Stantec - Q1 2024

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to Stantec's first quarter 2024 results webcast and conference call. Leading the call today are Gord Johnston, President and Chief Executive Officer, and Theresa Jang, Executive Vice President and Chief Financial Officer. Stantec invites those dialing in to view the slide presentation, which is available in the Investors section at stantec.com. Today's call is also a webcast. Please be advised that if you have dialed in while also viewing the webcast, you should mute your computer as there is a delay between the call and the webcast. All information provided during this conference call is subject to the forward-looking statements qualification set out on slide 2, detailed in Stantec's management's discussion and analysis, and incorporated in full for the purpose of today's call. Unless otherwise noted, dollar amounts discussed in today's call are expressed in Canadian dollars and are generally rounded.

With that, I'm pleased to turn the call over to Mr. Gord Johnston.

Gord Johnston (President and CEO)

Good morning. Thank you for joining us today. Stantec is off to a great start for the year. Momentum continues to build on the favorable market trends that have emerged over the past two years. We continue to see strong demand in major projects in water security and water treatment. With the recently announced EPA regulations on PFAS, we expect this area to grow significantly. Stantec's been on the leading edge of PFAS work for several years, with multiple contracts underway in data analysis, treatment piloting, site remediation, and full-scale system design, and we have several PFAS treatment systems that are fully operational. We also continue to see great demand for energy transition and climate solutions, including strengthening of electrical grids and for environmental services. Aging infrastructure continues to drive significant needs, either for the repair or replacement of roads, bridges, railways, and transit.

With approximately CAD 400 billion of IIJA funding now distributed, investment towards addressing these needs is spurring growth. The ongoing push to reshore productive capacity continues to drive significant work in advanced manufacturing, data centers, and other mission-critical facilities in all of our key markets. Our solid first quarter results reflect our ability to capitalize on this robust market demand and to deliver strong operational performance. We are also successfully executing on our plans to grow through strategic and disciplined M&A. In the first quarter, we closed our acquisitions of ZETCON and Morrison Hershfield. It's been very gratifying to see that since joining Stantec, both companies have continued to attract new employees, as both firms have grown their headcount by over 5% organically. On May 1st, we announced that we acquired Hydrock, a 950-person firm headquartered in Bristol, England.

With 22 locations across the U.K., Hydrock provides integrated engineering design and energy and sustainability consultancy services. They offer solutions to major infrastructure projects and landmark buildings across a number of attractive sectors, including healthcare, energy, education, logistics and distribution, and the public sector. Hydrock is a great strategic fit for Stantec. It grows our presence in the U.K. by more than 30% and provides us with a highly complementary line of services and expertise that bolsters our U.K. service offerings. Combined with ZETCON and Morrison Hershfield, we have added over 2,700 people to Stantec's team in the first four months of 2024. This, in conjunction with our Q1 performance, sets us up very well in progressing towards our three-year targets. This brings me to our Q1 results. We achieved record net revenue for the quarter, up 12% year-over-year with 7% organic and 6% acquisition growth.

We continue to see high demand for water in all of our regions, delivering 16% organic growth. Buildings also delivered double-digit organic growth this quarter. Adjusted EBITDA increased to CAD 212 million with a margin of 15.5%. As a result, we delivered a 23% increase in adjusted EPS of CAD 0.90. Our U.S. business continues to perform extremely well, delivering a 14% increase in net revenue for the quarter, including 10% organic growth and 4% acquisition growth. We achieved organic growth in every one of our business units. Our water business delivered over 20% organic growth. The key drivers included industrial and major water security projects like the City of Joliet Alternative Water Source Program. Our healthcare expertise in hospital structures, medical technology, and service delivery models drove double-digit organic growth in our buildings business, along with strong demand for industrial projects, particularly in data centers and other mission-critical facilities.

Infrastructure also had a solid quarter, with heavy activity in major transit, rail, and roadway projects, reflecting the beginnings of the ramp-up of projects funded by the IIJA. In Canada, we increased net revenue by 7% with 6% acquisition growth from Morrison Hershfield and 1% organic growth. Our water business delivered double-digit organic growth, as activity on major wastewater projects remained high. Infrastructure also delivered double-digit organic growth on the strengths of several roadway projects across the country. And education and civic projects drove organic growth in buildings. Energy and resources retracted this quarter, as several significant projects wound down late in 2023, and we experienced delays in the ramp-up of new projects. We're beginning to see these new projects moving towards commencement, and we have successfully added new contracts to our backlog, and so we're confident that E&R will shift towards organic growth later this year.

