from 2006 to 2007 was partially due to an
increase in the revenue earned by the Transportation practice area in the United
States compared to Canada. Gross margins on transportation projects in the
United States are typically lower than gross margins on transportation projects
in Canada.
The
increase in our gross margin percentage from 2005 to 2006 was due
to
|
|
·
|
Improved
markets for our services with corresponding increases in fee
rates
|
|
|
·
|
Improved
project management through enhanced staff training and support systems.
This improvement was achieved through the expansion of our on-line
Learning Resource Center during 2006 with updated content and in-house
programs and training in project and financial
management.
|
|
|
·
|
The
implementation of an improved system for invoicing project-related
administrative costs in 2005. Following this implementation, we continued
to reflect these recoveries as part of revenue, but we now report the
costs in administrative and marketing expenses. This contributed to both
the increased gross margin and the increased administrative and marketing
expenses in 2006.
|
The
following table summarizes our gross margin percentages by practice area for
2007, 2006, and 2005:
|
Practice
Area Gross Margin
|
2007
|
2006
|
2005
|
|||||||||
|
Buildings
|
57.7 | % | 57.3 | % | 55.9 | % | ||||||
|
Environment
|
58.4 | % | 58.1 | % | 56.6 | % | ||||||
|
Industrial
|
51.2 | % | 50.4 | % | 49.2 | % | ||||||
|
Transportation
|
53.8 | % | 55.7 | % | 56.1 | % | ||||||
|
Urban
Land
|
58.5 | % | 58.6 | % | 56.1 | % | ||||||
Our gross
margin percentages improved in all practice areas with the exception of a
decline in the Transportation practice area from 2005 to 2007 and a decline in
the Urban Land practice area from 2006 to 2007. These decreases can be
attributed to the same factors discussed above about the overall decline in our
gross margin percentage in 2007.
Administrative
and Marketing Expenses
Our
administrative and marketing expenses increased $59.3 million from 2006 to 2007.
As a percentage of net revenue, our administrative and marketing expenses were
42.3% in 2007 compared to 41.3% in 2006, slightly above our expected range of 40
to 42%. The increase was mainly due to integration activities during the year.
In the months following the completion of an acquisition, there can be an
increase in staff time charged to administration and marketing due to systems
integration and the orientation and integration of newly acquired staff. In 2007
we integrated staff from the 11 acquisitions completed during the year. The
largest acquisitions completed in 2007 were of the Neill and Gunter companies,
with 650 employees, and Vollmer, with 600 employees. Administrative and
marketing expenses were also affected by the following:
|
|
·
|
A
$7.6 million increase in bad debt expense in 2007 compared to 2006. Our
allowance for doubtful accounts is an estimate that is subject to
measurement uncertainty. We adjust the provision quarterly based on
historical experience.
|
|
|
·
|
An
increase in the accrual of performance and retention bonuses arising from
acquisitions to $5.2 million in 2007 from $3.2 million in
2006
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
17
Administrative
and marketing expenses as a percentage of net revenue were 41.3% in 2006
compared to 40.6% in 2005. This increase was mainly due to $3.2 million of
performance and retention bonuses arising from acquisitions completed in 2006
and prior years. As well, when we implemented an improved system for invoicing
project-related administrative costs in 2005, we continued to reflect these
recoveries as part of revenue, but we now report the costs in administrative and
marketing expenses. This change in reporting has contributed to both our
increased gross margin percentage and increased administrative and marketing
expenses in 2006. The 41.3% in 2006 was within the expected range of 40 to 42%
set out in our 2005 Annual Report.
Our
administrative and marketing expenses may fluctuate from year to year as a
result of the amount of non-billable staff time allocated to administration and
marketing, which is influenced by the ratio of work carried out on proposals and
other non-billable administrative and marketing activities during the
year.
Depreciation
of Property and Equipment
Depreciation
of property and equipment as a percentage of net revenue was 2.3% in 2007, 2.2%
in 2006, and 2.4% in 2005. The $3.4 million increase in depreciation from 2006
to 2007 and the $3.2 million increase in depreciation from 2005 to 2006 were
primarily due to the addition of property and equipment from acquisitions made
in the year.
Amortization
of Intangible Assets
The
timing of completed acquisitions, the size of acquisitions, and the type of
intangible assets acquired affect the amount of amortization of intangible
assets in each year. Client relationships and other intangible assets are
amortized over estimated useful lives ranging from 10 to 15 years, whereas
contract backlog is amortized over an estimated useful life of generally less
than one and a half years. As a result, the impact of the amortization of
contract backlog can be significant in the two to six quarters following an
acquisition. The following table summarizes the amortization of identifiable
intangible assets:
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands of Canadian dollars)
|
||||||||||||
|
Amortization
of client relationships
|
2,384 | 2,401 | 1,050 | |||||||||
|
Amortization
of backlog
|
974 | 3,508 | 1,349 | |||||||||
|
Other
|
344 | 223 | 143 | |||||||||
|
Total
amortization of intangible assets
|
3,702 | 6,132 | 2,542 | |||||||||
The
decrease of $2.4 million between 2006 and 2007 was primarily due to the backlog
balances of Keen Engineering Co. Ltd. (Keen) and CPV Group Architects &
Engineers Ltd. (CPV) being fully amortized at the end of 2006 and to the backlog
balances of Keith being fully amortized at the beginning of Q2 07. During 2007,
$16.1 million in intangible assets was established as a result of the 11
acquisitions completed in the year, of which $1.0 million was amortized in
2007.
The
increase of $3.6 million between 2005 and 2006 was primarily due to the
intangible assets acquired from the Keith, Keen, and CPV acquisitions in
September and October of 2005. Of the $6.1 million amortized in 2006, $4.1
million was related to the Keith acquisition.
Net
Interest Expense
The
$298,000 decrease in net interest expense in 2007 compared to 2006 was a result
of our long-term debt position throughout the second, third, and most of the
fourth quarter of 2007 being lower than in 2006, offset by higher interest rates
in the first three quarters of 2007 compared to the same period in 2006. Near
the end of the fourth quarter of 2007, our long-term debt position exceeded our
2006 position since we accessed our revolving credit facility to finance
acquisitions. At December 31, 2006, we had used $8.2 million of our credit
facility, and at December 31, 2007, we had used $52.1 million. Depending on the
form under which the credit facility is accessed and certain financial covenant
calculations, rates of interest may vary among Canadian prime, US base rate, or
LIBOR or bankers’ acceptance rates plus 65 or 85 basis points. Our average
interest rate was 5.51% at December 31, 2007, compared to 6.0% at December 31,
2006. We estimate that, based on our loan balance at December 31, 2007, a 1%
change in interest rates would impact our annual earnings per share by less than
$0.01.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
18
The
increase of $1.3 million in net interest expense in 2006 compared to 2005 was a
result of our long-term debt balance throughout the first two quarters of 2006
being higher than in the same period in 2005 and the prevailing interest rates
in 2006 being higher than in 2005. Near the end of the third quarter of 2005, we
accessed our revolving credit facility to finance the Keith acquisition. In 2006
we repaid our credit facility using cash generated from operations. Our average
interest rate was 6.0% at December 31, 2006, compared to 4.34% at December 31,
2005.
Foreign
Exchange Gains
We
reported a foreign exchange gain of $2.5 million in 2007 compared to $0.1
million in 2006 and $0.4 million in 2005. These foreign exchange
gains arose on the translation of the foreign-denominated assets and liabilities
held in our Canadian companies and in our non-US-based foreign subsidiaries. We
minimize our exposure to foreign exchange fluctuations by matching US-dollar
assets with US-dollar liabilities and, when appropriate, by entering into
forward contracts to buy or sell US dollars in exchange for Canadian
dollars.
The
exchange gains reported from 2005 to 2007 arose on transactions related to the
financing of acquisitions. By entering into these transactions, there was a
period when our US-dollar-denominated liabilities exceeded our
US-dollar-denominated assets while the Canadian dollar strengthened, resulting
in exchange gains. In 2007 the exchange rate rose from US$0.86 at the beginning
of the year to US$1.01 at the end of the year.
As at
December 31, 2007, we had entered into a foreign currency forward contract that
provided for the purchase of US$34.1 million on January 24, 2008,
at the rate of 0.9804 per US dollar. The fair value of this contract,
estimated using market rates at December 31, 2007, was a gain of $0.4
million.
Income
Taxes
Our
effective income tax rate for 2007 was 30.1% compared to 32.7% for
2006 and 35.0% for 2005. Our 2007 effective tax rate fell below the expected
range of 32.0 to 34.0% set out in our 2006 Management’s Discussion and
Analysis. We review our estimated income tax rate quarterly and adjust it
based on changes in statutory rates in the jurisdictions in which we operate as
well as on our estimated earnings in each of these jurisdictions. Based on these
factors, in Q3 07 we estimated that our effective tax rate would be 33%. During
Q4 07, the following items reduced our effective rate to 30.1% for the
year:
|
|
·
|
We
earned more income in Canada than anticipated, and after deducting
internal financing costs, we incurred losses in our US-based subsidiaries.
Since our Canadian income is taxed at lower income tax rates than income
earned in the United States, the impact of this shift in income reduced
our overall effective tax rate.
|
|
|
·
|
In
2006 the Quebec government enacted Bill 15 to amend the Quebec Taxation
Act, legislation that retroactively eliminated the benefit of certain
financing trust arrangements. Subsequent to year-end, we accepted a
compliance proposal from the Canadian Revenue Agency related to this
retroactive legislation. This proposal resulted in a reduction of
approximately $662,000 of tax, which we recorded as an additional expense
in 2006.
|
|
|
·
|
Income
tax rate reductions were enacted in certain of our tax jurisdictions.
Since we were in a net future income tax liability position in these
jurisdictions, these reductions in carrying value resulted in a recovery
of future taxes.
|
Our
effective tax rate for 2006 was 32.7% compared to 35.0% for 2005. As a result of
the Quebec government enacting Bill 15 as described above, we recorded an
additional $1.0 million of income tax expense in Q2 06. The impact of this
increase was offset by the relative amount of income earned in our low tax rate
jurisdictions, resulting in an effective income tax rate that was below the
middle of our expected range for 2006.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
19
Fourth
Quarter Results and Quarterly Trends
The
following is a summary of our quarterly operating results for the last two
fiscal years:
|
Quarterly
Operating Results
|
||||||||
|
(In
millions of Canadian dollars, except per share amounts)
|
||||||||
|
2007
|
2006
|
|||||||
|
Dec
31
|
Sep
30
|
Jun
30
|
Mar
31
|
Dec
31
|
Sep
30
|
Jun
30
|
Mar
31
|
|
|
Gross
revenue
|
258.3
|
235.3
|
244.7
|
216.3
|
211.8
|
210.2
|
208.8
|
185.3
|
|
Net
revenue
|
215.9
|
207.0
|
215.7
|
192.3
|
180.6
|
182.0
|
182.2
|
163.1
|
|
Net
income
|
19.0
|
17.4
|
17.5
|
15.4
|
15.6
|
16.5
|
16.7
|
11.4
|
|
EPS
– basic
|
0.42
|
0.38
|
0.38
|
0.34
|
0.35
|
0.36
|
0.37
|
0.25
|
|
EPS
– diluted
|
0.41
|
0.38
|
0.38
|
0.33
|
0.34
|
0.36
|
0.36
|
0.25
|
|
The
quarterly earnings per share on a basic and diluted basis are not additive
and may not equal the annual earnings per share reported. This is due to
the effect of shares issued or repurchased during the year on the weighted
average number of shares. Diluted earnings per share on a quarterly and
annual basis are also affected by the change in the market price of our
shares, since we do not include in dilution options whose exercise price
is not in the money.
|
||||||||
The
following items impact the comparability of our quarterly results:
|
Q4
07 vs.
Q4
06
|
Q3
07 vs.
Q3
06
|
Q2
07 vs.
Q2
06
|
Q1
07 vs.
