Alithya Group Inc.
Q2 2023 Earnings Call Transcript

Published: 13 Nov 2022

[Operator:]

Good morning, ladies and gentlemen. Welcome to Alithya Q2 Fiscal 2023 Results Conference Call. I would now like to turn the meeting over to Rachel Andrews, Vice President, Communications and Marketing at Alithya. Please go ahead, Ms. Andrews.

[Rachel Andrews:]

Good morning, everyone and thank you once again for joining us for Alithya’s second quarter fiscal 2023 results conference call. The press release and MD&A with complete financial statements and related notes were issued this morning and are now posted on our website. The webcast presentation call also be found on our website in the Investors section. Please be advised that this call will contain statements that are forward-looking and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. For more information, please refer to the cautionary note in our presentation and to the forward-looking statements and Risks and Uncertainties section of our MD&A available on our website. All figures discussed on today’s call are in Canadian dollars, unless otherwise stated and we may refer to certain indicators that are non-IFRS measures. Please refer to the cautionary note in our presentation and to the non-IFRS measures section of our MD&A for more details. Presenting this morning are Paul Raymond, Alithya’s President and Chief Executive Officer as well as Claude Thibault, our Chief Financial Officer. Now, it’s my pleasure to turn the call over to Paul Raymond. Paul?

[Paul Raymond:]

Yes, Rachel. Good morning, everyone and thank you all for joining us on the call this morning to discuss Alithya’s second quarter 2023 financial performance. To begin, I’d like to congratulate the Alithya team on delivering another record performance in what is typically a seasonally slower quarter. I would also like to come back on the three guiding principles that allowed us to achieve these results and which continue to guide us through the economic up-and-down ahead

[Claude Thibault:]

Thank you, Paul. [Foreign Language] Good morning. Over the past few years, since becoming public, we have had quarters with strong organic growth and quarters with no growth. We have had quarters with strong gross margins and quarters where gross margin was a challenge. And over time, our SG&A steadily increased, even if mainly driven by our strong growth in acquisitions. As such, as Paul mentioned, our second quarter marks a clear shift in Alithya’s financial results as we’re presenting today’s strong performance on all three levels together, namely organic growth, gross margin progress and SG&A reductions. Let’s look at those numbers in detail. Please turn to Slide 11. Revenues for the quarter amounted to $128.9 million, an increase of 22.5% or $23.6 million compared to revenues of $105.3 million for the second quarter last year. Vitalyst and Datum respectively contributed $8.3 million and $4.9 million in the second quarter. Excluding the impact of those acquisitions, which occurred on February 1 and July 1, 2022 respectively and excluding foreign currency impacts, true organic growth was 9.2%. In other words, we recorded good sustained organic growth once again. In Canada, revenue increased organically by 12.2% to $75.1 million, all due to growth across all of our operations, including continued growth from the two long-term contracts signed concurrently with the acquisition of April 2021. In the U.S., revenues increased 41.8% to $49.8 million due again to the Vitalyst and Datum acquisitions, a favorable U.S. dollar exchange rate and some organic growth. As far as our international operations, they also reported a strong quarter in terms of growth, increasing 25.3% to $4 million versus $3.2 million for the same quarter last year and despite some negative currency impacts. On a sequential basis from Q1 to Q2, the overall increase in revenues mainly comes from the Datum acquisition, which was partially offset by the normal usual slowdown in revenues occurring during the summer quarter in all geographies. Lastly on revenues, a quick word on our second quarter book-to-bill ratio of 0.93, a ratio under 1 is normal for summer quarter. And this year’s ratio was actually higher than the Q2 ratios of the previous 2 years. Of note, excluding revenues from the two 10-year guaranteed contracts, which were all recorded to bookings in one lump in the first quarter of fiscal 2022, our second quarter book-to-bill ratio is actually above 1. Now let’s take a look at our second quarter gross margin, which increased by 32.6% or by $9.3 million to $37.8 million, up from $28.5 million last year. As a percentage of revenues, our second quarter consolidated gross margin was at 29.3%. This is up 2.3 percentage points over the same quarter last year at 27%. On a sequential basis, comparing Q2 to Q1 of this year, we are showing an increase from 26.9% in Q1 to, again, 29.3% in Q2 for a sequential increase of 240 basis points during a quarter which is typically softer also from a gross margin perspective. The increase in gross margin percentage in Canada is derived from increased revenues from permanent employees relative to subcontractors, increased average hourly selling rates and improved overall project performance. In the U.S., most gross margin drivers, utilization rates, project mix and performance, et cetera, led to the improvement both on a year-over-year and sequential basis. And that is before taking into account the expected positive margin impact from our two recent acquisitions. Now let’s look at SG&A. We are beginning to show the benefits of the efficiency initiatives we talked about back in June, particularly considering the additional expenses incurred relative to the 3 acquisitions completed in the last 3 quarters and the increased compensation costs that kicked in at the start of this fiscal year. Total gross SG&A expenses in the second quarter totaled $30.4 million, an increase of $5.5 million or 22.2% compared to $24.9 million in the same quarter last year. The increase was primarily due to the expenses coming from the Vitalyst and Datum acquisitions, the salary increases at the beginning of the year, an increase in non-cash share-based compensation as well as the negative impact of the U.S. dollar appreciation. More importantly, when looking at the sequential variation of SG&A, we see an increase from $28.9 million in the first quarter of fiscal 2023 to again $30.4 million in the second quarter or a $1.5 million increase. However, if we take into account the following