Our global operations generated 11% net revenue growth, with an 8% increase from ZETCON and 5% organic growth. Our water, buildings, and environmental services business units all delivered double-digit organic growth. Our industry-leading water business delivered strong results across the U.K., New Zealand, and Australia through long-term framework agreements and public sector investment in water infrastructure. Buildings achieved over 20% organic growth, with high levels of activity in every major region. Growth was most pronounced in the Middle East, where we are the lead designer of the Hamdan Bin Rashid Cancer Hospital in Dubai. Buildings also started work on the GBP 4 billion Agratas battery manufacturing facility in the U.K. The strong performance from environmental services was driven by European energy transition projects. Infrastructure net revenue retracted this quarter, due in part to the Australian government's decision to delay or cancel certain transportation projects.

Now I'll turn the call over to Theresa to review our financial results in more detail.

Theresa Jang (EVP and CFO)

Thank you, Gord. Good morning, everyone. We delivered a very solid quarter of performance in Q1, with record net revenue, enhanced project margin, and disciplined cost management. In Q1, we generated gross revenue of CAD 1.7 billion and net revenue of CAD 1.4 billion, both of which were up 12% compared to Q1 2023. Project margin increased 50 basis points due to our continued discipline in project execution, our ability to raise rates on certain projects to mitigate the impacts of wage inflation, and increased selectivity in project pursuits. This, along with our continued focus on operational efficiency, drove a 90 basis point increase in adjusted EBITDA margin to 15.5%. Diluted EPS for the quarter increased 19% to CAD 0.70, and adjusted diluted EPS was up 23% to CAD 0.90. Again, this quarter, we saw a meaningful increase in our share price, which required the revaluation of our long-term incentive plan.

Excluding the effect of the LTIP revaluation, our adjusted EBITDA margin would have been 15.9%, and Q1 adjusted EPS would have been CAD 0.94. Turning to our liquidity and capital resources, we delivered a strong quarter of cash flow generation in Q1. Operating cash flow increased to CAD 57 million compared to CAD 37 million in Q1 2023, and DSO was 79 days below our target of 80 days. Capital return to our shareholders increased as a result of the board raising the dividend rate and a higher number of common shares outstanding compared to Q1 2023. Our net debt to adjusted EBITDA ratio was 1.5x, reflecting the funding for ZETCON and Morrison Hershfield, still within our internal leverage range of 1x-2x. I'll turn the call back to Gord.

Gord Johnston (President and CEO)

Thanks, Theresa. At the end of the first quarter, our backlog stood at a record CAD 7 billion. Our recent acquisitions contributed 7% to our backlog since December 2023, primarily in infrastructure and buildings. Backlog increased organically by 3%, with growth in Canada and the U.S. predominantly in our environmental services and infrastructure business units. Project wins in environmental services translated into solid, low double-digit organic growth in our global and U.S. operations. U.S. infrastructure also had a number of strong wins, translating into mid-single-digit organic growth. We're seeing strong demand for transit, bridge, and highway projects underpinned with funding from the IIJA. The nominal organic retraction in global's backlog reflects, in part, the drawdown of our U.K. backlog associated with the AMP7 cycle. And although we have already won over 60% of the AMP8 programs we are pursuing, these contracts are not yet in backlog.

In aggregate, our backlog represents 13 months of work, which is one month higher than it was at year-end. We continue to hire at near-record pace, and our voluntary turnover remains well below industry average, meaning that we are attracting and retaining the workforce needed to deliver on our growing backlog. Turning now to major projects awarded in Q1. Through our Climate Solutions Strategic Growth Initiative, we continue to advance our services and technologies for efficient water use and reuse projects, including a design-build project for Arlington County. This CAD 175 million upgrade will enhance the solid handling facilities and incorporate cutting-edge technology to sustainably transform wastewater into a renewable energy source and a nutrient-rich soil amendment. In support of the energy transition, our energy and resources team will be providing project management and transmission and distribution engineering to the BC Hydro and Power Authority.

This is a seven-year master services agreement valued at CAD 186 million. In Eastern Canada, also under a seven-year MSA with options to be extended, we will be providing services to Hydro-Québec for environmental assessments. The last project I'd like to highlight is an exciting win in Australia that underscores our global strength in the water industry. As part of this four-year project, our water, environmental services, and infrastructure teams will collaborate to assist with the CAD 595 million wastewater system upgrade in Sydney, Australia. This is a prime example of how we were able to leverage our leading expertise in water to broaden the scope of services and bring together our expertise from all disciplines and regions across Stantec. Looking at the remainder of the year, we are reaffirming our 2024 financial targets, which were provided in February.

