Earnings Call Transcript - ALYAF Q4 2022

Operator, Operator

Good morning, ladies and gentlemen. And welcome to Alithya's Fourth Quarter and Fiscal 2022 Financial Results. 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, Vice President of Communications and Marketing

Good morning, everyone. And thank you once again for joining us for Alithya's fourth quarter and fiscal 2022 results conference call. The press release and MD&A with complete financial statements and our related notes were issued this morning and are now posted on our website. The webcast presentation can also be found on our website in the Investors section. Before we begin, I'd like to specify that this conference call is intended for the financial community. Also, 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 I would like to turn the call over to Paul Raymond. Paul?

Paul Raymond, President and CEO

Thank you, Rachel. And good morning, everyone. Bon jour. I'm very pleased to be here with you this morning to speak about another quarter of record revenues for Alithya to close out our 2022 fiscal year. The quarter was marked by industry-leading growth in revenues and adjusted EBITDA, both on a sequential basis and year-over-year. On that note, before I dive deeper into the drivers behind our fourth quarter numbers, I'd like to take a moment to discuss our latest transaction, the acquisition of Datum Consulting Group, which is expected to close on July 1. As you have seen in the past, we continue to adhere to a very disciplined approach to mergers and acquisitions. Our strategy remains focused on a balanced approach to organic growth and on acquiring quality companies at the right time for the right price. Again, we look for complementary companies that can leverage our platform to accelerate growth and generate synergies from our scale. The acquisition of Datum really epitomizes that strategy, and there are three main takeaways from the transaction that I would like to share with you. First and foremost, Datum is a leader in specialized digital transformation services and software that primarily targets the insurance industry and public sectors, which are two staples of Alithya's existing operations. As Alithya continues to penetrate deeper into the global insurTech market, the acquisition of Datum adds six of the top 10 health insurers in the United States through our growing client base. Additionally, I spoke earlier about the importance of synergies. The acquisition of Datum adds a suite of 14 intellectual property-based products to our toolbox, which greatly enhances our flexibility in addressing an even wider range of customer projects. And finally, Datum generates a growing proportion of revenues from its SaaS offering, our Software-as-a-Service, which will bolster Alithya's offer of cloud-based solutions that are always in growing demand. Now back to our fourth quarter performance. We closed out the year with another quarter of record revenue, and our signed contracts continue to feed a healthy pipeline of projects. So we head into fiscal 2023 with a solid book-to-bill ratio of 2.4 for the past 12 months. Furthermore, with the announcements of three acquisitions in our last two quarters alone, this will also add to our bookings going forward. In the past quarters, we spoke a great deal about the relevance of bookings, which translates into future revenue. In the fourth quarter, our past bookings contributed to a record of $120 million in revenue or a 54% increase over the same quarter in fiscal 2021. We are very proud of this industry-leading achievement. At the same time, Q4 was another exceptionally strong quarter in terms of new bookings, particularly in the manufacturing and health care verticals in the United States and the financial services in Canada. Those new bookings have replenished our healthy pipeline as we head into fiscal 2023, allowing us to maintain our momentum. Also, we are more than happy to have welcomed to Alithya more than 120 new customers throughout the fiscal year. Now on a regional basis, Alithya experienced 63% revenue growth across our Canadian operations. That is a significant number driven by general post-pandemic recovery in many sectors of the economy and the accelerating need for a trusted digital transformation partner. Part of that growth is also attributable to Alithya's acquisition of R3D in April 2021, with synergies reached through the completion of the company's administrative integration into Alithya's operations in Q3 and revenue generated by two long-term contracts signed with Beneva and Quebecor as part of that acquisition. On that note, I'm pleased to inform you that after one year of doing business with these two major clients, we are on track in generating more than $60 million in billable hours promised per year. Of note, future bookings from Beneva and Quebecor contracts will not be included unless the contractual revenue minimums are exceeded. Organic growth was also the name of the game in the United States, where Alithya experienced a 40% year-over-year increase in revenues, particularly as previously mentioned, in the manufacturing and health care verticals. Our U.S. growth included a $5 million revenue contribution from the newly acquired Vitalyst and that from only two months on the books in the quarter. We are also encouraged by the continued growth and momentum of both our Oracle and Microsoft practices in the U.S., particularly the latter, which is now generating returns on substantial bookings reported in previous quarters. Our dedicated team successfully completed 21 go lives of enterprise cloud implementations. Internationally, our European operations also experienced a record quarter with a year-over-year organic increase in revenues of 55%. That performance is an encouraging sign of a healthy business in a region where our customers were particularly hard hit by the pandemic. And as we continue to leverage synergies across all of our operations, the Alithya Digital Solutions Center headquartered in the province of Quebec, and by extension our Morocco hub have stepped in to assist our office in France in addressing its growing portfolio of new projects. Filling that void of technical expertise remains one of the biggest challenges at the forefront of a competitive IT industry, along with lingering global uncertainties and inflationary pressures. Accordingly, accelerated growth sometimes forces us to reluctantly hire subcontractors in order to fill our growing pipeline of projects and that in turn has a negative impact on our gross margins. That being said, the harmonization of our internal training initiatives, our recruitment campaigns, our new offshore offices, and our organizational culture is strengthening our ability to hire and maintain the best available talent, which provides us with confidence and optimism as we enter fiscal 2023. Indeed, our customers can now count on more than 3,700 professionals to drive their digital projects, and this is not including the 150 new colleagues we are about to welcome on July 1 with the expected closing of the Datum transaction. At the same time, we experienced an important growth in the number of permanent employees during fiscal 2023, namely an increase of almost 30%. Please turn to Slide 6 to discuss our gross margin objectives. Given our new critical mass and growing maturity, in Q4, we started accelerating our efforts to drive cost efficiencies and synergies across the company and achieved industry standard SG&A targets. Also, as explained in our strategic 2022 - 2024 plan, we are continuing our initiatives to transition to higher-value services to hire more permanent employees and to acquire complementary companies with higher margin profiles.