[Paul Raymond:]

[Foreign Language] Claude. So to recap, the three key takeaways of this quarter, first, we recorded an adjusted EBITDA that amounted to $9.4 million for this past quarter, a record. Second, we delivered revenue growth of 23% or $129 million, fueled by leveraging the valuable assets across our platform as well as the growing capabilities of our global delivery teams. And third, Alithya has a longer term approach to building its workforce based on the mindset of competitive compensation, world-class leadership, robust training and abundant career growth opportunities. So before we open up to questions, I’d also like to take a moment to remind everyone that tomorrow is Remembrance Day. And as a veteran myself, events such as the ongoing war in Ukraine, unfortunately reminds me daily of the horrible human cost of war and the struggles for freedom that continue around the world. Here at home, let us never forget that those who’ve sacrificed have enabled us to mark this day in peace each year. So on that, Ennis, we will take questions.

[Operator:]

Thank you, sir. [Operator Instructions] Your first question comes from Jerome Dubreuil with Desjardins. Please go ahead.

[Jerome Dubreuil:]

Thanks for taking my question. Good slide on Page 9 to explain your evolving business model I found. So it shows that you have more of the fixed pricing versus time and material. If you can just explain the strategy here, a bit what this could mean, and if you can also confirm that fixed price can still include maybe inflation escalators for longer-term deals. Thank.

[Paul Raymond:]

Yes, sure. Thanks, Jerome. Thanks for the question. So as we’ve said, as the business grows, right, we try to move up the value chain with our customers. And more and more of the customers are looking for turnkey solutions. So we can commit upfront, help them with the strategic planning, the architecting of the work and helping them decide on which direction to go, helping them pick a solution, and then implementing it and supporting it for them. So we’ve built the pieces in our platform to be able to do the cradle to grave of the project. So a good example, we spoke about MUFG Bank earlier. So in a typical project, we – in the past, we would implement a project and leave. Now we actually stay behind, and we can train the people in a new platform and even support them through the change management process. So as we do those things, many of those projects either come with a fixed price or a fixed envelope or a transaction basis after when we’re supporting. So it’s per head or per call or per – so we try to move towards that more and more because the client sees more value, we have higher margin, and it’s a repeat business that just keeps on going. Datum acquisition is the same thing. They actually have IP or intellectual property that helps us accelerate the transformation of legacy applications to the cloud. So again, when we do those types of things, it’s a service fee. So we control the entrants. We control the costs. We can do the work from anywhere. We can structure it in a way to maximize the margin and quality of what we deliver and based on availability of the personnel across our platform. So we see that evolving more and more in our business. I’m not sure if that answers your question, Jerome, but that’s the long-term plan for the company.