We expect net revenue growth for the year to be in the range of 11%-15% and expect organic net revenue growth to be in the mid- to high-single digits. For U.S. and global, we expect mid- to high-single-digit organic revenue growth. In Canada, we're guiding to mid-single-digit growth. Acquisition net revenue growth, which will now include a partial year for Hydrock, is expected to be in the mid-single digits. Our adjusted EBITDA margin target for the year remains in the range of 16.2%-17.2%. Finally, we expect our adjusted diluted EPS growth to be in the range of 12%-16%. We are very confident in being able to achieve these targets given the robust activity we're seeing throughout our regions and the three successful acquisitions we've completed so far this year.

With that, I'll turn the call back to the operator for questions. Operator?

Operator (participant)

Ladies and gentlemen, if you have a question or comment at this time, please press star one one on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, simply press star one one again. Once again, if you have a question or comment at this time, please press star one one on your telephone keypad. Please stand by while we compile the Q&A roster. Our first question or comment comes from the line of Benoit Poirier from Desjardins. Sir, your line is open.

Benoit Poirier (VP and Industrial Products Analyst)

Yes. Thank you very much, and congratulations for the strong start of the year. In terms of M&A environment, obviously quite positive. You've been able to add almost 2,700 people so far, so congrats. And obviously, in terms of size, it compares pretty well to Cardno. But is there any main difference when it comes to integrating different acquisitions versus a big one like Cardno? And could you talk about whether there's any limit in terms of number of people you could integrate, let's say, over a year? Thank you.

Theresa Jang (EVP and CFO)

Hi, Benoit. So as we look at integrating these three different firms, they are all a little bit unique and slightly different from Cardno. So Cardno, we had almost two integrations, one in the U.S., one in Australia. The U.S. business, of course, very mature and lots of expertise around to contribute to getting that integration accomplished. Australia was a little bit farther afield but still had developed a pretty good ability to integrate there. But you'll recall there was some disruption. It was challenging just given its overall size. When we look at these three acquisitions we've just completed, ZETCON is a little bit different from other firms we've acquired because it is our only presence in Germany. And so between language difference, they use German GAAP. At ZETCON, we, of course, report under IFRS. And so the transition will take a little bit longer.

We're not looking to move as fast to bring them onto Oracle because they are our only presence in Germany. Morrison Hershfield in Canada, again, great depth here, more presence here. And so I think that is a process that is already underway, and we would look to complete that financial integration in the second half of this year. And then Hydrock is. It's pretty early days for Hydrock as we start mapping out what that integration could look like. So I think these things are always complicated. They always create a little bit of noise, particularly in the acquiring firm. But I think we have a pretty great track record of getting through that quickly and then moving towards sort of that holistic value creation that we can achieve from our acquisitions.

Benoit Poirier (VP and Industrial Products Analyst)

Okay. Is there any reason, Theresa, why you did not adjust yet the guidance this year in light of the solid start but also the fact that you just completed the Hydrock acquisition?

Theresa Jang (EVP and CFO)

Yeah. I mean, I think the range for guidance is appropriate. We are off to a strong start to the year. But as we look out to the rest of the year, there's always puts and takes in various corners of our business that we consider. And I think at the beginning of the year, we want to make sure that we've got latitude to adapt if things unfold either more quickly or more slowly than we've seen. Hydrock, it's eight months of results we'll have. And as we just talked about, we're going to be moving into integration at varying paces, though, of three firms. So it's a pretty high degree of difficulty that we have set for ourselves. We're confident that we're going to be successful in getting these firms integrated and creating value. But I think it's early in the year.

We want to make sure that we're focused on integrating and getting these firms aligned within Stantec's practices and driving toward those revenue synergies and not overly concerned about how that first stub period performance looks for the year.

Benoit Poirier (VP and Industrial Products Analyst)

Okay. And last one for me on the water side, obviously a great achievement so far in Q1, organic growth 16%. Great opening remarks also about all the awards that are not yet in the backlog with respect to the AMP8 program. So could you maybe talk a little bit about the kind of quantify the opportunities that will be added to the backlog? And I know that over the next three years, you're targeting high single-digit growth. But given the start and the potential around the AMP8, could we even see a low double-digit given the backdrop in the water segment overall?

Gord Johnston (President and CEO)

You're right. The water segment, on top of 20% organic growth last year, putting up another 16% in Q1 just shows the strength of that water franchise we have really around the world. So we see strength in all of the regions. It could be in Canada. We're seeing great opportunities from a wastewater perspective, a lot of water work here as well. The U.S., certainly, while it's already very robust with both municipal and advanced manufacturing facilities, we see considerable growth opportunities in the PFAS space there as well. Then outside of North America, we've talked about just the strength as we come into the AMP8 program and the framework agreements in Australia and New Zealand. So we feel very, very strong and positive about our water franchise moving forward. But that said, it's one component of the overall diversified profile that we have.

