Alithya Group inc Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen. Welcome to Alithya's Third Quarter Fiscal 2022 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.

Good morning, everyone. And thank you for joining us for Alithya's third quarter fiscal 2022 results conference call. The press release and MD&A with complete financial statements and related notes were issued earlier today and are posted on our website. The webcast presentation can also be found on our website in the Investors section. Presenting this morning are Paul Raymond, Alithya's President and Chief Executive Officer; and Claude Thibault, our Chief Financial Officer. Before we begin, I'd like to specify that this conference call is intended for the financial community. 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 notes in our presentation into the forward-looking statements and Risks and Uncertainties section of our MD&A available on our website. Let me remind you that all figures expressed on today's call are in Canadian dollars, unless otherwise stated, and be aware that we will refer to certain indicators that are non-IFRS measures. Please refer to our cautionary note in the presentation in the MD&A for more results. Now, I would like to turn the call over to Paul.

Good morning, everyone, bonjour. I look forward to discussing some of the highlights of another record quarter for Alithya's revenues and client go-lives. But before I dive into the highlights of our third quarter, I'd like to take a moment to reflect on our most recent acquisition. On February 1, as you remember, we announced Alithya's acquisition of Vitalyst, a U.S.-based learning and workforce development company with a blue-chip customer base of Fortune 1000 companies and the leading Microsoft partner in their field. Here are the key highlights of this transaction. One, Vitalyst will accelerate our entry into the massive learning and workforce development industry, recently valued at over CAD50 billion in North America alone. The transaction also enhances Alithya's revenue mix with new high-margin subscription-based recurring revenue streams; and three, it presents strong organic growth prospects and promising cross-selling potential with Alithya's current services and client base. By the way, it also enhances our already solid partnership with Microsoft. On a final note, our new proprietary Adaptive Learning platform now enables us to provide post-implementation change enablement to our customers. We can, therefore, accompany them long-term in their digital transformation journey. Alithya will now be able to evolve the Adaptive Learning platform to fit the needs of our Oracle Practice moving forward, a reminder that this acquisition occurred during our fourth quarter and is therefore not reflected in the financial results that we are disclosing today. Now, on to Q3, another record quarter. Let's go through our three key takeaways for the quarter. First, Alithya has posted, once again, continued industry-leading growth and another record quarter in terms of revenues with more than 55% year-over-year growth. We also continued to experience substantial organic growth across all of our geographies, including a record quarter for go-lives posted by our Microsoft Practice for enterprise cloud implementations. Including Microsoft and Oracle Cloud Enterprise Solutions, we had a record 27 successful client go-lives in the quarter. Our Oracle Practice experienced record bookings as well for the U.S. in Q3. This is largely due to a sense of urgency amongst healthcare sector clients to accelerate their digital transformation plans. With the current challenges and pressures that the healthcare industry faces, it is more important than ever to provide technology solutions that reduce risk and assist clients in focusing on improving patient care. We also continue to deepen our public sector market penetration in Canada. In January, we started a CAD3 million services contract with a federal government agency, the Parliamentary Protective Service. We also continue to leverage our Quebec government qualification that allows the Company to serve as a trusted adviser to other public organizations. In addition to paving the way to establishing a track record of ongoing successful projects with government agencies, the qualification positions Alithya to take advantage of our recent Quebec government announcement that all of its departments will be migrating to the cloud within the next three years. Secondly, in line with the continued growth of our business, our recruitment campaigns continue on all fronts as we strive to expand the knowledge and expertise of our workforce. We continue to be very successful in attracting new employees looking for exciting challenges with a rapidly growing digital transformation leader. We recently hired 192 employees, and our growth-related job openings have increased by 92% over the same period last year. We also continue to strengthen our internal resources dedicated to skills development for our professionals, which includes a series of specialized academies that focus on core expertise. To mention another highlight from the acquisition of Vitalyst earlier this month, Alithya will now be able to leverage the Adaptive Learning platform in order to sharpen the skills of our own professionals. And thirdly, despite the impacts from employee downtime due to COVID and well-deserved vacations for any of our people in December, we posted a record quarter for billable hours and total revenue in the quarter at close to CAD110 million. Q3 also saw the completion of our integration of R3D as of December 31, right on schedule. We're also on track with the ramp-up of our long-term agreements totaling CAD600 million in guaranteed revenues over the next decade with QMI and Beneva as announced in our first quarter. This brings me to some highlights on some of our new partnerships. So, our success in greater scale and attracting attention from industry-leading solution partners, Alithya is in the process of finalizing its AWS advanced tier services partner accreditation, enabling us to now access the full spectrum of AWS cloud-based services and solutions. As you know, the Quebec government has awarded some 40 cloud computing contracts totaling more than CAD55 million over the past 1.5 years. A recent CAD10.5 million contract won by AWS alone represents more than 15% of the value of the agreements concluded since January 2020. Therefore, Alithya's AWS certification will open more doors for us for a broader cloud consulting and solutions implementation offering moving forward. We also continue the critical process of developing strategic partnerships and achieving certifications with other industry leaders our clients care about. For example, our partnership with Vitech, a global provider of cloud native benefits and administration software for the insurance industry, will enable Alithya professionals to unlock a transformative suite of applications embraced by our current and future insurance customers. We also gained accreditation as a systems integrator of solutions from Talent, a California-based technology company with a global clientele. This enables us to expand our offering of both on-premise and cloud-based migrations. Despite the context surrounding the cohort around the world, we are encouraged by our continued strong bookings. They are the best predictor of what is to come. In Q3, bookings reached CAD125 million, which translated into a book-to-bill ratio of 1.14. As for the trailing 12 months, even excluding our CAD600 million 10-year contract, other bookings are in excess of CAD330 million. That translates into a book-to-bill ratio above one. Our continued superior bookings reflect not only strong demand for our digital transformation services from our existing clients, but also the fact that we are gaining market share and new customers who are now turning to Alithya. Before I turn things over to Claude, I would just like to shine a light on the significance of the collective achievements of our company in Q3. Powered by our rapid growth, the completion of the R3D integration and the addition of our latest acquisition, Vitalyst, Alithya's scale now enables us to fine-tune our cost structures in order to reap the benefits of past investments. This scale and strong financial position also enable us to continue our accretive acquisition strategy. I will now pass it over to Claude to cover some of the financial highlights.