Q1
06
|
|
|
(In
millions of Canadian dollars)
|
||||
|
Increase
(decrease) in gross revenue due to:
|
||||
|
Acquisition
growth
|
46.5
|
27.4
|
22.3
|
12.9
|
|
Internal
growth
|
11.6
|
3.5
|
15.2
|
16.8
|
|
Impact
of foreign exchange rates on revenue
earned
by foreign subsidiaries
|
(11.6)
|
(5.8)
|
(1.6)
|
1.3
|
|
Total
increase in gross revenue
|
46.5
|
25.1
|
35.9
|
31.0
|
Fourth
Quarter Results
As
indicated in the tables above, during Q4 07, our gross revenue increased by
$46.5 million, or 22.0%, to $258.3 million compared to $211.8 million for the
same period in 2006. Approximately $46.5 million of this increase resulted from
acquisitions completed in 2006 and 2007 and internal growth of $11.6 million,
offset by a foreign exchange impact of $11.6 million due to the strengthening of
the Canadian dollar during 2007.
The
following table summarizes our key operating results for Q4 07 on a percentage
of net revenue basis and the percentage increase in the dollar amount of these
results compared to the same period last year:
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
20
|
Quarter
ended Dec 31
|
||||||||||||
|
%
of Net Revenue
|
%
Increase*
|
|||||||||||
|
2007
|
2006
|
2007 vs.
2006
|
||||||||||
|
Gross
revenue
|
119.6 | % | 117.3 | % | 22.0 | % | ||||||
|
Net
revenue
|
100.0 | % | 100.0 | % | 19.5 | % | ||||||
|
Direct
payroll costs
|
42.5 | % | 41.7 | % | 21.9 | % | ||||||
|
Gross
margin
|
57.5 | % | 58.3 | % | 17.8 | % | ||||||
|
Administrative
and marketing expenses
|
43.5 | % | 43.4 | % | 19.8 | % | ||||||
|
Depreciation
of property and equipment
|
2.7 | % | 2.4 | % | 39.5 | % | ||||||
|
Amortization
of intangible assets
|
0.5 | % | 0.7 | % | (15.4 | %) | ||||||
|
Net
interest expense
|
0.4 | % | 0.0 | % | n/m | |||||||
|
Share
of income from associated companies
|
(0.1 | %) | (0.1 | %) | 0.0 | % | ||||||
|
Foreign
exchange gains
|
(0.5 | %) | 0.0 | % | n/m | |||||||
|
Other
income
|
(0.1 | %) | (0.1 | %) | 200.0 | % | ||||||
|
Income
before income taxes
|
11.1 | % | 12.0 | % | 10.6 | % | ||||||
|
Income
taxes
|
2.3 | % | 3.4 | % | (18.0 | %) | ||||||
|
Net
income for the period
|
8.8 | % | 8.7 | % | 21.8 | % | ||||||
|
* %
increase calculated based on the dollar change from the comparable
period
|
||||||||||||
|
n/m
= not meaningful
|
||||||||||||
Net
income during Q4 07 increased by $3.4 million, or 21.8 %, from the same period
in 2006. Basic earnings per share in Q4 07 increased by $0.07, or 20.0%,
compared to the same period in Q4 06. Net income during Q4 07 was positively
affected by the growth in gross revenue and a $1.1 million decline in income tax
expense. Our income tax expense in Q4 07 was positively impacted by the enacted
reduction in income tax rates in certain of our tax jurisdictions and the
recovery of income tax previously provided for as a result of the Quebec tax
settlement. In addition, we earned more income in Canada than anticipated, and
after deducting internal financing costs, we incurred losses in our US-based
subsidiaries. Since our Canadian income is taxed at lower income tax rates than
income earned in the United States, the impact of this shift in income reduced
our overall effective tax rate.
Net
income in Q4 07 compared to Q4 06 was negatively impacted by a $15.5 million
increase in administrative and marketing expenses due to our focus on the
integration of approximately 790 staff from the acquisition of Woodlot
Alternatives, Inc., the Neill and Gunter companies, Moore Paterson Architects
Inc., Murphy Hilgers Architects Inc., Brentcliffe Financial Services Inc., and
Dekko Studio Inc. during the quarter and on the continued integration of staff
added through acquisitions during the year. Acquired staff are required to learn
new practices and processes and understand new systems, and such a learning
curve can result in decreased productivity until the learning is complete. As
well, depreciation increased $1.7 million in Q4 07 compared to Q4 06 due to the
inclusion of property and equipment from companies acquired in the quarter and
year to date.
Our gross
margin percentage was 57.5% in Q4 07 compared to 58.3% in Q4 06. Because of the
nature of our business model, which is based on diversifying our operations
across geographic regions, practice areas, and all phases of the infrastructure
and facilities project life cycle, there will continue to be fluctuations in our
gross margin percentage from period to period depending on the mix of projects
during any quarter.
The
following table summarizes the growth in gross revenue by practice area in the
fourth quarter of 2007 compared to the same period in 2006.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
21
|
Quarter
Ended December 31
|
||||||||||||||||||||||||
|
|
Change
Due
|
Change
Due
|
Change
Due
|
|||||||||||||||||||||
|
to
|
to
Internal
|
to
Foreign
|
||||||||||||||||||||||
|
Practice
Area Gross Revenue
|
2007
|
2006
|
Total Change |
Acquisitions
|
Growth
|
Exchange
|
||||||||||||||||||
|
(In
millions of Canadian dollars)
|
||||||||||||||||||||||||
|
Buildings
|
60.5 | 46.9 | 13.6 | 9.8 | 4.4 | (0.7 | ) | |||||||||||||||||
|
Environment
|
44.2 | 42.5 | 1.7 | 4.1 | 0.3 | (2.7 | ) | |||||||||||||||||
|
Industrial
|
45.3 | 27.6 | 17.7 | 11.5 | 7.3 | (1.0 | ) | |||||||||||||||||
|
Transportation
|
40.2 | 24.9 | 15.3 | 9.2 | 7.8 | (1.8 | ) | |||||||||||||||||
|
Urban
Land
|
68.1 | 69.9 | (1.8 | ) | 11.9 | (8.2 | ) | (5.4 | ) | |||||||||||||||
|
Total
Consulting Services
|
258.3 | 211.8 | 46.5 | 46.5 | 11.6 | (11.6 | ) | |||||||||||||||||
The $11.6
million internal growth in revenue was net of a decline of $8.2 million in the
Urban Land practice area. This practice area continued to be impacted by a
decline in housing starts in various parts of the United States, particularly
California. Although acquisitions in 2007 added employees to this practice area,
certain of our urban land operations in the United States decreased their staff
levels in Q4 07 in reaction to the weaker market conditions.
Quarterly
Trends
During Q1
07, our gross revenue grew by $31.0 million, or 16.7%, to $216.3 million
compared to $185.3 million for the same period in 2006. Approximately $12.9
million of this increase resulted from acquisitions completed in 2006, $16.8
million in internal growth, and a $1.3 million positive impact from foreign
exchange due to the weaker Canadian dollar in Q1 07 compared to Q1 06. Net
income increased by $4.0 million, or 35.1%, in Q1 07 compared to the same period
in 2006, and basic earnings per share increased by $0.09 compared to the same
period last year. The increase in net income was mainly due to our amortization
of intangible assets and net interest expense being lower than in the same
period in 2006. As well, our gross margin percentage was higher than anticipated
due to the mix and type of projects completed during the quarter.
During Q2
07, our gross revenue increased by $35.9 million, or 17.2%, to $244.7 million
compared to $208.8 million for the same period in 2006. Approximately $22.3
million of this increase resulted from acquisitions completed in 2006 and 2007
and $15.2 million in internal growth, offset by $1.6 million in foreign exchange
due to the stronger Canadian dollar in Q2 07 compared to Q2 06. Net income
increased by $0.8 million, or 4.8%, in Q2 07 compared to the same period in
2006, and basic earnings per share increased by $0.01 compared to the same
period last year. Net income did not increase in line with net revenue due to an
increase in administrative and marketing expenses in Q2 07 because of our focus
on the integration of approximately 670 staff from the acquisition of Vollmer,
Land Use Consultants, Inc., and Geller. In addition, we incurred $2.8 million in
bad debt expense in Q2 07 compared to Q2 06 as a result of an adjustment to our
provision based on historical experience. We also incurred a $2.2 million
expense for self-insured professional liabilities claims in Q2 07 versus a $1.0
million recovery in Q2 06. Our claims expense fluctuates based on the results of
actuarial reviews as well as the timing of the initiation and settlement of
claims.
During Q3
07, our gross revenue increased by $25.1 million, or 11.9%, to $235.3 million
compared to $210.2 million for the same period in 2006. Approximately $27.4
million of this increase resulted from acquisitions completed in 2006 and 2007
and $3.5 million in internal growth, offset by $5.8 million in foreign exchange
due to the stronger Canadian dollar in Q3 07 compared to Q3 06. Net income
increased by $0.9 million, or 5.5%, in Q3 07 compared to the same period in
2006, and basic earnings per share increased by $0.02 compared to the same
period last year. As in Q2 07, net income did not increase in line with net
revenue due to an increase in administrative and marketing expenses in Q3 07 due
to our focus on the integration of approximately 300 staff from the acquisition
of Trico Engineering and Chong Partners during the quarter and on the continued
integration of more than 970 staff acquired year to date.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
22
Liquidity
and Capital Resources
The
following table represents summarized working capital information as at December
31, 2007, compared to December 31, 2006:
|
Dec
31, 2007
|
Dec
31, 2006
|
Change
|
||||||||||
|
(In
millions of Canadian dollars, except ratio)
|
||||||||||||
|
Current
assets
|
323.2 | 264.6 | 58.6 | |||||||||
|
Current
liabilities
|
(232.7 | ) | (159.7 | ) | (73.0 | ) | ||||||
|
Working
capital (note 1)
|
90.5 | 104.9 | (14.4 | ) | ||||||||
|
Current
ratio
|
1.39 | 1.66 | n/a | |||||||||
note
1: Working capital is calculated by subtracting current liabilities from current
assets. Current ratio is calculated by dividing current assets by current
liabilities.
note
2: Certain comparative figures have been reclassified to conform to the
presentation adopted for the current year.
Our cash
flows from operating, investing, and financing activities, as reflected in our
consolidated statements of cash flows, are summarized in the following
table:
|
2007
|
2006
|
2005
|
$
Change
2007
vs.
2006
|
$
Change
2006
vs.
2005
|
|
|
(In
millions of Canadian dollars)
|
|||||
|
Cash
flows from operating activities
|
87.5
|
93.4
|
57.3
|
(5.9)
|
36.1
|
|
Cash
flows used in investing activities
|
(135.2)
|
(15.6)
|
(114.6)
|
(119.6)
|
99.0
|
|
Cash
flows from (used in) financing
activities
|
33.9
|
(77.4)
|
47.9
|
111.3
|
(125.3)
|
Our
liquidity needs can be met through a variety of sources, including cash
generated from operations, long- and short-term borrowings from our $250 million
credit facility, and the issuance of common shares. Our primary use of funds is
for paying operational expenses, completing acquisitions, and sustaining capital
spending on property and equipment.
We
believe that internally generated cash flows, supplemented by borrowing from
existing financing sources, if necessary, will be sufficient to cover our normal
operating and capital expenditures and anticipated acquisition growth activities
in 2008. We continue to manage according to our internal guideline of
maintaining a debt to equity ratio of less than 0.5 to 1. Confidence in our
ability to generate cash from operations was demonstrated by our success in
negotiating an increase in the limit of our existing revolving credit facility
from $160 to $250 million. As well, we believe that the design of our business
model reduces the impact of changing market conditions on our operating cash
flows. At this time, we do not reasonably expect any presently known trends or
uncertainty to affect our ability to access our historical sources of cash. We
do not invest in any asset-backed commercial paper and, therefore, do not
consider that we are exposed to current uncertainties in the
marketplace.