So while we do see opportunities for continued organic growth going forward, I think at this point, we're not looking to change that guidance from that 7% organic growth target for the next three years. As things evolve, as we move into budgeting and guidance for next year and the following year, then perhaps we'll make an adjustment if required. But we're not looking to do so at this point.

Benoit Poirier (VP and Industrial Products Analyst)

Perfect. So congrats and thanks for the time.

Gord Johnston (President and CEO)

Thanks, Benoit.

Operator (participant)

Thank you. Our next question or comment comes from the line of Devin Dodge from BMO Capital Markets. Mr. Dodge, your line is now open.

Devin Dodge (Director of Equity Research)

Yeah. Thanks. Good morning. So I asked one of your competitors a similar question earlier, but I wanted to give you a chance to address it as well. So look, the demand environment is clearly strong across a lot of your regions. You've talked about this. But how do you think about the balance between pursuing the growth opportunities that are available but requires a lot of effort to expand the workforce with being more selective in your bidding activity to drive margin expansion?

Gord Johnston (President and CEO)

Yeah. No, that's actually a good question. But I think we're really in a unique environment right now. At Stantec, we're focusing on both. So we are absolutely being more selective in both our project and our client selection. And you can see that in the strong project margins that we've been delivering. And actually, even last year in December, when we rolled our three-year strategic plan and targets, we increased the top end of our project margin guidance range previously from 53%-55% to now to 53%-56%. So we see that client selection, that being more discriminating, only taking the higher margin projects, being very, very successful.

We've also talked to our project managers about if you have a client that is particularly problematic and that they pay slow, they don't want to give change orders for changes in work, they're litigious, this is the time in the evolution of our overall company and the industry to not work for those clients and instead expend your energy on positive clients with good projects and good project margins. So we are absolutely increasing the selectivity of the projects and clients that we're working on. But in the same way, you've heard us say and very accurate that we have one of the lowest voluntary turnover rates in the industry and one of the highest attraction of new staff.

So we are growing our headcount both by retaining existing staff and attracting new so that we can also take on that higher volume of work and grow organically because of that. So I think while it's an excellent question, we are focusing on both the focus on clients and projects and on the growth component.

Devin Dodge (Director of Equity Research)

That was excellent. Good color. Thanks for that. Second question. Look, the double-digit organic growth in the building sector, I thought, was interesting. You went through some of the major projects in your prepared remarks. But what are some of the subsectors that are driving that strong growth?

Gord Johnston (President and CEO)

So a couple in particular. Healthcare is very, very strong for us. And so we are continuing to ramp up over the past number of years on that. So we talked about the cancer center in Dubai. We've also been awarded the design of the first proton therapy treatment center in Canada because we have our particular expertise from that perspective. We're seeing a lot of growth also in data centers. Now, we were strong in data centers before. But then when ESD joined us, we got even stronger. And then with the Morrison Hershfield team joining us, we're even stronger again. So we see a lot of growth in that data centers, mission-critical facilities, and healthcare in particular as two areas that are very, very strong. And then, of course, on top of that is our focus on advanced manufacturing. And so we've talked about the Agratas battery facility.

We've talked previously about the solar panel manufacturing facilities. There's just an enormous amount of work out there that's really driving solid growth in our buildings business.

Devin Dodge (Director of Equity Research)

Great. Thanks for that. I'll turn it over.

Gord Johnston (President and CEO)

Thanks, Devin.

Operator (participant)

Thank you. Our next question or comment comes from the line of Jacob Bout from CIBC. Mr. Bout, your line is now open.

Rahul Malhotra (Director of Institutional Equity Research)

Good morning, Gord, Theresa. This is Rahul on for Jacob.

Gord Johnston (President and CEO)

Hey. Good morning.

Rahul Malhotra (Director of Institutional Equity Research)

Morning. So looking at organic net revenue growth, strong performance in water and buildings. But notice that growth in the infrastructure business has been creeping higher as well. So with about 40% of the IIJA funds now released, are you seeing that hit the revenue line more meaningfully now? And how should we be thinking about the ramp-up there for the balance of the year?