Bonjour, good morning. Please turn to Slide 8 for the key third quarter highlights. Revenues for the quarter increased 55.4% or by CAD39.1 million to CAD109.7 million. Excluding the impact of the R3D acquisition, which occurred on April 1, 2021, true organic growth was 33.5% or 35.1% on a constant currency basis, in other words, significant and accelerating organic growth. In Canada, revenues increased 80.2% to CAD72.1 million due to organic growth in all areas of our Canadian operations, a general recovery of activity levels and revenues of CAD15.4 million from the R3D acquisition, including intercompany revenues; and finally, growth from the two associated long-term contracts. In the U.S., revenues increased 22.2% to CAD33.7 million as we experienced strong organic growth in all areas. The increase was partially offset by foreign exchange variations as the increase would have been 26.4% assuming a constant U.S. dollar. As for our international operations, they are showing a similar strong performance. Looking at gross margin, it increased by CAD7.9 million or 38.3% to CAD28.3 million for the third quarter. As a percentage of revenues, the third quarter gross margin was 25.8% or, if excluding the impact of the R3D acquisition, 28.1%. That is down from 28.9% for the same quarter last year. As previously mentioned, the R3D revenues historically show a higher proportion of billable subcontractors and a corresponding lower gross margin profile. When excluding R3D, the decline in gross margin percentage mainly comes from, A, an increase in subcontractor revenues relative to those from permanent employees, coupled with an increase in the average cost of subcontractors, explained in part by the tightening labor market; B, increased costs in certain customer projects; and C, decreased software revenues, which typically carry higher margins. SG&A expenses in Q3 totaled CAD25 million, an increase of CAD4.6 million or 22.4%. This increase is primarily driven by the R3D acquisition as well as by certain increases in employee compensation and recruiting costs, in line with our strong organic growth, partially offset by decreases in share-based compensation and the favorable U.S. dollar exchange rate. As a percentage of revenues, total SG&A decreased to 22.8% for the three months ended December 31, 2021, compared to 28.9% last year. As Paul mentioned, we have now completed the migration of R3D's commercial and administrative functions into Alithya's infrastructure, resulting in certain additional cost savings to come. Overall, our third quarter adjusted EBITDA amounted to CAD4.5 million, an increase of CAD2.2 million compared to the same quarter last year. As in previous quarters, the amount of non-cash depreciation and amortization totaling CAD4.8 million is notably greater than the quarter's accounting loss of CAD3.5 million. Looking at long-term trends on Slide 9, we can see the impact of our acquisitions and more importantly of our strong organic growth of the past several quarters. Regarding gross margin, we see a similar trend in dollars, but recent challenges in percentages for the reasons I mentioned before. We believe most of these factors are largely cyclical, subject to some natural recovery over time. And we aim to reverse the trend also with a number of targeted initiatives, focusing on labor mix and costs due to utilization improvements, setting pricing adjustments and focusing future growth in our higher-margin segments. On Slide 10, our long-term EBITDA trend reflects our growth but also our recent gross margin percentage challenges, as well as some increases in SG&A despite their gradual expected decrease as a percentage of revenue. I would like to take a moment to put our recent results in the context of our long-term business objectives, which we have often been communicating over the past few years. For revenues, we pursue sustained organic growth and selected strategic acquisitions in order to reach the CAD600 million mark. Our organic growth and acquisitions of the last year have taken us close to the CAD0.5 billion mark, and we certainly intend to maintain the efforts on both fronts. For gross margin, we believe our long-term strategies, some discussed on this call, remain appropriate and relevant for gradual recovery and further improvement, including as it relates to the two long-term agreements stemming from the R3D acquisition. We also intend to keep targeting acquisitions with a higher gross margin profile, and the recent Vitalyst acquisition is certainly a very good example of that. For SG&A, we believe that we have now reached a certain critical mass and a stabilization of certain SG&A categories, including with regards to corporate and head office costs. Going forward, these expenses should grow more slowly than our revenues. And as such, we intend to continue our downward trend of SG&A as a percentage of revenues with some acquisition synergies still to come, including longer-term savings relating to rent. Also, most acquisition targets that we look at typically have a lower SG&A percentage profile even before potential synergies, which should further compound the trend. In a nutshell, that is the step-by-step playbook of how Alithya believes that it can realistically aim to achieve its three-year objective of CAD600 million in revenues with an EBITDA margin of 3% to 13%. Now turning to our liquidity and financial position on Slide 11. Net cash from operating activities improved to CAD10.1 million in the third quarter, a significant increase from the third quarter of last year. Excluding our positive working capital variations, the third quarter cash flow from operating activities was CAD2.3 million, which represents over 50% of the reported adjusted EBITDA. Moreover, considering that we have fairly stable interest expenses and CapEx and fairly low effective tax rates with our available tax pools, this conversion percentage should increase exponentially with any future growth in EBITDA. On Slide 12, we see total debt decreasing from CAD84.5 million down to CAD61.6 million during the third quarter, with a similar decrease of our net bank borrowing. This comes from cash flow generated by operating activities, as mentioned before, a transfer of cash balances to debt, and the new financing facility, reducing bank borrowing. This decrease of total debt, combined with a higher trailing adjusted EBITDA, shows a steady four-quarter deleveraging trend, bringing us to a 3.1 ratio of total debt to trailing 12-month adjusted EBITDA. Looking at these metrics following the Vitalyst acquisition on Slide 13, we see the pro forma total debt-to-TTM EBITDA multiple decreasing to 2.6. This reflects the debt and equity raised for the acquisition and the current profitability of the target. Looking forward, even considering the historical profitability of Alithya and Vitalyst, we are expecting deleveraging dynamics to continue. Of note, we also announced in the context of the Vitalyst acquisition, an increase of our senior credit facility from CAD60 million to CAD125 million. As such, considering our permitted 5.5x maximum ratio, this provides us with ample capital to continue on our growth strategy, even though we intend to maintain, as always, our prudent use of debt. In closing, our normal course issuer bid launched on September 20 is progressing as planned. Since its beginning, Alithya has repurchased and canceled 330,000 Class A shares for a total cash consideration of CAD1.1 million.