Working
Capital
Our
working capital at the end of 2007 was $90.5 million compared to $104.9 million
in 2006. Current assets increased by $58.6 million, and current liabilities
increased by $73.0 million. The increase in current assets was mainly due to a
$41.1 million increase in accounts receivable, net of allowance for doubtful
accounts, and a $23.9 million increase in costs and estimated earnings in excess
of billings (work in progress). These increases resulted from internal growth
and growth from acquisitions during the year and were partly offset by a $14.2
million decrease in cash and cash equivalents used for operating and acquisition
purposes.
The $73.0
million increase in current liabilities from 2006 to 2007 was mainly due to a
$47.9 million increase in accounts payable and accrued liabilities. This
increase was the result of internal growth and growth from
acquisitions
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
23
during
the year. As well, the current portion of long-term debt increased by $17.4
million due to promissory notes used to finance various acquisitions coming due
in 2008.
In 2006
our current ratio was higher than in 2007 mainly due to the availability of cash
and cash equivalents, which was subsequently drawn down in 2007 for operating
and acquisition purposes. As well, in 2006 there were fewer promissory notes
from acquisitions becoming due within one year.
Cash
Flows From Operating Activities
Our cash
flows from operating activities decreased by $5.9 million in 2007 from 2006 and
increased by $36.1 million from 2005 to 2006. Our cash flows from operating
activities declined in 2007 due to a net decrease of $13.2 million in cash
receipts from clients less cash paid to suppliers and employees. In 2006 cash
receipts from clients less cash paid to suppliers and employees were high due to
additional revenue generated by acquisitions completed in the second half of
2005. The successful integration of these acquisitions resulted in a reduction
in our combined investment in accounts receivable and costs and estimated
earnings in excess of billings from 101 days of revenue at the end of 2005 to 92
days at the end of 2006. In 2007 our combined investment in accounts receivable
and costs and estimated earnings in excess of billings was 94 days of
revenue.
Positively
impacting our operating cash flows in 2007 was a $3.9 million decrease in income
taxes paid in 2007 compared to 2006 due to a decrease in the income tax
installments required in 2007.
Cash
Flows Used In Investing Activities
Cash
flows used in investing activities increased by $119.6 million from 2006 to 2007
and decreased by $99.0 million from 2005 to 2006. In 2007 we used $105.4 million
to finance the 11 acquisitions completed during the year versus using $12.2
million in 2006 and $100.4 million in 2005. The use of cash and cash equivalents
for acquisitions in 2006 was also offset by a drawdown of restricted cash
acquired in connection with the Keith acquisition.
Our
investment activities in 2007 compared to 2006 also included an $8.4 million
increase in purchases of property and equipment. One factor that contributed to
this increase was $8.1 million spent on improvements made to our Toronto,
Ontario; Markham, Ontario; Vancouver, British Columbia; and Edmonton, Alberta,
offices. Our 2006 investment activities increased compared to 2005 due to the
use of $2.9 million for improvements to our offices in Vancouver, British
Columbia, and Edmonton, Alberta.
As a
professional services organization, we are not capital intensive. Our capital
expenditures have historically been made primarily for property and equipment
including such items as leasehold improvements, computer equipment and business
information systems software, furniture, and other office and field equipment.
Our cash outflows for property and equipment were $27.3 million, $18.9 million,
and $17.0 million in each of 2007, 2006, and 2005, respectively. Our capital
expenditures during 2007 were financed by cash flows from operations. We expect
our total capital expenditures in 2008 to be in the range of $27 to $30 million,
excluding capital acquired from acquisitions.
Cash
Flows From (Used In) Financing Activities
Our cash
flows from financing activities increased by $111.3 million from 2006 to 2007
and decreased by $125.3 million from 2005 to 2006. In 2007 we generated
sufficient cash from our operations to reduce the amount outstanding on our
credit facility by $78.5 million and repay $6.3 million of our acquired debt.
However, during the year, we also accessed our credit facility for acquisition
purposes. As at December 31, 2007, $106.5 million of our credit facility was
available for future use. As well, we used $0.3 million to repurchase shares
under our normal course issuer bid in 2007. The above use of cash was offset by
$1.9 million generated from options exercised during the year.
In 2006
we generated sufficient cash from our operations to reduce the amount
outstanding on our credit facility by $85.6 million and repay $1.8 million of
our acquired debt. At December 31, 2006, $149.9 million of our credit facility
was available for future use. As well, we used $1.0 million to repurchase shares
under our normal course issuer bid in 2006. The above use of cash was offset by
$1.9 million generated from options exercised during the year.
Our
credit facility is available for acquisitions, working capital needs, capital
expenditures, and general corporate purposes. Depending on the form under which
the credit facility is accessed and certain financial covenant calculations,
rates of interest will vary between Canadian prime, US base rate, or LIBOR or
bankers’ acceptance rates plus 65 or 85 basis points. The average interest rate
on the amounts outstanding at December 31, 2007, was 5.51%. We are subject to
financial and operating covenants related to our credit facility. Failure to
meet the terms of
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
24
one or
more of these covenants may constitute a default, potentially resulting in
accelerated repayment of the debt obligation. We were in compliance with these
covenants as at and throughout the year ended December 31, 2007.
Subsequent
to December 31, 2007, we were successful in reaching an agreement with our
lenders to increase our revolving credit facility from $160 million to $250
million as further described in the Subsequent Events section
below.
Shareholders’
Equity
Our
shareholders’ equity increased by $31.8 million in 2007 and by $62.8 million in
2006. The following table summarizes the reasons for these
increases:
|
2007
|
2006
|
|||||||
|
(In
millions of Canadian dollars)
|
||||||||
|
Beginning
shareholders’ equity (before change in accounting policy)
|
410.9 | 348.1 | ||||||
|
Change
in accounting policy
|
0.5 | 0.0 | ||||||
|
Beginning
shareholders’ equity
|
411.4 | 348.1 | ||||||
|
Net
income for the year
|
69.3 | 60.2 | ||||||
|
Currency
translation adjustments
|
(45.7 | ) | 0.7 | |||||
|
Shares
issued on acquisition
|
3.4 | 0.0 | ||||||
|
Recognition
of fair value of stock-based compensation
|
2.1 | 1.6 | ||||||
|
Share
options exercised for cash
|
1.9 | 1.9 | ||||||
|
Shares
repurchased under normal course issuer bid
|
(0.3 | ) | (1.0 | ) | ||||
|
Other
|
0.6 | (0.6 | ) | |||||
|
Total
change
|
31.3 | 62.8 | ||||||
|
Ending
shareholders’ equity
|
442.7 | 410.9 | ||||||
The
change arising on the translation of our US-based subsidiaries in 2007 was $45.7
million compared to $0.7 million in 2006. The change in 2007 was due to the
strengthening of the Canadian dollar—from US$0.86 to US$1.01—during the year. In
2006 the Canadian dollar was valued at US$0.86 at both the end and beginning of
the year.
In 2007,
under our Company’s share option plan and as part of our incentive program, our
Board of Directors granted 467,500 stock options to various officers and
employees of the Company (471,000 options were granted in 2006). These options
vest equally over a three-year period and have a contractual life of seven years
from the grant date.
Our
normal course issuer bid on the TSX was renewed in 2007 and allows us to
repurchase up to 2,279,496 of our common shares. We continue to believe that,
from time to time, the market price of our common shares does not fully reflect
the value of our business or future business prospects and that, at such times,
outstanding common shares are an attractive, appropriate, and desirable use of
available Company funds. In 2007 we purchased 9,200 common shares at an average
price of $31.91 per share for an aggregate price of $0.3 million. In 2006 we
purchased 51,600 common shares at an average price of $19.69 per share for an
aggregate price of $1.0 million.
In
October 2007, we issued 96,925 of our common shares as part of the consideration
for the purchase of the Neill and Gunter companies. The $3.4 million in
consideration was based on the average of the closing price of our common shares
on the TSX for five trading days around the acquisition date.
Other
Outstanding
Share Data
As at
December 31, 2007, there were 45,698,143 common shares and 1,751,022 share
options outstanding. During the period of December 31, 2007, to February
20, 2008, 112,400 shares were repurchased under our normal course issuer
bid; 47,862 share options were exercised; 11,666 share options were
forfeited; and 3,520 common shares were issued upon the vesting of
restricted shares issued on the Keith acquisition. As at February 20, 2008,
there were 45,637,125 common shares and 1,691,494 share options
outstanding.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
25
Contractual
Obligations
As part
of our continuing operations, we enter into long-term contractual arrangements
from time to time. The following table summarizes the contractual obligations
due on our long-term debt, other liabilities, and operating lease commitments as
of December 31, 2007:
|
Payment
Due by Period
|
||||||||||||||||||||
|
Less
than 1
|
After
5
|
|||||||||||||||||||
|
Contractual
Obligations
|
Total
|
year
|
1-3
years
|
4-5
years
|
years
|
|||||||||||||||
|
(In
millions of Canadian dollars)
|
||||||||||||||||||||
|
Long-term
debt
|
96.1 | 21.6 | 74.3 | 0.1 | 0.1 | |||||||||||||||
|
Interest
on debt
|
10.8 | 4.9 | 5.9 | - | - | |||||||||||||||
|
Other
liabilities
|
3.2 | 0.5 | - | - | 2.7 | |||||||||||||||
|
Operating
lease commitments
|
299.2 | 49.8 | 86.3 | 64.4 | 98.7 | |||||||||||||||
|
Total
contractual obligations
|
409.3 | 76.8 | 166.5 | 64.5 | 101.5 | |||||||||||||||
For
further information regarding the nature and repayment terms of our long-term
debt, refer to the Cash Flows From Financing Activities section. Our operating
lease commitments include obligations under office space rental agreements, and
our other liabilities primarily include amounts payable under our deferred share
unit plan.
Off-Balance
Sheet Arrangements
As of
December 31, 2007, we had off-balance sheet financial arrangements relating to
letters of credit in the amount of $1.9 million that expire at various dates
before October 2009. These letters of credit were issued in the normal course of
operations, including the guarantee of certain office rental
obligations.
In the
normal course of business, we also provide indemnifications and, in very limited
circumstances, surety bonds. These are often standard contractual terms and are
provided to counterparties in transactions such as purchase and sale contracts
for assets or shares, service agreements, and leasing transactions. In addition,
we indemnify our directors and officers against any and all claims or losses
reasonably incurred in the performance of their service to the Company to the
extent permitted by law. These indemnifications may require us to compensate the
counterparty for costs incurred as a result of various events. The terms of
these indemnification agreements will vary based on the contract, the nature of
which prevents us from making a reasonable estimate of the maximum potential
amount that could be required to pay counterparties. Historically, we have not
made any significant payments under such indemnifications, and no amounts have
been accrued in our consolidated financial statements with respect to these
guarantees.
Market
Risk
We are
exposed to various market factors that can affect our performance, primarily
with respect to currency and interest rates.
Currency. Because a
significant portion of our revenue and expenses is generated or incurred in US
dollars, we face the challenge of dealing with fluctuations in exchange rates.
To the extent that US-dollar revenues are greater than US-dollar expenses in a
strengthening US-dollar environment, we expect to see a positive impact on our
income from operations. Conversely, to the extent that US-dollar revenues are
greater than US-dollar expenses in a weakening US-dollar environment, we expect
to see a negative impact. This exchange rate risk primarily reflects, on an
annual basis, the impact of fluctuating exchange rates on the net difference
between total US-dollar professional revenue and US-dollar expenses. Other
exchange rate risk arises from the revenue and expenses generated or incurred by
subsidiaries located outside Canada and the United States. Our income from
operations will be impacted by exchange rate fluctuations used in translating
these revenues and expenses. In addition, the impact of exchange rates on the
balance sheet accounts of subsidiaries located outside Canada and the United
States will affect our operating results. We also continue to be exposed to
exchange rate risk for the US-dollar and other foreign currency-denominated
balance sheet items carried by our Canadian, US, and international
operations.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
26
Interest Rate. Changes in
interest rates also present a risk to our performance. Our credit facility
carries a floating rate of interest. We estimate that, based on our balance at
December 31, 2007, a 1% change in interest rates would impact our earnings per
share by less than $0.01.