Gord Johnston (President and CEO)

Yeah. Yeah. So we absolutely are starting to see more IIJA projects being awarded. We're starting to generate some revenue there. But we see that ramping up even more as the year progresses. So a little bit coming on now, but backlogs are coming up. And we see that work increasing even more in the second half of the year and then holding pretty steady, even growing a little bit kind of through 2025 through 2028, 2029. So we see now that the ramp-up is happening, of course, it always took longer to get going than the industry had hoped it would. But we are seeing it now ramping up through the second half of the year and then holding at a pretty elevated level for the next three to five years.

Rahul Malhotra (Director of Institutional Equity Research)

Great. Okay. No, that's helpful. And then maybe just a question on the pace of M&A. So three deals announced so far this year. Do you expect this pace to continue in 2024, or do you now anticipate taking a bit of a pause to focus on integration? And maybe if you can comment on your overall M&A pipeline, that would be helpful.

Gord Johnston (President and CEO)

Great. The overall M&A pipeline is really full and just continues to strengthen. Our balance sheet is good. Our ability to integrate is solid. We don't see taking a pause at all. We're, as we always are, actively in different levels of discussion with companies and around the world. We're maintaining our discipline. When the right opportunity comes around, we absolutely would pull the trigger and make that happen.

Rahul Malhotra (Director of Institutional Equity Research)

Great. Appreciate the responses. Thank you. I'll turn it over.

Gord Johnston (President and CEO)

Thank you.

Operator (participant)

Thank you. Our next question or comment comes from the line of Michael Doumet from Scotiabank. Mr. Doumet, your line is now open.

Michael Doumet (Equity Research Analyst)

Good morning, guys.

Gord Johnston (President and CEO)

Morning.

Michael Doumet (Equity Research Analyst)

Good morning, Gord. Hey, Theresa. So maybe first question, can you remind us how much of the E&R is in Canada and just maybe discuss the moving pieces for Canada? And then just maybe as a follow-on to that, I think you laid out in the prepared remarks a comment about returning to organic growth in E&R in the second half of the year. Just wondering if we should assume, but maybe Q2 growth there should be a little squishy?

Gord Johnston (President and CEO)

Sure. So I'll start there. So we had really strong growth in E&R in Canada through last year, working on several significant projects. Then Trans Mountain and others, and a lot of them wrapped up near the end of last year. So we expected, of course, a little bit of revenue contraction from that. But our backlog has really increased in that group over the last period of time. So we do see that coming back in the second half of last year. We're also coming off a really high comp. And when you look at Q1 2023, E&R was a really high comp. So we're seeing that, inflation, rising interest rates, slow regulatory approvals, all slowing a little bit of that in Western Canada in particular. But overall, E&R in Canada is less than 5% of the overall net revenue for Stantec.

Michael Doumet (Equity Research Analyst)

Okay. Very helpful. Thank you. And then last year, the organic hires accounted for about 5% of the increase in the employee base. So you're nearing or maybe a couple of months away from peak season. How do you think 2024 will traverse that? And I'm just wondering, how much of the organic hires is in water maybe versus the rest of the company?

Gord Johnston (President and CEO)

Yeah. Well, we are, of course, actively hiring in water, but we're actively hiring in a number of our other groups as well. While water ramps up a little bit in the summer months, some of our other groups even ramp up more when you get into the northern hemisphere field season. Environmental services gets more busy, more people out in the field, a lot of transportation, land development workout. So it always depends a little bit about the types of people you're hiring have some seasonality impact as well. So as we said in the prepared remarks, we are at a record hiring. We're just a little bit off of kind of the pace where we were last year. So we see really continued strong organic growth from a hiring perspective this year. And we've also seen that labor pressures have come off a little bit.

A little easier to hire people than it was a couple of years ago, salary increase pressure a little bit less than it was a couple of years ago. So we're actually feeling really good about both our ability to retain, of course, but our ability to attract people and then, as you've seen through our project margin, pass along any salary increases or any pressure we see that way to our clients. The other interesting point just to note is that our water group has the lowest voluntary turnover rate of any of our business lines. So while we're actively hiring there, while we do an incredibly good job of retaining everywhere, it's even more solid in the water franchise.

Michael Doumet (Equity Research Analyst)

Super helpful. Thank you very much.

Gord Johnston (President and CEO)

Thanks, Michael.

Operator (participant)

Thank you. Our next question or comment comes from the line of Chris Murray from ATB Capital Markets. Mr. Murray, your line is now open.

Chris Murray (Managing Director of Institutional Research and Diversified Industries)

Gord, Theresa, I don't know who wants to take this one. Turning back to Hydrock and just talking a little bit about maybe the U.K. water business and what that brings to you, a couple of questions around this. First of all, you described Hydrock as an integrated firm. And I wanted to maybe get your thoughts on, does that mean there's a construction element in there that we have to be thinking about or anything like that? And as also part of this, was Hydrock a competitor of yours around AMP 8, or does it change how you guys can attack maybe the rest of the AMP 8 program as we go through the year?