Thank you, Claude. So, our industry-leading growth is a reflection of the quality of the work of our people and at the level of trust that our customers have in our ability to guide them through their complex digital transformations. Accordingly, Alithya will continue to focus on those core values that guide us towards the objectives set forth in our three-year strategic plan, which foresee the delivery of more than CAD600 million in revenue and between 9% to 13% EBITDA by the end of that period. As we wrap up Q3, we're also very pleased with the strides we are making in mounting a comprehensive environmental, social and governance strategy that is in line with Alithya's values and the many initiatives already underway. For example, our management incentive plan already includes ESG criteria, and we were the first technology services company in Canada to join the 30% club years ago. We are one of the few IT services companies that provide all of its employees with paid leave to give back to their communities. We have paperless work environments, work from home and employee assistance programs, and many more. As with everything we do, we want to be a leader in the field of sustainability. So it should be of no surprise that we're establishing progressive ESG guidelines that meet the expectations of all of our stakeholders and reflect much of the valuable work our people have done over the years to improve the communities where we live and work. To that end, and in association with a leading Canadian ESG consulting firm, Alithya completed all of the steps of their Phase 1 recommendations in Q3, and we now turn our attention to Phase 2, and we look forward to sharing our ESG framework with you in the near future. But thank you for being with us this morning, and Julie will now be opening up for questions.