Related-Party
Transactions
We have
not entered into any related-party transactions as defined in Section 3840
of the Canadian
Institute of Chartered Accountants (CICA) Handbook.
OUTLOOK
The
following table summarizes our expectations for the coming year:
|
Measure
|
Expected
Range
|
|
|
Debt
to equity ratio (note
1)
|
At
or below 0.5 to 1
|
|
|
Return
on equity (note
2)
|
At
or above 14%
|
|
|
Net
income as % of net revenue
|
At
or above 6%
|
|
|
Gross
margin as % of net revenue
|
Between
55 and 57%
|
|
|
Administrative
and marketing expenses
as
% of net revenue
|
Between
41.5 and 43.5%
|
|
|
Effective
income tax rate
|
Between
29 and 31%
|
note
1: Debt to equity ratio is calculated as the sum of (1) long-term debt,
including current portion, plus bank indebtedness, less cash divided by (2)
shareholders’ equity.
note
2: Return on equity is calculated as net income for the year divided by average
shareholders’ equity over each of the last four quarters.
We have
revised our targets for our administrative and marketing expenses and for our
effective income tax rate for 2008. Fluctuations in our actual performance occur
due to the particular client and project mix achieved as well as the number of
acquisitions completed in a year. Some targets, such as debt to equity ratio,
could be impacted and potentially exceeded by completing an opportune larger
acquisition that increases our debt level above our target for a period of
time.
The
infrastructure and facilities market in North America, our principal area of
operation, is large and is estimated to generate over US$70 billion in revenue
for our addressable market. The North American market is also diverse,
consisting of many technical disciplines, practice areas, client types, and
industries in both the private and public sectors. Overall, we expect the
outlook for professional services in our key markets and practice areas to
remain positive, with continuing robust private and public sector spending on
the development of new and the rehabilitation of existing infrastructure. We
base this expectation on a variety of factors as described below.
Canada
The
outlook for Canada, particularly western Canada, remains strong for 2008.
According to the Conference Board of Canada, the Canadian real gross domestic
product (GDP) is expected to grow by 2.8% in 2008 and by 3.0% in 2009. We
believe that the infrastructure gap will keep spending growth strong in the
infrastructure and facilities industry, with 59% of Canada’s infrastructure
aging beyond the 40-year mark. The following factors are evidence of a positive
Canadian outlook for 2008 in areas that directly impact infrastructure
spending:
|
|
·
|
High
energy prices are spurring investment in the oil and gas construction
segment in Canada. Much of this investment is in Alberta’s oil sands,
where spending is estimated to reach $150 billion in the next
decade.
|
|
|
·
|
Although
the manufacturing industry was negatively affected by the rising Canadian
dollar in the last two quarters of 2007, third quarter profit margins for
the industry remained healthy at 6.5%. The rising Canadian dollar has
supported increased investment in the machinery and equipment sector,
which is expected to reach 7.8% in 2008 and to decline slightly to 6.9% in
2009. Both of these factors have helped to ease concerns about the outlook
for the manufacturing industry in 2008 and the increased valuation of the
Canadian dollar relative to the US dollar. In addition, the federal
government’s corporate income tax
cuts
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-27
|
|
and
accelerated capital consumption allowances for manufacturers have helped
to bolster confidence in the
industry.
|
|
|
·
|
Governments
and the public are becoming increasingly aware of environmental issues as
well as sustainable design and development. This awareness includes, for
instance, an increased interest in the development of buildings and
facilities that require less energy for operation and have a reduced
ecological impact, as well as improvements to water, water distribution,
and water treatment infrastructure. Recognition of the need for these
initiatives has come at the federal level in the Canadian government’s new
“Building Canada” infrastructure investment plan, which supports
infrastructure development with a focus on a cleaner environment and more
prosperous communities. The British Columbia government has also announced
a $14 billion plan aimed at expanding public transit systems in the
province and reducing greenhouse gas emissions. Implementation of this
plan is expected to be completed by 2020. It will expand the rapid transit
lines in the Greater Vancouver Area and add high-capacity,
energy-efficient, and clean-energy buses to transit systems in
metropolitan areas across British Columbia. We believe that we are well
positioned to capture opportunities in these areas, since we have
developed expertise in delivering sustainable design
services.
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Expenditures
on electricity are expected to increase nationally as investments continue
to be made in wind power and the development and maintenance of
hydroelectric projects. For instance, the Ontario government has committed
to replacing all coal-fired energy generation, which currently makes up
20% of the province’s power, in the earliest practical time frame, which
is forecasted to be in the next 10 years. Alternatives being proposed
include the use of renewable supply methods, nuclear power generation,
natural gas power generation, and conservation. The Ontario government has
also proposed undertaking a number of transmission projects to strengthen
its transmission system and accommodate its power generation
goals.
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According
to the Canadian Mortgage and Housing Corporation, housing starts are
expected to decrease in 2008 but to remain strong by historical standards.
Single detached home starts are expected to decrease by 8.1% to 107,500
units, while all residential construction home starts will stay above
200,000 units for the seventh consecutive
year.
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The
Canadian government’s new Building Canada infrastructure plan, announced
in 2007, is to provide a long-term investment of $33.0 billion in
infrastructure. The program outlines a seven-year plan for infrastructure
spending in the areas of transportation, gateways and border crossings,
connectivity and broadband technology, water and wastewater, solid waste
management, renewable energy, disaster mitigation, brownfield
redevelopment, and sports and
culture.
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United
States
The
general outlook for the United States is less optimistic due to the declining
housing market and the slowdown of the economy. The Congressional Budget Office
anticipates in its Budget and Economic Outlook that the US GDP will grow by 1.7%
in 2008 due to slower consumer spending brought on by higher energy prices, weak
consumer confidence, and higher debt levels. In 2009, with a recovering housing
market and strong exports, US GDP growth is expected to strengthen to 2.8%. The
following factors support our outlook for 2008:
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The
manufacturing industry is expected to be weaker in 2008 as consumer
spending decreases and job losses affect the industry. This weakness may
be mitigated in part by the expected double-digit growth of US exports due
to the weaker US dollar. Although industrial output does appear to be
slowing, there are still companies that need to expand their warehousing
and manufacturing facilities.
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The
implementation of the six-year, US$286.4 billion SAFETEA-LU, which was
passed into law on August 10, 2005, continues to support transportation
projects.
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The
housing market is forecasted to continue to decline in 2008, with
seasonally adjusted annual rates of single-family housing starts expected
to bottom out at around 780,000 units. This decline is expected to be
moderate, and the market is forecasted to begin showing positive growth in
2009. We continue to have a strong market position in the regions we
service; however, in 2008 we will continue to monitor our short-term
backlog and manage our staff levels to match the amount of work
available.
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Supported
by this overall market outlook for our practice areas, we plan to continue to
grow our operations through a combination of internal organic growth and
acquisitions. We continue to target to achieve a long-term
average
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
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annual
compound growth rate of 15 to 20% for gross revenue—a target we have realized
since our initial public offering in 1994. Continued growth allows us to enhance
the depth of our expertise, broaden our service offerings, provide expanded
opportunities for our employees, and lever our information technology and other
“back office” systems. Our ability to grow at this rate depends on the
availability of acquisition opportunities. To date, locating available
acquisition candidates has not been an issue, and we do not expect it to become
one since our industry is made up of many small to midsize firms and there is a
consolidation trend occurring as smaller firms desire to join larger, more
stable organizations. Because it is important to find an appropriate cultural
fit and complementary services, the process of courting an acquisition can
extend over months or even years. Consequently, at any one time we are engaged
in discussions with as many as 30 or more firms.
We expect
to support our targeted level of growth using a combination of cash flows from
operations and additional financing.
CRITICAL
ACCOUNTING ESTIMATES, DEVELOPMENTS, AND MEASURES
Critical
Accounting Estimates
Our
consolidated financial statements are prepared in accordance with Canadian GAAP,
which require us to make various estimates and assumptions. The notes to our
December 31, 2007, consolidated financial statements outline our significant
accounting estimates. The accounting estimates discussed below are considered
particularly important because they require the most difficult, subjective, and
complex management judgments. However, because of the uncertainties inherent in
making assumptions and estimates regarding unknown future outcomes, future
events may result in significant differences between estimates and actual
results. We believe that each of our assumptions and estimates is appropriate to
the circumstances and represents the most likely future outcome.
Unless
otherwise specified in our discussion of specific critical accounting estimates,
we expect no material changes in overall financial performance and financial
statement line items to arise either from reasonably likely changes in material
assumptions underlying an estimate or within a valid range of estimates from
which the recorded estimate was selected. In addition, we are not aware of
trends, commitments, events, or uncertainties that can reasonably be expected to
materially affect the methodology or assumptions associated with our critical
accounting estimates, subject to items identified in the Caution Regarding
Forward-Looking Statements and Risk Factors sections of this discussion and
analysis.
Revenue and Cost Recognition
Estimates on Contracts. Revenue from fixed-fee and
variable-fee-with-ceiling contracts is recognized using the percentage of
completion method based on the ratio of contract costs incurred to total
estimated contract costs. We believe that costs incurred are the best available
measure of progress toward completion of these contracts. Estimating total
direct contract costs is subjective and requires the use of our best judgments
based upon the information we have available at that point in time. Our estimate
of total direct contract costs has a direct impact on the revenue we recognize.
If our current estimates of total direct contract costs turn out to be higher or
lower than our previous estimates, we would have over- or underrecognized
revenue for the previous period. We also provide for estimated losses on
incomplete contracts in the period in which such losses are determined. Changes
in our estimates are reflected in the period in which they are made and would
affect our revenue and cost and estimated earnings in excess of
billings.
Goodwill. Goodwill is assessed
for impairment at least annually. This assessment includes a comparison of the
carrying value of the reporting unit to the estimated fair value to ensure that
the fair value is greater than the carrying value. We arrive at the estimated
fair value of a reporting unit using valuation methods such as discounted cash
flow analysis. These valuation methods employ a variety of assumptions,
including revenue growth rates, expected operating income, discount rates, and
earnings multiples. Estimating the fair value of a reporting unit is a
subjective process and requires the use of our best judgments. If our estimates
or assumptions change from those used in our current valuation, we may be
required to recognize an impairment loss in future periods, which would decrease
our goodwill assets and increase our reported expenses.
Provision for Doubtful
Accounts. We use estimates in determining our allowance for doubtful
accounts related to trade receivables. These estimates are based on our best
assessment of the collectibility of the related receivable balance based, in
part, on the age of the specific receivable balance. A provision is established
when the likelihood of collecting the account has significantly diminished.
Future collections of receivables that differ from our current estimates would
affect the results of our operations in future periods as well as our accounts
receivable and general and administrative expenses.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
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Self-Insured Liabilities. We
self-insure certain risks, including professional liability and automobile
liability. The accrual for self-insured liabilities includes estimates of the
costs of reported claims and is based on estimates of loss using our
assumptions, including consideration of actuarial projections. These estimates
of loss are derived from loss history that is then subjected to actuarial
techniques in the determination of the proposed liability. Estimates of loss may
vary from those used in the actuarial projections and may result in a larger
loss than estimated. Any increase in loss would be recognized in the period in
which the loss is determined and would increase our self-insured liability and
reported expenses.
Income Taxes. Our income tax
assets and liabilities are based on interpretations of income tax legislation
across various jurisdictions in Canada and the United States. Our effective tax
rate can change from year to year based on the mix of income among different
jurisdictions, changes in tax laws in these jurisdictions, and changes in the
estimated value of future tax assets and liabilities. Our income tax expense
reflects an estimate of the cash taxes we expect to pay for the current year, as
well as a provision for changes arising in the values of future tax assets and
liabilities during the year. The tax value of these assets and liabilities is
impacted by factors such as accounting estimates inherent in these balances, our
expectations about future operating results, and possible audits of our tax
filings by regulatory authorities. We assess the likelihood of recovering value
from future tax assets, such as loss carryforwards, on a regular basis, as well
as the future tax depreciation of capital assets, and may establish a valuation
provision. If our
estimates or assumptions change from those used in our current valuation, we may be
required to recognize an adjustment in future periods that would increase or
decrease our future income tax asset or liability and increase or decrease our
income tax expense.