[Jerome Dubreuil:]

Yes. No, that’s great. And second one, just to help us a bit model the growth in the coming quarters. I was wondering if, in the third quarter of last year, the two large contracts from the R3D acquisition were fully ramped up?

[Paul Raymond:]

So from a revenue perspective, we’ve already reached the minimum required from the agreement, and we’re still growing. And the focus, as you can imagine right now, and we’re seeing it as part of the improvement in the margin that you’re seeing quarter-over-quarter is we’re replacing the subcontractors that came with the agreement with full-time employees. So that’s also helping in the gross margin.

[Jerome Dubreuil:]

Great, and congrats on the quarter.

[Paul Raymond:]

Thank you.

[Operator:]

Thank you. Your next question comes from Deepak Kaushal with BMO Capital Markets. Please go ahead.

[Paul Raymond:]

We can’t hear you. Whoever is asking the question, we can’t hear you. So maybe go to the next one, as and we will come back.

[Operator:]

Your next question comes from Amr Ezzat with Echelon Wealth Partners. Please go ahead.

[Amr Ezzat:]

Hi, thanks for taking my questions. On the book-to-bill, I know it’s hard to make the conclusions on the quarter-to-quarter numbers, but maybe you could speak to us on how conversations are evolving with clients both existing and potential ones in light of a more fragile economic outlook?

[Paul Raymond:]

Thanks for the question, Amr. It’s a question I ask at every meeting that I have with my team and with our clients, Amr. Everybody is concerned with what’s happening out there. But in the same conversation, the next thing is that they ask us how we can help them become more efficient. So we’re not seeing a slowdown from that perspective. If anything, based on past experience, and I’ve mentioned this before, we are keeping a close eye on it, but if I look at our bookings, we’re not seeing that slowdown. And I think or I believe the desire for ways to become more efficient from our customers is going to increase. So I believe our offshore managed services offerings, fixed price projects to modernize and become more efficient, robotic process automation, we’re seeing an uptick in that area, I think we’re going to be seeing more of that over the coming – I mean, we still have many, many open positions. We still have a pretty good backlog in the sales funnel. So we’re not seeing it so far.

[Amr Ezzat:]

Okay. That’s pretty encouraging. Then on the gross margins, it’s good to see it rebound this quarter, and I appreciate the color on the shifts to permanent staff from subcontractors. I’m not sure if you’re able to tell us where that ratio stands or how far along are we in that process?

[Paul Raymond:]

Just want to talk about the replacement of subcontractors?

[Amr Ezzat:]

Yes, to the – yes, go ahead.

[Paul Raymond:]

Yes. Sure. We’re – the mix is progressing well. The target we always said we’d like to get to at least 70%. That’s where we were when we completed the R3D acquisition 1.5 years ago. And if you remember, R3D had a very, very high percentage of subcontractors. And we said we’d give ourselves 24 months to get through that, and we’re progressing on our plan. We like where we’re going, and there is still some room there for more upside.

[Amr Ezzat:]

Okay. So sort of a bit of room but late innings of that process is fair?

[Paul Raymond:]

No, I think there is still a lot of room. Coming back to your first question on the recession, if anything, I think that’s also going to open up more opportunities for more full-time employees.

[Amr Ezzat:]

Okay. Okay. That’s great color. Then on the leverage, yes, obviously, pro forma like 3.8x. I think you’ve got a couple of earnouts, you – one which is coming up in December. So how do we think about leverage going forward? Is the expectation for you guys to deleverage or stay at 3.8. Maybe you could speak to what you guys feel is an optimal leverage level?