Thank you. Your first question comes from Kevin Krishnaratne with Desjardins.

I have a question about the gross profit for the quarter, and then I will ask about future trends. In the quarter, you mentioned several factors affecting it, including certain customer projects, a tightening labor market, the software mix, and an increased number of unbillable hours at year-end. Could you please elaborate on those four elements and provide some way to quantify them, at least to some extent?

I think we just lost Kevin, but I'll answer the question. Kevin, if you can still hear us, I think you wanted more details on the comments on the billable climate margin. So thank you for the question. Basically, as I was mentioning, it was a record quarter for billable hours. At the same time, we also had a high number of non-billable hours, especially at quarter end, with COVID and more vacation and project ends and starts. So, I guess, the positive of that is the people who were non-billable at the end of Q3, which are billable in Q4. So, same cost, more revenues with more and more of the billable time. So, it's a positive. I think it was a temporary thing. We also listed a list of other small things that impacted in the quarter, but we see those as temporary quarter-end type stuff. And we're very, very confident with where we're going with that. And if you get back on the line, the second part of your question...

So you talked about...

Sorry, did you hear the answer?

I heard the answer, yes. And so, I guess, I mean, there are just a number of things. Is there any way to quantify, though, maybe perhaps even the customer projects, like what would it have been ex some of these one-time transitory impacts?

I’d like to provide you with a specific example. During the quarter, we achieved 27 go-lives, setting an all-time record for us. These include our ERP, CRM, and all enterprise solution projects, such as those with Oracle and Microsoft. Once a project concludes, the team usually transitions to a new one, which typically leads to a lag. As we approach the end of the year, those go-lives mean that people are not starting new projects around December 15, right before the holiday season. Consequently, many go-lives occurring later in the quarter mean that the team will begin working on new projects in January. Therefore, we took the opportunity to encourage our team to enjoy some well-deserved vacation time over the holidays. Additionally, some customers closed down entirely due to the Omicron shutdowns and COVID situations in various countries, and we used this chance to motivate our employees to take vacation.