Long-Lived Assets and Intangibles.
We regularly review long-lived assets and intangible assets with finite
lives when events or changes in circumstances indicate that the carrying amount
of such assets may not be fully recoverable. The determination of recoverability
is based on an estimate of undiscounted future cash flows, and the measurement
of impairment loss is based on the fair value of the asset. To determine
recoverability, we compare the estimated undiscounted future cash flows
projected to be generated by these assets to their respective carrying value. In
performing this analysis, we make estimates or assumptions about factors such as
current and future contracts with clients, margins, market conditions, and the
useful life of an asset. If our estimates or assumptions change from those used
in our current analysis, we may be required to recognize an impairment loss in
future periods that would decrease our long-lived and intangible assets and
increase our reported expenses.
Liabilities for Lease Exit
Activities. We accrue charges when closing offices in existing operations
or finalizing plans to downsize offices in locations assumed from an acquiree
upon a business acquisition. Included in these liabilities is the present value
of the remaining lease payments reduced by estimated sublease rentals that can
reasonably be obtained. These provisions are based on our estimates and reflect
plans in place at the time the liability is recorded. If actual sublease
payments and rental circumstances change from our original estimate, the
liability will change, and we will be required to increase or decrease it and
adjust goodwill or reported expenses depending on whether the adjustment relates
to a liability established pursuant to an acquisition.
Business Combinations—Purchase Price
Allocation. In a business combination, we may acquire the assets and
assume certain liabilities of an acquired entity. The allocation of the purchase
price for these transactions involves judgment in determining the fair values
assigned to the tangible and intangible assets acquired and the liabilities
assumed on the acquisition. The determination of these fair values involves a
variety of assumptions, revenue growth rates, expected operating income,
discount rates, and earning multiples. If our estimates or assumptions change
prior to finalizing the purchase price allocation for a transaction, a revision
to the purchase price allocation or the carrying value of the related assets and
liabilities acquired may impact our net income in future periods. We are
currently in the process of finalizing the purchase price allocation for the
Vollmer, Geller DeVellis Inc., Trico Engineering, Chong Partners, Woodlot
Alternatives, Inc., Neill and Gunter companies, Moore Paterson Architects Inc.,
Murphy Hilgers Architects Inc., Brentcliffe Financial Services Inc., Dekko
Studio Inc., FMSM, and Leestown Leasing, L.L.C. acquisitions.
Accounting
Developments
Canadian
Financial Instruments, Equity, and
Comprehensive Income. Effective January 1, 2007, we adopted the CICA
Handbook Section 3855, “Financial Instruments—Recognition and Measurement;”
Section 1530, “Comprehensive Income;” and Section 3251, “Equity.” These
pronouncements further aligned Canadian GAAP with US GAAP and require the
following:
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
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Financial assets are classified as loans or receivables, held to maturity, held for trading, or available for sale. Held-to-maturity classification is restricted to fixed maturity instruments that we intend and are able to hold to maturity. These investments are accounted for at amortized cost. Held-for-trading instruments are recorded at fair value, with realized and unrealized gains and losses reported in net income. The remaining financial assets are classified as available for sale. These assets are recorded at fair value, with accumulated unrealized gains and losses reported in a new category of the consolidated balance sheets under shareholders’ equity called “Accumulated Other Comprehensive Income” until the financial asset is disposed, at which time the realized gains and losses are recognized in net income. Changes in fair value from reporting period to reporting period are recorded in “Other Comprehensive Income.” |
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Financial
liabilities are classified as either held for trading or other.
Held-for-trading instruments are recorded at fair value, with realized and
unrealized gains and losses reported in net income. Other instruments are
accounted for at amortized cost, with related gains and losses reported in
net income.
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Derivatives
are classified as held for trading unless designated as hedging
instruments. All derivatives are recorded at fair value on the
consolidated balance sheets.
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As a
result of adopting these standards, we classified our financial instruments as
follows:
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Cash
and cash equivalents and restricted cash are classified as financial
assets held for trading.
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Accounts
receivable net of allowance for doubtful accounts are classified as
receivables.
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Investments
held for self-insured liabilities are classified as financial assets
available for sale.
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Bank
indebtedness, accounts payable and accrued liabilities, and long-term debt
are classified as other financial
liabilities.
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Foreign
currency exchange contracts are derivatives that are classified as held
for trading. Our foreign currency forward contracts are not accounted for
as hedges.
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In
accordance with the provisions of these new standards, accumulated other
comprehensive income is included on our consolidated balance sheets as a
separate component of shareholders’ equity. Accumulated other comprehensive
income includes, on a net of tax basis, net unrealized gains and losses on
available-for-sale financial assets and unrealized foreign currency translation
gains and losses on self-sustaining foreign operations. On January 1, 2007, in
accordance with transitional provisions, unrealized foreign currency translation
gains and losses on self-sustaining foreign operations were reclassified from
the cumulative translation account to accumulated other comprehensive income.
Prior periods presented were also restated to reflect this
reclassification.
The
impact of recording our investments held for self-insured liabilities at fair
value on January 1, 2007, in accordance with transitional provisions was to
increase other assets by approximately $493,000, increase opening accumulated
other comprehensive income by approximately $481,000 (after-tax), and increase
future income tax liabilities by $12,000. Accumulated other comprehensive income
also decreased by the $24.8 million balance previously reported in our
cumulative translation account. These transition adjustments did not affect net
income or basic or diluted earnings per share. Prior period consolidated
financial statements were not restated except for the presentation of the
cumulative translation account.
Accounting Changes. CICA
Handbook Section 1506 establishes criteria for changing accounting policies,
together with the accounting treatment and disclosure of changes in accounting
policies, changes in accounting estimates, and the correction of errors. It
includes the disclosure, on an interim and annual basis, of a description and
the impact on our financial results of any new primary source of GAAP that has
been issued but is not yet effective. The adoption of this new section did not
have an effect on our financial position or on the results of our
operations.
Financial Instruments—Disclosures and
Presentation. In November 2006, the CICA issued the new handbook Section
3862, “Financial Instruments—Disclosures,” and Section 3863, “Financial
Instruments—Presentation,” effective for annual and interim periods beginning on
or after October 1, 2007. These pronouncements further aligned Canadian GAAP
with US GAAP. Early adoption of these recommendations is permitted. Section 3862
requires companies to provide disclosures in their financial statements that
enable users to evaluate a) the significance of financial instruments for their
financial position and performance and b) the nature and extent of risks arising
from financial instruments to which they are exposed during the period and at
the balance sheet date and how they manage those risks. Section 3863 establishes
standards for the presentation of financial instruments. It
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
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addresses
the classification of financial instruments between liabilities and equity; the
classification of related interest, dividends, and losses and gains; and the
circumstances in which financial assets and financial liabilities are offset.
The adoption of these new standards is not expected to have a material effect on
our financial position or on the results of our operations.
Capital Disclosures. In
November 2006, the CICA released the new handbook Section 1535, “Capital,”
effective for fiscal years beginning on or after October 1, 2007. This section
establishes standards for disclosing information about a company’s capital and
how it is managed in order that a user of the company’s financial statements may
evaluate its objectives, policies, and processes for managing capital. The
adoption of this new standard is not expected to have a material effect on our
financial position or on the results of our operations.
International Financial Reporting
Standards. The CICA plans to converge Canadian GAAP for public companies
with International Financial Reporting Standards over a transition period that
is expected to end in 2011. The impact of this transition on our consolidated
financial statements has not yet been determined.
United
States
Stock-based compensation. In
December 2004, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No.123 (revised 2004), “Share-Based Payment”
(SFAS 123R), effective for the first interim or annual financial statements
beginning on or after June 15, 2005. SFAS 123R requires all share-based payments
to employees, including grants of employee stock options, to be recognized in
financial statements based on their fair values. We recognize share-based
payments at fair value for options granted subsequent to January 1, 2002, using
the Black-Scholes option-pricing model. We adopted SFAS 123R using the
modified-prospective transition method. The adoption of this standard did not
have an impact on our consolidated financial statements.
Uncertainty in Income Taxes.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty
in Income Taxes—An Interpretation of FAS Statement No. 109” (FIN 48), effective
for fiscal years beginning on or after December 15, 2006. FIN 48 creates a
single model for addressing the accounting for uncertainty in tax positions. It
also clarifies the accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet before being recognized
in financial statements. In addition, this interpretation provides guidance on
derecognition, measurement, classification, interest and penalties, accounting
in interim periods, disclosure, and transition. We adopted FIN 48 as of January
1, 2007, as required. The adoption of this pronouncement did not have a material
effect on our financial position or on the results of our
operations.
Fair Value Measurements. In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, “Fair Value Measurements” (SFAS 157), effective for fiscal years beginning
after November 15, 2007. SFAS 157 establishes a framework for measuring fair
value under US GAAP and requires additional disclosure. The statement defines a
fair value hierarchy, with the highest priority being quoted prices in active
markets. Under this statement, fair value measurements are disclosed by level
within the hierarchy. This standard does not require any new fair value
measurements. We are currently considering the impact of the adoption of this
standard on our consolidated financial statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, “The Fair Value Option for Financial Assets and Financial
Liabilities—Including an Amendment to FASB Statement No. 115” (SFAS 159),
effective for fiscal years beginning after November 15, 2007, although early
adoption is permitted. SFAS 159 allows an entity to choose to measure certain
financial instruments and other items at fair value that are not currently
required to be measured at fair value. At each subsequent reporting period,
unrealized gains and losses would be reported in earnings on items for which the
fair value option has been elected. The adoption of this standard is not
expected to have an effect on our financial position or on the results of our
operations.
Business Combinations. In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141R, “Business Combinations” (SFAS 141R), effective for fiscal years beginning
after December 15, 2008. This pronouncement changes the accounting for business
combinations in a number of areas. It establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any non-controlling
interest in the acquiree, and the goodwill acquired. The statement also
establishes disclosure requirements that will enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. Although we are currently considering the impact of the adoption of
this standard on our consolidated financial statements, it will be limited to
any future acquisitions beginning in fiscal 2009.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
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In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, “Noncontrolling Interests in Consolidated Financial Statements—An Amendment
of ARB No. 51” (SFAS 160), effective for fiscal years beginning after December
15, 2008. SFAS 160 changes the accounting and reporting for ownership interests
in subsidiaries held by parties other than the parent. These non-controlling
interests are to be presented in the consolidated statement of financial
position within equity but separate from the parent’s equity. The amount of
consolidated net income attributable to the parent and to the non-controlling
interest is to be clearly identified and presented on the face of the
consolidated statement of income. In addition, SFAS 160 establishes standards
for a change in a parent’s ownership interest in a subsidiary and the valuation
of retained non-controlling equity investments when a subsidiary is
deconsolidated. It also establishes reporting requirements for providing
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. We are
currently considering the impact of the adoption of this standard on our
consolidated financial statements.
Materiality
We
determine whether or not information is “material” based on whether we believe
that a reasonable investor’s decision to buy, sell, or hold securities in our
Company would likely be influenced or changed if the information were omitted or
misstated.
Definition
of Non-GAAP Measures
This
Management’s Discussion and Analysis includes references to and uses terms that
are not specifically defined in the CICA Handbook and do not have any
standardized meaning prescribed by Canadian GAAP. These non-GAAP measures may
not be comparable to similar measures presented by other companies. We believe
that these are useful measures for providing investors with additional
information to assist them in understanding components of our financial
results.
Gross Revenue and Net Revenue.