[Paul Raymond:]

Well, it’s a range, obviously. And we’re probably towards the higher end of that range, but it’s within our – as I said in my notes, it’s within our comfort zone, for sure. And you know that level of profitability, our conversion to cash flow and, therefore, deleveraging is pretty good. So we’re quite satisfied with that. And last three quarters on the working capital variations, as I said, we’ve been hit a little bit. So that typically reverses itself or at least at the very least stabilizes. So we can expect better cash flow generation and debt reduction in coming quarters.

[Amr Ezzat:]

Okay. Is there – I recall yes, go ahead, sorry.

[Paul Raymond:]

No, just to say, overall, as I said, we’re – it’s on purpose that we got there. When we make acquisitions, we always have a bit of a choice between issuing shares and using leverage. We did not like where our stock price was. So we turned to leverage to a certain extent. So it’s all on purpose. So we’re pretty much where we want to be, and it’s looking good for the future going forward.

[Amr Ezzat:]

Understood. Then just a last one on the drag from working cap the last couple of years. Your Q3, your December quarter has been a positive working capital contributor to cash flows. Is the expectation the same for this year?

[Paul Raymond:]

You’ve done your homework. The – it really depends. We’re a service company, as you know. So it really depends when the end of the quarter lands so the impacts on the accrued payroll and stuff like that. So it’s a bit of a crapshoot. I’m expecting a stabilization. I wouldn’t go as far as to confirm we’re going to have the same numbers, but we should have some relief, for sure.

[Amr Ezzat:]

Fantastic. Thanks for all the details. I will pass it on.

[Paul Raymond:]

Thanks, Amr.

[Operator:]

Thank you. Your next question comes from Nick Agostino with Laurentian Bank. Please go ahead.

[Nick Agostino:]

Yes. Good morning. Apologies, I joined the call a little bit late. So were you guys – did you guys call out or maybe in your MD&A maybe call out what is the R3D gross margin presently?

[Paul Raymond:]

Good morning, Nick. No, we didn’t call it out. It’s merged into our operations now, so we don’t call it separate.

[Nick Agostino:]

Okay. How – I mean, if we think about where the – where you guys started on that front versus the margins today, how far along on that journey to improve those margins would you say that you are?

[Paul Raymond:]

On the commercial agreement perspective, we’re exactly where we wanted to be. So that’s going very well. The other big improvement that we saw year-over-year is the rest of the R3D business, again, replacing subcontractors with permanent employees on projects, and that’s also progressing well. And that’s why you’re seeing some of these improvements in the gross margins on the Canadian side.

[Nick Agostino:]

Okay. I guess maybe to think along the same line but a little bit of a different approach. What has – in prior quarters, the gross margins was always being impacted because, obviously, you would see strong sales demand, and you had to maintain a high subcontractor number just to be able to meet and service your clients. Should we – I’m just trying to understand what changed maybe this quarter as far as you guys being able to improve that permanent employee subcontractor ratio? Is it a case of – should we interpret as the market conditions are maybe slowing down a bit and you’re able to, I guess, use more of your employees to – permanent employees to service it? Or are you now able to hire at a faster rate than in prior quarters, especially on the – in Morocco and abroad? And if it’s the latter, maybe what has changed on the part of the strategy?