As I consider the future, you mentioned several initiatives such as labor mix and price adjustments, and the goal of developing higher-margin businesses. Can you discuss the timing for the expected improvement in gross margins? Additionally, could you provide insight into the near-term projections for gross margins as we transition from this year to next year? I understand that Vitalyst is a factor in this, which should also contribute positively to the margins.

Again, here, maybe let me give you a color, one very simple factor here that influences your modeling. If you look at our business, one of the things that we've been saying is about moving to higher value employee-based projects. So, R3D, as you remember, is mostly subcontractor driven, which has very low gross margins. I mean, it's in the teens. So, we said we'd be shifting that over two years. Part of that shift is coming through the agreement we have with the Quebec government which is on track. It's exactly where we wanted it to be. So, one of the biggest initiatives that we have going forward is replacing those subcontractors with our full-time people. So, if everything else being equal, if we can just get that one under control over the next two years as part of our agreement, it would have a huge impact on gross margins.

So, you aspire to get the business to a 30% margin and then higher in time on layering on even more higher-margin businesses?

Exactly.

I just want to ask one more question about the software mix at GM. You mentioned that, and I'm curious about the overall mix of software versus services this quarter compared to a typical quarter. How does that mix differ?

So it's not a miss. Software revenues will fluctuate based on customer assignments. Regardless, software revenues are consistently below 5% of our overall revenue. We certainly aim to increase that. However, historically, we're discussing low dollar amounts. The margin is quite favorable, so even a small change in those small amounts significantly impacts the margin percentage.

I understand. Got you. Look, I'll switch gears just more to the top line. Really, really good results there, impressive organic gains. You talked about Oracle quite a number of times. So how did Oracle versus Microsoft perform in the quarter? Are you just seeing particular strength in Oracle? And do you want to touch on sort of what really is driving that, talk about your expertise in the healthcare vertical? Any incremental color you can just talk about on how you're seeing that strength was particularly strong?

Both Microsoft and Oracle are performing exceptionally well at the moment. However, our involvement with their solutions is in different industries. Microsoft is achieving remarkable success, as is Oracle. We have noted a significant acceleration in the healthcare sector. The COVID pandemic has highlighted many issues that healthcare providers face regarding their systems, emphasizing the need for them to focus more on patient care than on administrative problems, which have been evident over the past two years. This focus is driving growth in our strong position in healthcare. We're seeing substantial growth there. Additionally, Microsoft has set a record for go-lives in this quarter, indicating no signs of a slowdown.

Last one for me, maybe for both of you. Just thinking about future quarters, obviously very strong growth in Canada. You've been adding quite a bit of revenue quarter-over-quarter. I think you're coming up on a tougher comp year-over-year. In Canada, organic trends were 40% this quarter. And then, in the US, I think you're facing a bit of an easier comp, but revenues are trending there. Just how do we think about the near-term way of modeling the bookings translating to revenue just in light of the strong growth you've been recently posting?

One thing to consider is our Q4, which corresponds to January, February, and March. Typically, this period has fewer holidays or downtime compared to others. This year, March has significantly more billable days since Easter does not fall in that month. Given how the Christmas holiday fell this year, there were more vacations in December than in January. If we maintain the same number of staff, we expect to be in a better position. Therefore, we are quite optimistic about Q4.

Yes. And so I'll leave it at that. Congrats on a good top-line quarter for sure, given the seasonality and the schedule in the month of December. So congrats, and I'll pass the line.

Your next question comes from Gavin Fairweather from Cormark Securities.

I thought we'd start out on the bookings. It looks like a nice strong bookings print in the quarter. Any kind of trends that you would call out by region or a vendor or a mix of work under the hood there?