Our Company provides knowledge-based solutions for infrastructure and facilities
projects through value-added professional services principally under
fee-for-service agreements with clients. In the course of providing services, we
incur certain direct costs for subconsultants, equipment, and other expenditures
that are recoverable directly from our clients. The revenue associated with
these direct costs is included in our gross revenue. Since such direct costs and
their associated revenue can vary significantly from contract to contract,
changes in our gross revenue may not be indicative of our revenue trends.
Accordingly, we also report net revenue, which is gross revenue less
subconsultant and other direct expenses, and analyze our results in relation to
net revenue rather than gross revenue.
Gross Margin. We monitor our
gross margin percentage levels to ensure that they are within an established
acceptable range for the profitability of our operations and Company. Gross
margin is calculated as the difference of net revenue minus direct payroll
costs. Direct payroll costs include the cost of salaries and related fringe
benefits for labor hours that are directly associated with the completion of
projects. Labor costs and related fringe benefits for labor hours that are not
directly associated with the completion of projects are included in
administrative and marketing expenses.
Debt to Equity Ratio. As part
of our overall assessment of our financial condition, we monitor our debt to
equity ratio to ensure that it is maintained within our established range. Debt
to equity ratio is calculated as long-term debt plus the current portion of
long-term debt plus bank indebtedness less cash, all divided by shareholders’
equity.
Return on Equity Ratio. As
part of our overall assessment of value added for shareholders, we monitor our
return on equity ratio. Return on equity is calculated as net income for the
year divided by the average shareholders’ equity over each of the last four
quarters.
Working Capital. We use
working capital as a measure for assessing the overall liquidity of our Company.
Working capital is calculated by subtracting current liabilities from current
assets.
Current Ratio. We also use
current ratio as a measure for assessing the overall liquidity of our Company.
Current ratio is calculated by dividing current assets by current
liabilities.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
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RISK
FACTORS
The
following factors, among others, could cause our actual results to differ
materially from those projected in our forward-looking statements:
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Global
capital market activities
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Fluctuations
in interest rates or currency
values
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The
effects of war or terrorist
activities
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The
effects of disease or illness on local, national, or international
economies
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The
effects of disruptions to public infrastructure such as transportation or
communications
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Disruptions
in power or water supply
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Industry
or worldwide economic or political
conditions
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Regulatory
or statutory developments
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The
effects of competition in the geographic or business areas in which we
operate
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The
actions of management
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Technological
changes
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Investors
and the public should carefully consider these factors, other uncertainties, and
potential events as well as the inherent uncertainty of forward-looking
statements when relying on our forward-looking statements to make decisions with
respect to Stantec. Except as may be required by law, we do not undertake to
update any forward-looking statement, whether written or verbal, that may be
made from time to time by the organization or on its behalf. Additional
operating, market, and growth and acquisition integration risks are outlined
below.
Operating
Risks
Like all
professional services firms in the infrastructure and facilities industry, we
are exposed to a number of risks in carrying out the day-to-day activities of
our operations. These risks include the following:
Adverse
weather conditions and natural or other disasters may cause a delay or eliminate
net revenue that otherwise would have been realized and thus adversely affect
our profitability.
Our field
activities are generally performed outdoors and may include professional
surveying, resident engineering services, field data surveys and collection,
archeology, plant start-up and testing, and plant operations. Certain weather
conditions and natural or other disasters, such as fires, floods, influenza
pandemics, and similar events, may cause postponements in the initiation and/or
completion of our field activities and may hinder the ability of our office
employees to arrive at work, which may result in a delay or elimination of
revenue that otherwise would have been recognized while certain costs continued
to be incurred. Adverse weather conditions or disasters may also delay or
eliminate our initiation and/or completion of the various phases of work
relating to other engineering services that commence concurrent with or
subsequent to our field activities. Any delay in the completion of our field,
office, and/or other activities may require us to incur additional costs
attributable to overtime work necessary to meet our client’s required schedule.
Due to various factors, a delay in the commencement or completion of a project
may also result in the cancellation of the contract. As a result, our net
revenue and profitability may be adversely affected.
If
we experience delays and/or defaults in customer payments, we could suffer
liquidity problems or be unable to recover our expenditures.
Because
of the nature of our contracts, at times we commit resources to projects prior
to receiving payments from the customer in amounts sufficient to cover
expenditures as they are incurred. Delays in customer payments may require us to
make a working capital investment. If a customer defaults in making payments on
a project to which we have devoted significant resources, it could have a
material negative effect on our liquidity as well as on the
results
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
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of our
operations. In addition, in our experience, clients who withhold payment are
more likely to bring claims against us and have a higher tendency toward
dissatisfaction with the services we provide.
The
nature of our business exposes us to potential liability claims and contract
disputes, which may reduce our profits.
Our
operations are subject to the risk of third-party claims in the normal course of
business, some of which may be substantial. We have been and may in the future
be named as a defendant in legal proceedings where parties may make a claim for
damages or other remedies with respect to our projects or other matters. Any
litigation resulting from our business operations could distract management’s
attention from normal business operations, divert financial resources to the
defense of such claims, or result in significant attorney fees and damage
awards for which we may not be fully insured and which could harm our
reputation. Any of these circumstances could adversely affect our
profitability.
Our
backlog is subject to unexpected adjustments and cancellations and is,
therefore, an uncertain indicator of our future earnings.
As of
December 31, 2007, our backlog was approximately $831 million. However, the
revenue projected in our backlog may not be realized or, if realized, may not
result in profits. Projects may remain in our backlog for an extended
period of time. In addition, project cancellations or scope adjustments may
occur from time to time with respect to contracts reflected in our backlog.
Backlog reductions can adversely affect the revenue and profit we actually
receive from contracts reflected in our backlog. Future project cancellations
and scope adjustments could further reduce the dollar amount of our backlog and
the revenue and profits we actually receive. Finally, poor project or contract
performance could also impact our profits.
If
we are unable to engage qualified subconsultants, we may lose projects, revenue,
and clients.
We often
contract with outside companies to perform designated portions of the services
we provide to our clients. In 2007 subconsultant costs accounted for
approximately 8.6% (2006 – 8.6%) of our gross
revenue. If we are unable to engage qualified subconsultants, our ability to
perform under some of our contracts may be impeded and the quality of our
service may decline. As a consequence, we may lose projects, revenue, and
clients.
We
bear the risk of cost overruns in a significant number of our contracts. We may
experience reduced profits or, in some cases, losses under these contracts if
costs increase above our estimates.
We
conduct our business under various types of contractual arrangements, most of
which are fee-for-service agreements. However, approximately 70% of the dollar value
of our contracts in 2007 was based on a fixed-fee or time-and-materials contract
with a ceiling on the maximum costs to the client. Under fixed-fee contracts, we
perform services at a stipulated price. Under time-and-materials contracts
with not-to-exceed provisions, we are reimbursed for the number of labor hours
expended at an established hourly rate plus the cost of materials incurred
subject, however, to a stated maximum dollar amount for the services to be
provided. In both of these types of contracts, we agree to provide our services
based on our estimate of the costs a particular project will involve. These
estimates are established in part on cost and scheduling projections, which may
prove to be inaccurate, or circumstances may arise, such as unanticipated
technical problems, weaknesses in project management, difficulties in obtaining
permits or approvals, changes in local laws, or delays beyond our ability to
control, that may make our projections inaccurate. The underestimation of costs
for these types of contracts may cause us to incur losses or result in a
project not being as profitable as we expect. In addition, projects that are not
completed on schedule further reduce profitability because our staff must
continue to work on these projects longer than anticipated, which may prevent
them from pursuing and working on new projects. Projects that are over budget or
not on schedule may also lead to client dissatisfaction.
We
may have difficulty in attracting and retaining qualified staff, which may
affect our reputation in the marketplace and restrict our ability to implement
our business strategy.
We derive our revenue
almost exclusively from services performed by our employees. Consequently, one
of the key drivers of our business is our ability to attract and retain
qualified staff. However, we may not be able to attract and retain the desired
number of qualified staff over the short or long term. There is significant
competition for staff with the skills necessary for providing our services from
major and boutique consulting, engineering, public agency, research, and other
professional services firms. Our inability to attract and retain qualified staff
could impede our ability to secure and complete engagements, in which event we
may lose market share and our revenue and profits
MANAGEMENT’S
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could
decline. In addition, if our employees were to leave our Company and become
competitors of ours, we could lose other employees and some of our existing
clients who have formed relationships with such former employees. We could also
lose future clients to a former employee as a new competitor. In either event,
we could lose clients and revenue, and our profitability could
decline.
Reliance
on key personnel who may be unable or unwilling to continue their employment may
adversely impact our business.
Our
operations are dependent on the abilities, experience, and efforts of senior
management and other key personnel. If any of these individuals are unable or
unwilling to continue their employment with us, and if we do not have a
well-developed succession plan prior to their departure, our business,
operations, and prospects may be materially adversely affected.
One
of our primary competitive advantages is our reputation. If our reputation is
damaged due to client dissatisfaction, our ability to win additional business
may be materially damaged.
Although
we serve many diverse clients and are not dependent on any one client or group
of clients to sustain our business, our reputation for delivering effective and
efficient solutions for complex projects is one of our most valuable business
development assets. The loss of this reputation due to client dissatisfaction
represents a significant risk to our ability to win additional business both
from existing clients and from those with whom we may have dealings in the
future.
Inadequate
internal controls or disclosure controls may result in events that could
adversely affect our business.
Inadequate
internal controls or disclosure controls over financial reporting could result
in material misstatement in our financial statements and related public
disclosures. Inadequate controls could also result in system downtime, delayed
processing, inappropriate decisions based on non-current internal financial
information, fraud, or the inability to continue our business
operations.
If
fraud occurs and remains undetected, we may have a loss of assets or
misstatement in our financial statements.
Fraud may
occur and remain undetected, resulting in a loss of assets and/or misstatement
in our financial statements and related public disclosures.
Our
insurance may not cover all claims for which we may be liable, and expenses
related to insurance coverage may adversely impact our
profitability.
Although
we believe that we have made adequate arrangements for insuring against
potential liability claims, these arrangements may be insufficient to cover any
particular risk. When it is determined that we have liability, we may not be
covered by insurance, or, if covered, the dollar amount of these liabilities may
exceed our policy limits. Our professional liability coverage is on a
“claims-made” basis, covering only claims actually made during the policy period
currently in effect. In addition, even where insurance is maintained for such
exposures, the policies have deductibles resulting in our assuming exposure for
a layer of coverage with respect to any such claims. Any liability not covered
by our insurance, in excess of our insurance limits, or covered by insurance but
subject to a high deductible could result in a significant loss for us, which
may reduce our profits and cash available for operations. Moreover, we may
become subject to liability that cannot be insured against or against which we
may choose not to insure because of high premium costs or for other reasons. Our
expansion into new services or geographic areas could result in our failure to
obtain coverage for these services or areas, or the coverage being offered may
be at a higher cost than our current coverage. Due to the current insurance
environment, we have experienced and may continue to experience an increase in
our insurance premiums. We may not be able to pass these increases on to our
clients in increased billing rates.
Interruption
to our systems and network infrastructure could adversely impact our ability to
operate.
We rely
heavily on computer information, communications technology, and related systems
in order to properly operate. If we are unable to continually add software and
hardware, effectively upgrade our systems and network infrastructure, and take
other steps to improve the efficiency of and protect our systems, systems
operation could be
MANAGEMENT’S
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interrupted
or delayed. In addition, our computer and communications systems and operations
could be damaged or interrupted by natural disasters, telecommunications
failures, acts of war or terrorism, computer viruses, physical or electronic
security breaches, or similar events or disruptions. Any of these or
other events could cause system interruption, delays, and loss of critical data,
could delay or prevent operations, and may adversely affect our operating
results.
We
may not be able to adequately protect our intellectual property, which could
force us to take costly protective measures such as
litigation.