Gord Johnston (President and CEO)

Yeah. Great questions, Chris. So firstly, with 100% clarity, they do no construction work. And so when we talk about them being an integrated firm, they're really integrated. They fire safety, energy, sustainability, civil, structural, transportation, environmental, geotech, that's why they're integrated from their perspective. But they do little to no water work, which is why they're so complementary to Stantec there because there's very, very little overlap, but great opportunities for synergies. As we can bring our water expertise to their clients, they can bring some of their expertise in MEP and fire safety and so on to our clients. So that's why we're so excited about Hydrock. They're a great firm with incredibly strong leadership. So we're going to be really, really additive to our operations in the U.K.

Chris Murray (Managing Director of Institutional Research and Diversified Industries)

Okay. Great. No, that's great. I appreciate the clarification. And then the other question, just very quickly, I don't know who wants to take this one, but I guess Theresa, you indicated that you were thinking of retiring this year. Any update on the transition that you can provide us would be great?

Theresa Jang (EVP and CFO)

Actually, no, that's a good question for Gord to answer because I do fully intend to retire this year.

Gord Johnston (President and CEO)

Yeah. So the selection process is continuing. We've got some incredibly strong growth in internal and external candidates. So we're beginning the formal interview process. And we'll be able to announce something to you here when it's time. But the process is going along well. We've been extremely impressed with the quality of candidates that we're attracting.

Chris Murray (Managing Director of Institutional Research and Diversified Industries)

All right. I'll leave it there. Thanks, folks.

Gord Johnston (President and CEO)

Thanks, Chris.

Operator (participant)

Thank you. Our next question or comment comes from the line of Michael Tupholme from TD Securities. Mr. Tupholme, your line is now open.

Michael Tupholme (Director of Equity Research)

Thank you. Good morning.

Gord Johnston (President and CEO)

Morning.

Michael Tupholme (Director of Equity Research)

Gord or Theresa, a couple of questions about project margins. First off, looks like the improvement that you saw in the first quarter on a year-over-year basis was really driven by a couple of specific BOUs, namely water and buildings, whereas the other BOUs saw flatter down project margins year over year. I guess as we're looking toward the rest of the year, are the project margin improvement opportunities more prolific in certain BOUs than others?

Theresa Jang (EVP and CFO)

Yeah. I think that's accurate. We've always pointed to public sector work, which, of course, is very much where transportation sits, tends to be on the lower end of the project margin range that we put out there. Water, especially the specialty water work that we provide, does tend to garner those higher margins. We were flat in environmental services. But as we move into the peak season, which will be later Q2 and really strongly into Q3, I would expect to see that strengthen again. So I think that is just the nature of the differences you see across the businesses, but really strong performance, as you noted, in water and in buildings.

Michael Tupholme (Director of Equity Research)

Okay. That's helpful. Thank you. And then as a follow-up, at your investor day late last year, you talked about looking to reduce your subconsultant use and using that as a means of helping improve project margins. Wondering to what extent that is already happening, if that is something you would expect to happen in the near term, or if we should be thinking about that as more of a sort of medium to potentially longer-term opportunity?

Theresa Jang (EVP and CFO)

Yeah. I mean, it is absolutely a longer-term initiative. I would say what we've done thus far is really have all of our business leaders examine the makeup of their subconsultants. As we noted at investor day, there's always going to be a requirement to sub-workout, particularly for federal work in the U.S., in Canada, where you are required to allocate a portion of your contracts to indigenous-owned or minority-owned businesses and so on. But we are identifying where there are opportunities to use different components of Stantec as opposed to going outside. So that analysis is really well underway. And of course, in some BOUs, there's a greater opportunity than in others. But I think we've got a good handle on where we have the opportunities. And now we'll move towards that over the next couple of years.

Michael Tupholme (Director of Equity Research)

Great. Thank you. I will leave it there.

Operator (participant)

Thank you. Again, ladies and gentlemen, if you have a question or comment at this time, please press star one one on your telephone keypad. Our next question or comment comes from the line of Maxim Sytchev from NBF. Mr. Sytchev, your line is open.

Maxim Sytchev (Managing Director of Research)

Hi. Good morning.

Gord Johnston (President and CEO)

Morning.

Maxim Sytchev (Managing Director of Research)

Obviously, very solid performance on all the fronts. I was wondering if you don't mind providing a bit of an update on your design center strategy and especially how we should be thinking about this sort of like the ceiling we can contemplate over the long term because I mean, some of the federal work, I presume, you're not allowed to use some of those design centers. Just wondering if you can provide a bit more color on that process. Thank you so much.