[Paul Raymond:]

Thanks for the question, Nick. It’s a combination of many factors. So maybe to run you through the full scenario, I got to do a bit of a rewind. So if you go back to April 2021, so April 1.5 years ago, our gross margins were at 30% or thereabout within a couple of points. They were already 30%. Then we did the R3D acquisition, which was mostly subcontractors. And you saw the following quarter, we said that the gross margins went down dramatically just because of the mix – the headcount mix. And we’ve been gradually moving that back to the 30% mark, which we’re almost at by that mix of transforming the type of business and the type of employees from subcontractors to full time. So that’s a gradual thing. In parallel with that, the mix of business has also changed. So again, if you go to the Slide 9 that we talked about earlier, 26% of our business today is recurring business, right? So it’s either fixed price projects or subscription-type projects or managed services type projects. So that’s also changing the margin mix. And throw into that, we now have 5% of our workforce, so almost 200 people working from offshore, right? So again, the margin improvement tied to that new capability that we didn’t have a year ago, so all those three things combined together are impacting gross margins. I think the – on a side note, I can’t put a number on it yet, but it’s something that we’re tracking. I think the fear or talk of a recession is probably helping some people decide to become a permanent employee versus a subcontractor, but I can’t put a number on that one. It’s just based on what I see out there right now and I hear.

[Nick Agostino:]

Yes, I like that last comment. I think that is interesting in terms of the quarter-over-quarter change. Everything else, I follow. I’m just trying to see if the read-through is slowing or if the read-through is just more of, as you said, better revenue mix but also better hiring environment because of a potential recession. So all good there.

[Paul Raymond:]

I think it’s a combination, yes.

[Nick Agostino:]

Okay. And then my last question. I noticed in an earlier slide, obviously, and I think this came up in the past, the real estate optimization to meet the operational needs when you look at where you are today versus your needs for tomorrow, how much dollars do you think you guys can squeeze out from a real estate perspective?

[Paul Raymond:]

That’s a good question. And the main challenge to answer that is the subleasing market. So it’s not very strong right now, as you can imagine. So then we need to go to the end of certain leases before we get to savings but not sure how specific we want to be considering timing and considering our evolving needs. We always say we’re in – active on the acquisition front. We’ve always said that, and we remain on that basis. So – and the other thing you need to consider is that, because of IFRS 16, rent expense does not hit our P&L all that much. Some of it hits our cash flow statement. But I guess if we had to throw a number, if we don’t save 50% of our overall spend over the coming several years, we’re – I think we’re looking at least at that, just to give you a very rough feel for that.

[Nick Agostino:]

Okay. I appreciate that color. I will pass it on. Thank you.

[Paul Raymond:]

Thank you, Nick.

[Operator:]

Thank you. Your next question comes from Rini Sharma with BMO Capital Markets. Please go ahead.

[Rini Sharma:]

Hi, good morning. Can you hear me?

[Paul Raymond:]

Yes, good morning, Rini.

[Rini Sharma:]

Good morning. So I just had a question on the cash flow side of things. We noticed that we had a cash flow loss this quarter versus the EBITDA gain. And I know you mentioned that the working capital variance had some – a little bit to do with that. Is there anything else that you’d say drove the loss? Or – and really, when are you expecting cash flow to start tracking EBITDA and what expectation for the conversion rate would be?

[Claude Thibault:]

Well, the conversion of EBITDA to cash flow, basically, there is a few things to consider. There is our acquisition and integration expenses. That’s cash spend. So it impacts cash flow. You see this quarter was $2.7 million because Q2 was an acquisition quarter. We acquired Datum at the beginning of the quarter. So that’s a bit of a – that will track acquisitions. If we don’t have any acquisition, that number quickly goes down. Then there is obviously tax – cash taxes. That’s a very low amount in our case. You can see this quarter is $164,000. That’s very small, and that will stay that way for a while to go. We have tax pools we can use. The other one is CapEx. So CapEx, we spent under $300,000 this quarter. That’s a sustainable amount in our mind. The other one is repayment of lease liabilities. So you see that further down. That’s about $900,000 debt. We just talked about that. That’s going to go down eventually. But for now, it’s there until we sublease our space or we come to the end of certain leases. And finally, is the interest. So interest is $2.3 million in the quarter, a combination of the debt level increasing and also the interest rate increasing. So that amount should be trending down as we deleverage we generate cash flow. So if you take our EBITDA number, Rini, in round numbers, about $10 million, and then you deduct tax and CapEx and interest. That leaves maybe 75% of it, and then it depends on the integration and acquisition costs.