To
establish and protect our intellectual property rights, we rely on a combination
of trademark and trade secret laws, along with licenses, exclusivity agreements,
and other contractual covenants. However, the measures we take to protect our
intellectual property rights may prove inadequate to prevent the
misappropriation of our intellectual property. Litigation may be necessary to
enforce our intellectual property rights or to determine the validity and scope
of the proprietary rights of others. Litigation of this type could result in
substantial costs and the diversion of resources, may result in counterclaims or
other claims against us, and could significantly harm the results of our
operations.
Market
Risks
We are
also exposed to various market factors that can affect our performance. These
risks include the following:
Economic downturns could have a
negative impact on our business since our clients may curtail investment in
infrastructure projects.
Demand
for the services we offer has been, and is expected to continue to be, subject
to significant fluctuations due to a variety of factors beyond our control,
including economic conditions. During economic downturns, the ability of both
private and government entities to make expenditures may decline significantly,
which would have a material adverse effect on our revenue and profitability. We
cannot be certain that economic or political conditions will generally be
favorable or that there will not be significant fluctuations that adversely
affect our industry as a whole or the key markets we target.
A
significant portion of our revenue is derived from clients in the real estate
industry. Consequently, our business could suffer materially if there were a
downturn in the real estate market.
In 2007,
29.8% (2006 – 34.5%) of our gross revenue was derived from services provided by
our Urban Land practice area, the majority (about 85%) of which are related to
residential and commercial real estate development projects. Consequently,
reduced demand in the real estate market would likely have an adverse impact on
our Urban Land practice area. The real estate market, and, therefore, our
business, may be impacted by a number of factors, which may include the
following:
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Changes
in employment levels and other general economic
conditions
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Changes
in interest rates and in the availability, cost, and terms of
financing
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The
impact of present or future environmental, zoning, or other laws and
regulations
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Changes
in real estate tax rates and assessments and other operating
expenses
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Changes
in levels of government infrastructure spending and fiscal
policies
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Natural
or human-made disasters and other factors that are beyond our
control
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A
significant decrease in the demand for our real estate-related services could
have a material adverse effect on our overall business, including the results of
our operations and liquidity.
The
professional consulting services industry is highly competitive, which could
have a negative impact on our profit margins and market share.
The
markets we serve are highly competitive, and we have numerous competitors for
the services we offer. The principal competitive factors include reputation,
experience, breadth and quality of services, technical
proficiency,
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local
offices, competitive total project fees, and service delivery. The number and
identity of competitors vary widely with the type of service we provide. For
small- to medium-sized projects, we compete with many engineering,
architecture, and other professional consulting firms. For larger projects,
there are fewer but still many competitors, and many of these competitors have
greater financial and other resources than we do. Although we compete with other
large private and public companies in certain geographic locations, our primary
competitors are small and midsize, privately held regional firms in the United
States and Canada. Generally, competition places downward pressure on our
contract prices and profit margins. However, such impact is difficult to
quantify. Intense competition is expected to continue in these markets,
presenting significant challenges to our ability to maintain strong growth rates
and acceptable profit margins. If we are unable to meet these competitive
challenges, we could lose market share to our competitors and experience an
overall reduction in our profits. We may not be able to compete successfully
with such competitors, and such competition could cause us to lose customers,
increase expenditures, or reduce pricing, any of which could have a material
adverse effect on our earnings and stock price.
If
we need to sell or issue additional common shares and/or incur additional debt
to finance future acquisitions, our share ownership could be diluted and the
results of our operations could be adversely affected.
Our
business strategy is to expand into new markets and enhance our position in
existing markets through the acquisition of complementary businesses. In order
to successfully complete targeted acquisitions or to fund our other activities,
we may issue additional equity securities that could dilute share ownership. We
may also incur additional debt if we acquire another company, and this could
increase our debt repayment obligations, which could have a negative impact on
our future liquidity and profitability.
As
mentioned previously, we currently have a $250 million credit facility. However,
we have no assurance that debt financing will continue to be available from our
current lenders or other financial institutions on similar terms.
We
derive significant revenue from contracts with government agencies. Any
disruption in government funding or in our relationship with those agencies
could adversely affect our business.
The
demand for our services is related to the level of government funding that is
allocated for rebuilding, improving, and expanding infrastructure systems. We
derive a significant amount of our revenue from government or government-funded
projects and expect to continue to do so in the future. Between 30 and
57% of our gross
revenue during the years ended December 31, 2005, through December 31,
2007, was derived from government or government-funded projects.
Significant changes in the level of government funding could have an unfavorable
impact on our business, financial position, results of operations, and cash
flows.
We
believe that the success and further development of our business depends, in
part, on the continued funding of these government programs and on our ability
to participate in these programs. However, governments may not have available
resources to fund these programs or may not fund these programs even if they
have available financial resources. Some of these government contracts are
subject to renewal or extensions annually, so we cannot be assured of our
continued work under these contracts in the future. In addition, government
agencies can terminate these contracts at their convenience. We may incur costs
in connection with the termination of these contracts and suffer a loss of
business. As well, contracts with government agencies are sometimes subject to
substantial regulation and audit of the actual costs incurred. Consequently,
there may be a downward adjustment to our revenue if accrued recoverable costs
exceed actual recoverable costs.
Because
we report our results in Canadian dollars and a substantial portion of our
revenue and expenses is recorded in US dollars, our results are subject to
currency exchange risk.
Although
we report our financial results in Canadian dollars, a substantial portion of
our revenue and expenses is generated or incurred in US dollars. For the
purposes of financial reporting under Canadian GAAP measures, revenue and
expenses denominated in foreign currencies are translated into Canadian dollars
at the average exchange rates prevailing during the year. We expect to continue
to report our financial results in Canadian dollars in accordance with
Canadian GAAP measures. Therefore, if the Canadian dollar were to
strengthen relative to the US dollar and other currencies, the amount of
net income from our non-Canadian-dollar-denominated business could decrease,
which could have a material adverse effect on our business, financial condition,
and results of operations.
The value
of the Canadian dollar relative to the US dollar is subject to volatility.
For example, the average exchange rates for the years ended December 31, 2007;
December 31, 2006; and December 31, 2005, for C$1.00 were
US$0.93, US$0.88,
and US$0.83, respectively. Furthermore, this volatility may continue in the
future, and, as
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discussed
above, increases in the strength of the Canadian dollar relative to the
US dollar may have a negative impact on the results of our
operations.
From time
to time, we enter into forward contracts to manage risk associated with net
operating assets outside our US operations denominated in US dollars
(other than with respect to net operating assets that are owned by
US subsidiaries). These derivative contracts, which are not accounted for
as hedges, are marked to market, and any changes in the market value are
recorded in income or expense when they occur. As a result, we may not benefit
from any weakening of the Canadian dollar relative to the
US dollar.
Our
share price could be adversely affected if a large number of our common shares
are offered for sale or sold.
There may
be instances in which we negotiate an acquisition where the consideration for
the purchase may include Stantec shares. In the event that the acquired entity’s
shareholders subsequently decide to dispose of Stantec shares following the
acquisition, there could be a large supply of our common shares on the market.
If the supply of our common shares is significantly greater than the associated
demand, the market price of our common shares may significantly decline and may
not recover.
Our share price
has historically been subject to volatility. As a result, the price of our
common shares may decrease in the future due to a number of Company- and
industry-specific or general economic factors.
Our share
price has experienced volatility in the past and will likely be volatile in the
future. For example, the intraday high and low prices for our common shares on
the TSX and New York Stock Exchange (NYSE) during the 52 weeks ended December
31, 2007, were C$39.31 and C$23.70, respectively, and US$39.64 and US$20.10,
respectively.
The price
of our common shares may fluctuate substantially in the future due to, among
other things, the following factors: (1) the failure of our quarterly or
annual operating results to meet expectations; (2) the reaction of markets
and securities analysts to announcements and developments involving our Company;
(3) adverse developments in the worldwide, Canadian, or US economy, the
financial markets, or the engineering and consulting services market;
(4) changes in interest rates; (5) announcements by key competitors;
(6) additions or departures of key staff; (7) announcements of legal
proceedings or regulatory matters; or (8) general volatility in the stock
market.
In
addition, the stock market has experienced volatility that has affected the
market prices of the equity securities of many companies and that has often been
unrelated to the operating performance of such companies. A number of other
factors, many of which are beyond our control, could also cause the market price
of our common shares to fluctuate substantially.
Increasing
awareness of environmental factors may result in the cancellation of major
projects by key clients and thus adversely affect our
profitability.
As part
of increasing awareness of global climate change, some experts have suggested
that companies involved in industries that impact the environment may be subject
to litigation from governments, shareholders, or environmental activists. The
cancellation of major projects due to environmental concerns or significant
environmental litigation impacting key clients could affect our future
results.
Growth
and Acquisition Integration Risks
We are
also exposed to factors arising from growth and acquisition activities that can
affect our performance. These risks include the following:
If
we are unable to manage our growth effectively, we may experience a decline in
our revenue and profitability.
We have
grown rapidly in the last few years, and we intend to pursue further growth
through acquisitions and internal hiring as part of our business strategy.
However, there is a risk that we may not be able to manage our growth
effectively and efficiently. Our inability to manage our growth could cause us
to incur unforeseen costs, time delays, or other negative impacts, any of which
could cause a decline in our revenue and profitability. Our rapid growth has
presented, and will continue to present, numerous administrative and operational
challenges, including the management of an expanding array of engineering and
consulting services, the assimilation of financial reporting systems, increased
pressure on our senior management, and increased demand on our systems and
internal controls. Furthermore, as we expand our service offerings and
geographic presence, we may not be able to maintain the current quality of our
services.
MANAGEMENT’S
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We may
also encounter difficulties in integrating acquisitions that we do make.
Acquired businesses may not be profitable, because we may not be successful in
generating the same level of operating performance that an acquired company
experienced prior to its acquisition. As well, we may not be able to maintain
our reputation in an acquired company’s geographic area or service offerings,
which may negatively impact our ability to attract and retain clients in those
or other areas. Any of these integration issues could divert management’s
attention from other business activities and impact our ability to grow our
business effectively.
From
time to time, we have pursued and may continue to pursue and invest in business
opportunities that are not directly within our core competencies. These new
business opportunities may require a disproportionate amount of management’s
time to develop profitably and may not perform as expected.
Acquisitions
may bring us into businesses that we have not previously conducted and expose us
to additional business risks that are different from those we have traditionally
experienced. Consequently, we may depend in part on the knowledge and expertise
of the professional service providers and management teams that we acquire in
order to make these business opportunities profitable. New business
opportunities frequently bring a learning curve that may require substantial
management time, which may create a distraction from our day-to-day business
operations. If these business opportunities do not perform as anticipated or are
not profitable, our earnings during periods of greater learning may be
materially adversely affected, and we may experience a partial or complete loss
of our investment.
Goodwill
and other intangible assets acquired as a result of our acquisitions represent
substantial portions of our total assets. If our acquired businesses do not
perform as expected, we may be required to write down the value of our goodwill
and other intangible assets, which could have a material adverse effect on our
earnings.
Goodwill
and other intangible assets represent approximately 44.9% of our total assets.
When we acquire a consulting business, a significant portion of the purchase
price for the acquisition is generally allocated to goodwill and other
identifiable intangible assets. The amount of the purchase price allocated to
goodwill is determined by the excess of the purchase price paid by us to acquire
the consulting business over the fair value of the net identifiable assets
acquired. Canadian and US accounting rules require us to perform an annual
impairment test of our goodwill and indefinite life intangible assets. A
deterioration in the operating results of such acquired businesses or the
failure of these businesses to meet our expectations may adversely affect the
carrying value of our goodwill and other indefinite life intangible assets and
could result in an impairment of the goodwill associated with such businesses.
As part of our annual review of goodwill for impairment, we consider the actual
performance of each of our reporting units compared to our expectations and
update our future expectations for such reporting units. An impairment of
goodwill would be recorded as a charge in our income statement, which could have
a material effect on our earnings.