Gord Johnston (President and CEO)

Sure. Thanks, Max. So we have three of these integrated delivery centers currently. Our largest one is in Pune in India that we've talked about before, just a little bit less than 1,000 people there now. We have one in Manila in the Philippines that joined through the Cardno acquisition at just shy of 150 people. And then we have one in Vizag in India that came with MH, Morrison Hershfield, at about 75 people or thereabouts. So combined, let's call it just a little bit over 1,000 people. We have plans within our three-year target here to increase that to 2,000 people. We see the opportunity to do that. In Pune, India, we've already taken the real estate. We had an additional floor plate available above us. So we've taken that floor plate. We've fitted out. We've already moved people to it. So the resources are available to us.

So we're actively hiring to move that, to move forward on that and double that roughly to 2,000 people. We've mentioned before that when you compare at Stantec the percentage of our overall global employee headcount that's in our integrated delivery centers versus our competitors, we are probably subscale compared to a number of our other global competitors. So you have to manage the growth of that along with your client base and being clear and honest and disclose everything to them, your clients, as you work through it. But we still see great opportunities for further expansion there.

Maxim Sytchev (Managing Director of Research)

Okay. That's super helpful. Thank you so much. Maybe just a quick follow-up to probably Michael's question. Theresa, so when I look at environmental services, gross revenue versus net revenue, so gross, slight reduction and 3.5% growth on net basis, so is this where we're starting to see that sort of insourcing capacity bearing fruit? That's how we should be thinking about this? Thanks.

Theresa Jang (EVP and CFO)

I would say probably not, Max. I think what you saw in the first quarter, sometimes that happens where, depending on project mix, you can get that dynamic where at a gross revenue level, it attracts and net revenue grows organically. So I would not attribute that to the longer-term effort around subs.

Maxim Sytchev (Managing Director of Research)

Okay. Okay. Thanks for clarifying. That's it from me.

Operator (participant)

Thank you. Our next question or comment comes from the line of Frederic Bastien from Raymond James. Mr. Bastien, your line is now open.

Frederic Bastien (Head of Industrial Research)

Good morning.

Gord Johnston (President and CEO)

Morning.

Frederic Bastien (Head of Industrial Research)

Guys, if we look at your footprint, you still very much overweight North America, which has worked great in recent years, and you're comparatively more subscale globally. Now, if we take cue from the recent deals, you're obviously changing that. But is the intent longer-term to grow that 20% that you derive, that 20% of revenue that you derive globally?

Gord Johnston (President and CEO)

Yeah. I think as we look at things, a lot of the opportunities that we have for continued growth certainly will come from outside of North America. That said, we still have and I think we've mentioned before on our calls that we have the opportunity, based on the size of the U.S. market, to roughly double our footprint there or even more. So we are actively looking at opportunities there. But outside of North America, you're absolutely right that it's a big world out there. And so we have opportunities to continue to grow in the U.K., Australia. But then, as we talked about before, then up into the Nordics. And certainly, while we've got an initial start in Germany with ZETCON, great opportunities for further expansion there. The German market is extremely fragmented. With the largest firm, they're only taking about 1% of the overall revenue.

Great opportunities for continued growth into that market. I think we're looking at all markets, Frederic, and from a discipline perspective, and wherever we can find the best place to deploy capital to get good returns, we'll continue to grow there.

Frederic Bastien (Head of Industrial Research)

Great. You beat me to my second question. You answered it by discipline. So I'm all set. Thank you very much.

Gord Johnston (President and CEO)

Great. Thank you.

Operator (participant)

Thank you. Our next question or comment comes from the line of Ian Gillies from Stifel. Mr. Gillies, your line is now open.

Ian Gillies (Managing Director of Equity Research)

Morning, everyone.

Gord Johnston (President and CEO)

Morning.

Ian Gillies (Managing Director of Equity Research)

It feels like a lot of the growth or it seems that a lot of the growth is going to be coming for advanced manufacturing, power, data center, etc. Can you talk a little bit about how easy or how challenging it's going to be to repurpose some of your employees from other areas into that area?

Gord Johnston (President and CEO)

Yeah. You know what? While we certainly do see growth in those areas where you're describing, there's also considerable growth in the general core areas that we have. Water, obviously. We see transportation continuing to grow. So as we look at data centers, there are absolutely some specialty disciplines required there. But we have those through the ESD acquisition, through the MH acquisition, and others. Hydrock also brings a considerable amount of specialty building services, as does some of our Australian operations. So we actually feel really good about the overall mix of our disciplines, of our employee headcount in there. So where possible, we absolutely do cross-train and move people around. But we actually see growth really broad-brushed across the organization, Ian. So that whole cross-training and moving folks around isn't a huge part of what we're looking to do over the next little bit.