Claude Thibault, Chief Financial Officer

Good morning. Please turn to Slide 7 for our fourth quarter highlights. Revenues for the quarter increased 54% or by $42 million to $120 million. Excluding the impact of the Vitalyst acquisition, which occurred on February 1, 2022, and the R3D acquisition, which occurred on April 1, 2021, true organic growth was approximately 30%. In other words, strong sustained organic growth again. We see approximately 30% because we fully integrated R3D into Alithya, on December 31, 2021, and we no longer track the specific R3D numbers separately. In Canada, revenues increased by 63% to $74.2 million due to organic growth in all areas of our operations, a general recovery of DT levels, revenues from the R3D acquisition and finally, growth from the two associated long-term contracts with Beneva and Quebecor. In the U.S., revenues increased 39.4% to $41.3 million as we experienced strong organic growth in all areas, the general recovery of activity levels and revenues of $5 million for two months of the Vitalyst acquisition. This increase was partially offset by some unfavorable U.S. dollar exchange rate impacts. As for our international operations, they reported a record quarter in terms of revenues, increasing 55% to $4.5 million from $2.9 million for the same quarter last year. Well, let's look at gross margin. It increased by $7.6 million or 32.5% to $31.1 million in Q4. As a percentage of revenues, fourth quarter gross margin was 25.9%, that is down from 30.1% for the same quarter last year. As previously mentioned, the R3D revenues historically showed the higher proportion of billable subcontractors and a corresponding lower gross margin profile. The decline in gross margin percentage also comes from an increase in the subcontractor revenues relative to those from permanent employees, coupled with an increase in the average cost of those subcontractors, explained in part by the tightening labor market. Secondly, increased costs in certain customer projects. And thirdly, the absence of COVID wage subsidies, which we had received in the Q4 of last year. The decrease, however, was partially offset by increased gross margins internationally and a positive margin impact from the Vitalyst acquisition. SG&A expenses in Q4 totaled $26.2 million, an increase of $4.5 million or 20.5%. The increase was primarily due to an increase in Canada of employee compensation costs as headcount and salaries increased and an increase in information technology and communication costs, mostly relating to the R3D acquisition, which was partially offset by a decrease in non-cash share-based compensation. U.S. and international expenses increased due to higher employee compensation costs as headcount and salaries increased and variable compensation trended up along with revenues as well as increased information technology and communication costs, some of the overall increase, of course, coming from Vitalyst. As a percentage of consolidated revenues, total SG&A amounted to 21.8% for the Q4, a notable decrease compared to 27.9% last year. This is a trend which we intend to continue to pursue with a target of 20%. At the current scale of our development, we believe we can now turn our focus to further synergies and operational efficiencies, which will help us get there. Overall, our fourth quarter adjusted EBITDA amounted to $6 million, an increase of $2.7 million compared to the same quarter last year. As in previous quarters, while we have an accounting net loss of $7.3 million, I would bring to your attention the nonrecurring expenses in the quarter of $6.1 million and the non-cash depreciation and amortization totaling $5.2 million, resulting in a positive adjusted cash flow generation overall. Looking at long-term trends on Slide 8, 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, as mentioned before. We believe most of these factors are largely cyclical, subject to some natural recovery over time, and we also aim to reverse the trend with a number of targeted initiatives, focusing on labor mix and costs, including with our new Morocco operation, utilization improvement, selling price adjustments and by focusing future growth in our higher-margin segments. On Slide 9, our long-term EBITDA trend reflects our growth, but also our recent gross margin challenges as well as some increases in SG&A despite their gradual decrease as a percentage of revenues. We are again summarizing here our long-term business objectives, which we have been communicating over the years. Revenues, our recent organic growth and acquisitions have taken us close to the $0.5 billion mark, and we certainly intend to maintain the push on both fronts. For gross margin, we believe our long-term strategies remain relevant for gradual recovery and further improvement. Our SG&A, as I just discussed, we believe we will continue on our gradual decrease of SG&A as a percentage of revenues and will reach our targeted levels. That is how Alithya believes that it can realistically aim to achieve its three-year objective of $600 million in revenues with an EBITDA margin of 9% to 13% by 2024. Now turning to liquidity and financial position metrics on Slide 10. In line with our $6.1 million of non-recurring expenses during Q4, net cash used by operating activities was $4.8 million, including some negative working capital variations, which are in large part the result of our strong organic growth. On Slide 11, we see long-term debt increasing to $106.7 million, up from $61.6 million with a similar increase of our net bank borrowing. This increase comes from acquisitions, negative cash flow from operations, and an increase in our cash balances minus the proceeds from the share issuance, which we did at the end of January in conjunction with the Vitalyst acquisition. This increase in debt, however, does not translate into a much higher debt-to-EBITDA ratio at the end of Q4 because of the strong historical profitability of Vitalyst. As such, we still believe we are moderately leveraged, and we expect to see a steady deleveraging trend going forward. The acquisition of Datum, expecting to close on July 1, which will also bring good historical profitability and has built-in acquisition financing terms will not have a significant leverage impact either. In closing, our normal course issuer bid launched back in September is progressing as planned. Since the beginning, Alithya has repurchased and canceled approximately 0.5 million Class A shares for a total consideration of $1.6 million.