Actually, it's really everywhere, Gavin. I think we've been talking about our shift to higher value and digital transformation, and we're really reaping the benefits of that. All of our business now is driven by digital transformation. I think we're one of the leaders in the sector and they're being recognized not just by our customers, but by new loan bills that are calling us and joining us. And of course, we're getting a lot of referrals directly from Microsoft and Oracle on those solutions, but our digital solution center is also growing leaps and bounds and doing projects for customers and accelerating their move to the cloud. Like I said, the recent Quebec government announcement, they want to move every department to the cloud within the next three years. It's also something that's driving a lot of growth for us. So it's really everywhere right now.

And then, just thinking about your fiscal fourth quarter, obviously we've seen Omicron has kind of perked up and we've been living under COVID for, call it, a couple of years. So, I guess, to what extent are you thinking that that could present some challenges in terms of billings in Q4? Or do you find that most of the projects can kind of move despite that?

I believe the number of go-lives in the quarter serves as our best indicator of progress. We executed 27 ERP system go-lives remotely. At the start of the pandemic, many of you on this call were surprised that we managed to conduct a few go-lives remotely. Now, it's become the standard, and our team has gained significant expertise in this area. There’s no indication that this trend is slowing down. Additionally, we recently opened an offshore facility in Morocco, which is expanding. This will provide us with cost advantages moving forward and assist in recruitment efforts. We are very positive about the future and the opportunities that remote work and telecommuting present, along with the acceleration of digital transformation that accompanies it.

And earlier, you talked about the leverage in the business as you shift your mix more towards FTE from subcontractors. Obviously, the hard part is finding the FTEs in the current labor environment. So maybe just walk us through how you're feeling about your ability to kind of execute on shifting that mix. And then, maybe just touch on the Morocco development hub and the size of that operation and how scalable you think it is and how that plays into that shifting mix towards that piece.

So the first part was on Morocco, and regarding your earlier question, could you please repeat that?

I mean, you talked about the leverage of shifting from some in the business and just your ability and how you're planning to execute on that given the environment?

So we are still hiring quite effectively despite the current market conditions. We brought on over 190 new employees this quarter and are expanding our job openings. Our team is excelling in recruitment during these times, and I believe one of our main advantages is the exciting projects we offer, which continue to attract talent interested in working with new technology. We face similar turnover challenges as others in the industry, but based on our numbers, I think we are faring better than many. A significant issue in the market right now is the high turnover rates among employees hired in the last two years, particularly those who started during COVID and missed out on in-person interaction. We have adapted to remote management effectively and already had the necessary systems in place even before the pandemic. As we move towards reopening, we see positive prospects for bringing people back together for face-to-face meetings and team-building activities. Our recruitment strategy is particularly successful with referrals from current employees, yielding the best results. We have a strong recruiting team to manage this process. In Morocco, we are experiencing some ramp-up challenges, not due to a lack of candidates but because individuals must provide two to three months' notice before changing jobs. We are pleased with the progress and envision expanding the operation beyond our initial plans while also exploring other options. We remain active in mergers and acquisitions, with Vitalyst being a prime example of a profitable model independent of headcount. We're also considering targets that offer offshore extensions. Currently, with our run rate at CAD110 million for the quarter, we could exceed CAD500 million next year with minimal growth, especially with a couple of acquisitions aligned with our three-year strategy. Having more offshore capabilities would enhance our projects and help address global recruitment and workforce challenges. These are key considerations for our upcoming plans.

And then, just lastly for me, just on pricing. I mean, you mentioned that as a lever for gross margins, particularly given the strong demand environment. Can you perhaps share what kind of price increases you're looking at on when you're bidding on new business?