[Rini Sharma:]

Okay. Yes. Got it. That’s very helpful, thank you. And just another question on the OpEx side of things. Are you expecting it to trend going further over the next quarter? Are you expecting it to be sort of seeing a similar trend? And then particularly on the exchange gain side as well as on the share-based compensation side, has anything changed? And do you – will it be consistent with this quarter in terms of getting more permanent employees versus contractors?

[Claude Thibault:]

Okay. So when we talk about subcontractors versus employees, that’s mainly of a gross margin discussion if I understood the first part of your question. So the first part, we don’t provide guidance, and I’ve been very careful in my notes to stay away from that. So we have positives to come, and we have a few cautions to look at. So on the positive note, as I said, we have initiatives – expense reduction initiatives that took place over the second quarter. So that did not have a full quarter impact. So you can expect some additional gains there. And we’re still, as we said, keeping a close eye on the spend levels. But we also have a few headwinds, and I also mentioned that. There is inflation. There is some return to pre-COVID spending elements like travel, business developments. So we keep a close eye on that. And not all SG&A is fixed. Some SG&A elements are semi variable, so they will track to increase performance. So – but all that combined, we’re – how can I say, we’re – we like the trend. Paul is whispering in my ear. We like the trend, and we think we should see some stabilization. Yes, the level we had in the second quarter is a good base to work from.

[Rini Sharma:]

Okay, thank you very much for taking my questions. Appreciate the color.

[Paul Raymond:]

Thank you, Rini.

[Operator:]

Thank you. Your next question comes from John Shao with National Bank. Please go ahead.

[John Shao:]

Hey, good morning. Thanks for taking my question. I just want to get more color on [indiscernible] position. I know that was closed at the beginning of the quarter, but could you give us some updates on the current integration works? And when do you think the company will start realizing the expected synergies?

[Claude Thibault:]

Did you say integration?

[John Shao:]

Yes, integration.

[Claude Thibault:]

Of our acquisitions?

[John Shao:]

On Datum acquisition.

[Claude Thibault:]

Okay. So the – talking about the expenses, there is not much synergies and efficiencies to be had there. They were quite a small operation so operating there with very low costs. So there is not too many savings to gain there in the first place. But when we talk about synergies with Datum, it’s taking place mainly at the cross-selling side, really taking their unique technologies and expertise to our broad customer base. All of our clients sooner or later will need their modernization tools and expertise. They are big in the insurance industry. As we mentioned at the time, we had clients in the insurance industry before. So we started do the cross-selling there, so accelerated growth, higher revenues with great margin. So that’s more where we’re seeing the integration and the upside, much more so than the actual expenses – the [indiscernible] expenses.

[John Shao:]

Okay, great. That’s all my questions. I will pass the line. Thanks.

[Paul Raymond:]

Thanks, John.

[Operator:]

Thank you. There are no further questions at this time. Mr. Raymond, over to you.

[Paul Raymond:]

Alright. Thank you, Ennis. Thank you everybody for – again for participating today. I’d also like to draw your attention to our inaugural ESG report that was published in September. We’re very proud of this document. It outlines the current best practices that the company has put forth as well as the critical measures identified for future implication. So ESG intersects all lines of Alithya’s ecosystem, and our business has far-reaching effects on the important economic sectors that we service. And since the company’s founding, we’ve embraced the responsibility of being an agent of change in our industry, and that responsibility extends to helping our clients transition to a more sustainable economy. So if you haven’t read it, I strongly encourage you to do so. And I’d like to take this opportunity to thank our clients for the trust that they continue to place with us and to thank our passionate professionals who deliver high-quality service and advice to those clients every day. Thank you once again. Have a great day. Take care.

[Operator:]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.