Stantec
and an acquired entity may experience difficulties in integrating the acquired
entity’s business into the existing operations of Stantec and so may not realize
the anticipated benefits of the acquisition.
Our
rationale for acquiring a firm is, in part, predicated on our ability to
leverage the combined strengths of the two companies to increase our
opportunities and grow our revenue. Integrating an acquired firm’s operations
and staff into our own is a complex endeavor, and we may not be able to complete
the process rapidly or without encountering difficulties. Successful integration
requires, among other things, the assimilation of the firm’s professional
services, sales and marketing operations, and information and software systems
as well as the coordination of employee retention and hiring and training
operations. The diversion of management’s attention to the integration effort
and any difficulties encountered in combining operations could adversely affect
the combined company’s business and prevent it from realizing the anticipated
improvement in professional service offerings, market penetration, and
geographic presence that formed the foundation for the acquisition.
We
may be unsuccessful in our goal to increase the size and profitability of our
operations, which could lead to a reduction in our market share and
competitiveness as our industry consolidates.
We may
not be able to locate suitable acquisitions or to consummate any such
transactions on terms and conditions that are acceptable to us. As the
professional services industry consolidates, suitable acquisition candidates are
expected to become more difficult to locate and may only be available at prices
or under terms that are less favorable than in the past. In addition, some of
our competitors are much larger than us, have greater financial resources, and
can better afford to pay a premium for potential acquisition candidates. If we
are unable to effectively
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compete
for or locate suitable acquisitions, our business will not grow in the manner we
expect, and we will have difficulty achieving our growth plan.
Uncertainties
associated with an acquisition or merger or with Stantec as a new owner may
cause an acquired entity to lose customers.
An
acquired company’s customers may, in response to the announcement of the
acquisition, delay or defer decisions concerning their use of the acquired
company’s services because of uncertainties related to the consummation of the
acquisition, including the possibility that the acquisition may not be completed
if all the conditions of the transaction are not fulfilled. This circumstance
could have an adverse effect on our revenue and profitability.
Uncertainties
associated with an acquisition may cause a loss of employees.
The
ability to attract and retain trained professionals is one of the key drivers of
our business and results. Therefore, the success of an acquisition depends in
part on our ability to retain key employees of the acquired firm. Competition
for qualified staff can be very intense. In addition, key employees may depart
because of issues relating to the uncertainty and difficulty of the completion
of the acquisition or integration or a desire not to remain with the combined
company. Accordingly, we may be unable to retain key employees to the same
extent that we were able to do so in the past.
Managing
Our Risks
We
mitigate our operating, market, and growth and acquisition integration risks
through our business strategy and other measures. As mentioned previously, our
three-dimensional business model based on geographic, practice area, and life
cycle diversification reduces our dependency on any particular industry or
economic sector for our income. To help reduce our susceptibility to
industry-specific and regional economic cycles and to take advantage of
economies of scale in the highly fragmented professional services industry, we
intend to continue to diversify our business both in terms of geographic
presence and service offerings. From the beginning of 2002 to December 31, 2007,
we have completed 35 acquisitions, and we expect to continue to pursue selective
acquisitions of businesses that will enable us to enhance our market penetration
and increase and diversify our revenue base. We also differentiate our Company
from competitors by entering into a diverse range of contracts with a variety of
fee amounts. Focusing on this project mix continues to ensure that we do not
rely on a few large, single projects for our revenue and that no single client
or project accounts for more than 5% of our overall business.
To
address the risk of competition for qualified personnel, we offer a number of
employment incentives, including training programs, access to a plan that
provides the benefit of employee share ownership, and opportunities for
professional development and enhancement, along with compensation plans that we
believe to be competitive, flexible, and designed to reward top performance. In
2007 we completed a number of activities, including the expansion of our Career
Development Center with updated content and new in-house programs and training.
Launched in 2005, the center is the on-line source for all our learning,
coaching and mentoring, and professional and career development resources. It
provides access to programs and material on topics such as employee orientation,
people skills and leadership, project management, risk mitigation, business
development, and financial management, among others. During 2007, we also
introduced Ready. Set. Focus!, a revamp of our organization structure and
leadership team designed to increase our senior leaders’ involvement with our
clients and projects. As well, we continue to improve our project manager and
leadership portal dashboard training programs. These programs are intended to
make financially related information more visible in order to assist our
operations leadership in improving performance and decision making. We recognize
that through improved project management across our operations we will increase
our ability to deliver projects on schedule and within budget.
Since our
operations are dependent on the abilities and efforts of senior management and
other key personnel, our Board of Directors and senior leaders are taking the
necessary steps to develop and implement a formal plan of succession for
management.
To
mitigate the risk of fraud, we have various business conduct policies, including
our Code of Ethics, Conflict of Interest, and Whistleblower policies. In
addition, our Internal Audit team reviews opportunities and indicators for fraud
as part of its control evaluation program.
We
maintain insurance coverage for our operations, including policies covering
general liability, automobile liability, environmental liability, workers’
compensation and employers’ liability, directors’ and officers’ liability,
and professional liability. We have a regulated captive insurance company to
insure and fund the payment of any
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professional
liability self-insured retentions related to claims arising after August 1,
2003. We, or our clients, also obtain project-specific insurance for designated
projects from time to time. In addition, we invest resources in a Risk
Management team that is dedicated to providing Company-wide support and guidance
on risk avoidance practices and procedures. One of our practices is to carry out
select client evaluations, including credit risk appraisals, before entering
into contract agreements to reduce the risk of non-payment for our
services.
To
address the risk of being unsuccessful in integrating acquired companies, we
have an acquisition and integration program managed by a dedicated acquisition
team. The team supports, or is responsible for, the tasks of identifying and
valuing acquisition candidates, undertaking and coordinating due diligence,
negotiating and closing transactions, and integrating employees and systems
immediately following an acquisition. In addition, for each acquisition a senior
regional or practice leader is appointed to support the integration process. We
also have a coordinated integration plan that involves the implementation of our
Company-wide information technology and financial management systems as well as
provision of “back office” support services from our corporate and regional
offices.
CONTROLS
AND PROCEDURES
Disclosure
controls and procedures are designed to ensure that information we are required
to disclose in reports filed with securities regulatory agencies is recorded,
processed, summarized, and reported on a timely basis and is accumulated and
communicated to management, including our CEO and chief financial officer (CFO),
as appropriate, to allow timely decisions regarding required
disclosure.
Under the
supervision and with the participation of management, including our CEO and CFO,
we carried out an evaluation of the effectiveness of our disclosure controls and
procedures as of December 31, 2007, (as defined in rules adopted by the
Securities and Exchange Commission (SEC) in the United States and as defined in
Canada by Multilateral Instrument 52-109, Certification of Disclosure in
Issuer’s Annual and Interim Filings). Based on this evaluation, our CEO and CFO
concluded that the design and operation of our disclosure controls and
procedures were effective.
Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and of the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principals. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance with
respect to the reliability of our financial reporting and of the preparation of
our financial statements. Accordingly, management, including our CEO and CFO,
does not expect that our internal control over financial reporting will prevent
or detect all errors and all fraud. Management’s Annual Report on Internal
Control over Financial Reporting and the Independent Auditors’ Report on
Internal Controls are included in our 2007 consolidated financial
statements.
There has
been no change in our internal control over financial reporting during the year
ended December 31, 2007, that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
We will
continue to periodically review our disclosure controls and procedures and
internal control over financial reporting and may make modifications from time
to time as considered necessary or desirable.
CORPORATE
GOVERNANCE
Disclosure
Committee
In 2005
our Company established a Disclosure Committee consisting of a cross section of
management. The committee’s mandate is to provide ongoing review of Stantec’s
continuous disclosure policy and to facilitate compliance with applicable
legislative and regulatory reporting requirements.
Board
of Directors
Stantec’s
Board of Directors currently includes eight members, six of whom are independent
under Canadian securities laws and under the rules of the SEC and the NYSE and
free from any interest or relationship that could materially interfere with
their ability to act in the best interest of our Company and
shareholders.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
42
The
board’s mandate is to supervise Stantec’s management with a view to the
Company’s best interests. The board fulfils its mandate by
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Overseeing
the Company’s strategic planning
process
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Satisfying
itself as to the integrity of the CEO and other executive
officers
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Ensuring
that the Company has a policy in place for communicating effectively with
shareholders, other stakeholders, and the
public
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Reviewing
and monitoring the Company’s principal business risks as identified by
management, along with the systems for managing such
risks
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Overseeing
senior management succession planning, including the appointment,
development, and monitoring of senior
management
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Ensuring
that management maintains the integrity of the Company’s internal controls
and management information systems
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In 2007
Stantec’s board included two committees—the Audit Committee and the Corporate
Governance and Compensation Committee. Both committees are composed entirely of
unrelated, independent directors.
Audit
Committee
The Audit
Committee monitors, evaluates, approves, and makes recommendations on matters
affecting Stantec’s external audit, financial reporting, and accounting control
policies. The committee met nine times in 2007. The chairman of the committee
provides regular reports at the Company’s board meetings.
The board
has determined that each of the Audit Committee’s members is financially
literate and that all of the Audit Committee members are “financial
experts” as such term is defined under the rules of the SEC and
NYSE.
Corporate
Governance and Compensation Committee
The
Corporate Governance and Compensation Committee monitors, evaluates, approves,
and makes recommendations on matters affecting governance and compensation.
Governance matters include, but are not limited to, board size, nominations,
orientation, education, and self-evaluation. Compensation matters include, but
are not limited to, executive management compensation, performance review, and
succession plans. The Corporate Governance and Compensation Committee met two
times in 2007. The chairman of the committee provides regular reports at the
Company’s board meetings.
More
information about Stantec’s corporate governance can be found on our web site
(www.stantec.com) and in the Management Information Circular for our May 1,
2008, annual meeting of shareholders. In addition, the following documents are
posted on our web site:
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Code
of Ethics
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Corporate
Governance Guidelines
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Audit
Committee Terms of Reference
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Corporate
Governance and Compensation Committee Terms of
Reference
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The above
information is not and should not be deemed to be incorporated by reference
herein. Copies of these documents will be made available in print form to any
shareholder who requests them.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
43
SUBSEQUENT
EVENTS
Acquisitions
On
January 2, 2008, we acquired R.D. Zande, which added approximately 285 staff to
our Company. The acquisition of this firm strengthens our operations in the
midwestern United States and increases the depth of our service offerings to
public sector clients in the environment sector. R.D. Zande provides services
mainly in water and wastewater treatment facility design, environmental
management, and transportation, as well as complementary services in planning,
landscape architecture, surveying, and land development.
On
January 2, 2008, we acquired Rochester Signal, Inc., which added approximately
25 staff. The acquisition of this firm supplements the transit-related services
offered by our Rochester, New York, office. Rochester Signal, Inc. provides
signal design, construction management, installation, and testing services,
along with engineering support for the development of all types of rail systems,
from main and commuter lines to rapid transit and light rail.
On
February 1, 2008, we acquired SII Holdings, Inc. (Secor), adding approximately
700 staff. The acquisition of this firm significantly increases our
environmental service offerings, particularly for clients in the private sector.
Secor provides expertise in downstream marketing remedial services to the US
energy industry, as well as comprehensive environmental remediation services to
the manufacturing, chemical, pulp and paper, and transportation
industries.
R.D.
Zande , Rochester Signal, Inc., and Secor were acquired for an aggregate cash
consideration of $67.0 million and promissory notes of $10.7
million.
Revolving
Credit Facility
On
January 22, 2008, we reached an agreement to increase the limit of our existing
revolving credit facility from $160 million to $250 million. Depending on the
form under which the credit facility is accessed and on our debt to earnings
ratio, rates of interest will vary between Canadian prime, US base rate, or
LIBOR or bankers’ acceptance rates plus 65, 85, or 125 basis points. The
agreement also includes a provision for access to an additional $50 million
under the same terms and conditions upon approval from our lenders. This
financing provides us additional flexibility for continued growth.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
STANTEC
INC.
M-
44