It varies significantly across the different areas we operate in. However, as we’ve mentioned before, our goal when bidding on projects is not to win based on price. We aim to win because we offer the best solution, have the strongest reputation, or are perceived by customers as the most reliable option for delivering projects with minimal risk. This approach means we focus less on cost-cutting and more on the quality of our offerings. While we are witnessing price increases in all our services, our ability to utilize offshoring and lower-cost centers will have a much more significant positive effect on our gross margins.

And your next question comes from Paul Steep from Scotia Capital.

Paul, could you talk just maybe a little bit about obviously some of the bookings and maybe the transition in the business, how we should think about the duration reflecting that a lot of it's still consulting business, but if there's anything else you want to call out in terms of maybe longer-term contracts, ex the R3D deals. Just give us a sense of where that's been trending over time.

Thanks for the question, Paul. That's a very good point. If I look back five years, most of our work was done on a time and material basis, with only a few projects under our complete control. Today, I manage over 200 projects at any given time within the Company, and that number is set to grow. These projects involve us taking responsibility for our clients. Some are fixed price, some are not, but we can oversee the intake and ensure outcomes that positively affect our gross margins. We can select staff based on what we need to effectively deliver the project rather than relying solely on resumes. This approach allows us to market our qualifications and delivery capabilities more effectively. Our goal is to increase these types of projects, and we are seeing the benefits of this shift. Most of our new business, including the significant CAD600 million contract with Beneva and QMI, consists of these managed projects. This model is a substantial contributor to our gross margins because we can concentrate on outcomes while managing costs effectively, utilizing full-time employees and offshore resources. We're now at a critical mass of around CAD0.5 billion, enabling us to implement these strategies more successfully. Additionally, we're investing in academies where we hire college graduates and train them in specific areas, whether it be Microsoft, Oracle, or other technologies. This strategy has proven to be a great source for recruitment. We tend to select graduates without a tech background but with a business focus, training them in business-driven technology, which has been effective. While training these individuals can be costly, the payback period is within a year. To reiterate Claude's earlier comments, we are investing in growth, confident in the substantial returns, as evidenced by our growth trajectory. Scale is crucial for a company of our size, and we are noticing a consistent decrease in our SG&A percentage, with a goal to drop it below 20%. We are moving in the right direction.

It's progressing and that requires ongoing effort. In Q3, we unfortunately experienced a reversal in trend due to managing significant growth and searching for resources to support these services. We had to rely more on subcontractors than we would prefer. However, I believe this is a midterm effort to reach our objectives, despite the progress made. Regarding SG&A, we still have some savings to realize, most of which are already behind us. I don’t want to imply that we have large reductions remaining ahead of us, but there will still be some impact moving forward, which will be immediate. The remaining savings on that front will be completed by the end of the fourth quarter.

On the same topic, I know we touched on it earlier. Considering the timing of some of these projects, should we expect that Vitalyst will provide some offset on the gross line next quarter? Do you still have some of the same subcontractors working on these projects? Should we anticipate a bit of pressure on gross margin next quarter, with a potential easing as you implement the plans you've outlined?

On gross margin, we need to consider recovery in the short, mid, and long-term. Before the third quarter, our gross margin was already at lower levels due to the R3D acquisition. In the short term, we should return to those levels. Q3 was influenced by various factors that coincidentally affected us more than usual. The same factors I mentioned before, such as the labor mix and specific projects, create challenges that can appear more concentrated at times. This should balance out in the near future. As for software revenues, there isn't a clear trend; they can fluctuate significantly from quarter to quarter based on the projects and billing timelines. Therefore, Q3 is not indicative of a continuing trend. In the short term, we can expect some of the negative impacts that coincidentally bundled together in Q3 to diminish. Moving to the midterm, we're continually working on the labor mix, which is crucial for our growth. We have been investing successfully in growth, and we will likely focus more on performance and delivering that growth effectively. In the long term, factors like service mix, higher value-added projects, and acquisitions will contribute to an increase in gross margin. It's essential to evaluate all three levels, though we do not provide specific guidance.

Your next question comes from Amr Ezzat from Echelon Partners.