Ian Gillies (Managing Director of Equity Research)

Okay. That's helpful. And then obviously, you've added a footprint in Germany. Is there anywhere else in Europe at this juncture that you find yourself particularly interested in where you would like to add scale or perhaps add another leg under the stool?

Gord Johnston (President and CEO)

Yeah. I think the one area that we're continuing to look at is the Nordics. We have no presence up there currently. In addition to building out the footprint that we have now in Germany, we are still looking to see if there's an entry for us up into the Nordics.

Ian Gillies (Managing Director of Equity Research)

Okay. That's helpful. Thanks very much. I'll turn it back over.

Gord Johnston (President and CEO)

Great. Thank you.

Operator (participant)

Thank you. Our next question or comment comes from the line of Sabahat Khan from RBC. Mr. Khan, your line is now open.

Sabahat Khan (Equity Research Analyst)

Great. Thanks and good morning. I was hoping as we look ahead to 2024 and into 2025, if you can maybe give us some perspective on sort of the price and volume mix. Presumably, pricing was quite high over the last few years. Is it fair to assume that volume is becoming a bigger contributor? And how are the pricing discussions going with some of your customers as new work is up for bid or maybe places where you're looking to get price increases? Thanks.

Gord Johnston (President and CEO)

Yeah. So a couple of things there. Thanks, Sabahat. As we think about pricing, certainly, we're able to reflect in our pricing the increases that we see from, for the most part, from salary increases. You can see that because project margins continue to stay the same or even increase a little bit. So what we're hearing from clients now is, of course, there's always price sensitivity in our business. But clients that we're talking to now are more concerned about schedule. Can you get the work done within the timeframe that I require? Of course, with high quality is still important. And of course, pricing is still important. But it's really the schedule is the primary driver right now. So that gives us and the overall industry a little bit of opportunity and some tailwinds on pricing. Again, it's still competitive space.

No one gets to write their own ticket. But I think we do have some opportunities with some tailwinds to pricing over the next several years.

Sabahat Khan (Equity Research Analyst)

I guess then just a follow-up to that, presumably, you're able to reallocate staff across regions, and you leverage your international centers. But are there any areas of your business where you are seeing a bit of labor tightness or where you're more focused on for hiring because demand might be outpacing supply?

Gord Johnston (President and CEO)

Yeah. Not really. Where there is a lot of great demand, like in water, for example, we are so strong in water that we continue to attract sort of the best and brightest there. So where there is a little bit of additional tightness, we're very strong. So yeah, there's no particular areas that I can think of, Sabahat, that are of concern for us.

Sabahat Khan (Equity Research Analyst)

Okay. And then just one last quick one, I guess. There is this view out there that ramp-up in IIJA is expected over the next 12-18 months. Can you maybe talk about the end markets where you are starting to see some of that money show up in customer hands and where kind of the RFQs with RFPs are getting going? Just trying to get a perspective of which end markets we could see as some acceleration in the U.S. for yourself and maybe even just the broader industry. Thanks.

Gord Johnston (President and CEO)

Yeah. Yeah. And so we're starting to see primarily in the transportation space with the state departments of transportation and so on, local and local municipal government as well. So we see that ramp-up in transportation. We're starting to see some in water as well. But when you look at the overall IIJA funding, the majority of it is transportation-related. So I think we'll see a gradual run-up in transportation. You've seen that state DOT budgets are up roughly 12% already this year. And part of that will be through IIJA. So we'll see that ramp-up into the second half of this year and hold steady for the next several years and water kind of coming along as well, but of course, at a smaller level, supported by IIJA, but still water very, very robust due to the other drivers that we're seeing there.

Sabahat Khan (Equity Research Analyst)

Great. Thanks very much.

Gord Johnston (President and CEO)

Great. Thanks, Sabahat.

Operator (participant)

Thank you. I'm sure there are additional questions in the queue at this time. I'd like to turn the conference back over to Mr. Johnston for any closing remarks.

Gord Johnston (President and CEO)

Great. Well, thank you, operator. Thanks, everyone, for joining us this morning. In follow-up, should you have any questions, please contact Jess Nieukerk, our VP of Investor Relations. He's always available to take your call. Thank you.

Theresa Jang (EVP and CFO)

Thank you.

Operator (participant)

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.