This is Michael Vaccarino on behalf of Amr. So, most of my questions have been answered so far, but I'll throw in a couple of quick ones. In your prepared remarks, you spoke about deleveraging. Can you provide some color on how you're looking at M&A going forward? Is your current 2.6x net leverage at peak, whereby you wouldn't look at acquiring anything further? Or just kind of trying to get a sense of your appetite here?

There are two main factors to consider regarding this ratio. The first is our future performance in terms of EBITDA, which we haven’t commented on beyond what we've previously stated. The second factor is the debt itself, which will depend on whether we pursue additional acquisitions. We have consistently indicated that making acquisitions regularly is part of our strategic plan. Depending on the timing, especially if we continue to generate strong cash flow like we did in Q3, the deleveraging process could happen quickly. Our target has always been around 2x leverage. It's important to remember that the chart reflects only the reported EBITDA. Our bank covenants assess acquisitions on a pro forma basis, allowing us to account for the trailing 12 months of acquisitions even prior to ownership. This reflects the potential profitability once we invest cash into an acquisition. Hence, it's challenging to project that number for these reasons. However, I can tell you that our comfort zone is around 2x, slightly higher when we deal with acquisitions that have a recurring revenue profile, which is certainly true for Vitalyst.

And then, back on your comments on utilization. I know you don't release your utilization rates, but can you give us a sense of where you are currently sitting relative to Q3? Are you close to fully utilized?

Yes. We're not talking about Q4 today. Sorry, Michael.

And your last question for today comes from Nick Agostino from Laurentian Bank Securities.

So, just on the gross margin side, I mean, obviously it feels like, obviously in this case, you had lots of growth, and you've had to go out and get subcontractors to help you fulfill that growth. So it almost feels like added growth will impact your gross margin near-term, and slower growth. You can maybe offset that as you get more and more FTEs in the door. I'm assuming that that's a short-term view that we should be having here. And my question is, are you guys still comfortable, now that you've completed the R3D integration, are you still comfortable that you can get to that 25% gross margin level, plus or minus, I think it's within a two- to three-year time period, just given the growth that you guys are seeing in front of you and the rate at which you're adding people within North America and within Morocco?

On both of those, you're absolutely right. There's a short-term pressure just because we're ramping up so fast. But on the plan for the Beneva and Quebecor ramp-up and gross margins on those contracts, we're right on track. We're very comfortable with the target, the 25%. And remember, that contract is guaranteed margin. So, if something happens and we can't make the margin, there's a mechanism for compensation in that. So that's why we're 100% confident on that one.

You previously mentioned various markets, and I wanted to ask for an update on the higher education initiatives you've launched. What insights do you have regarding the higher education market and the opportunities within it? How have these initiatives contributed to the current quarter, and what are your expectations for the upcoming quarters?

In terms of higher education, we have very high expectations. We view it similarly to the current situation in healthcare. Many higher education institutions have faced challenges over the past two years due to COVID, remote service delivery, and fluctuating student attendance. There is significant potential in this area; the growth is underway, but it's not progressing at the same pace or level as in healthcare. I believe they are about a year or two behind healthcare. Additionally, the nature of these institutions means that decision-making tends to be more collaborative, which often leads to longer timelines. However, we see considerable potential in higher education that mirrors what we are experiencing in healthcare today.

And then, my last question, on prior calls and news releases, there was talk about a Canadian fixed price contract. Can you just give us an update as to the status of that contract and specifically if it has been or how close you are to completion?

Yes. As we mentioned last quarter, that one is over and done with. There are no more overages on that project. It's mostly completed and implemented, and everything else we're doing there is a new business with the customer.

And there are no further questions at this time. I will turn the call back over to the presenters for closing remarks.

Thank you very much, Julie. Thank you, everybody, for joining us today. Appreciate your questions and looking forward to talking to you on the next call. Take care.

This concludes today's conference call. You may now disconnect.