Operator, Operator

Thank you, Mr. Thibault. Your first question will be from Nick Agostino at Laurentian Bank.

Nick Agostino, Analyst

Yes. Good morning, gentlemen. To begin, I saw in your prepared remarks that you mentioned a 29% year-over-year increase in permanent employees. Could you provide some insight into how much of that increase is related to the Vitalyst acquisition? Additionally, how much of it is specifically linked to the R3D segment? A breakdown would be appreciated.

Paul Raymond, President and CEO

Yeah. Good morning, Nick. Thanks for the question. If I'm going on memory here and Claude correct me, but I believe Vitalyst had about 150 employees, all full time. So the balance would be from the rest of the business.

Nick Agostino, Analyst

But when you say the rest, are you hiring any permanent staff and targeting them specifically on our R3D?

Paul Raymond, President and CEO

Yeah. So yeah, great question. So there's a significant increase of permanent people tied to the two new agreements that we signed. If you remember, when we talked about the R3D acquisition, R3D was mostly a subcontractor base of business, very high percentage of subcontractors. So of course, we still have to deal with those contracts. But all of the new business that we're getting from the two large agreements that we have, there was a significant increase there in full-time employees instead of contractors.

Nick Agostino, Analyst

I appreciate that. I was wondering if you could discuss the pricing increases on contracts as they roll over and whether you had any implementations regarding that, as well as how it's being received in the marketplace.

Paul Raymond, President and CEO

We are continuously working on pricing for contract renewals and new proposals, incorporating some increases. Currently, the market seems to be absorbing these adjustments, as reflected in our bookings, which are not an issue for us. Our primary challenge lies in securing the necessary workforce for such projects. While we are selective in our bidding process, we are in high demand and do not want to decline any project opportunities. To address this short-term challenge, we are utilizing contractors as a temporary solution until we can hire permanent staff more quickly. Regarding the R3D initiative, we completed the first year of our two-year plan and are on track to resolve it by the year's end. We believe our operations in Morocco will significantly benefit us by allowing us to employ many full-time staff, reducing our dependency on subcontractors. Additionally, our recent acquisition of Datum, which will take effect July 1, will provide us with remote capacity in India and Eastern Europe, and we are eager to expand that business rapidly.

Nick Agostino, Analyst

Great. You mentioned on the call that you're aiming to speed up efforts to achieve cost efficiencies and synergies. In your presentation, you talked about rent reduction as one of the initiatives you're implementing. Can you share your expectations regarding the synergies you hope to achieve from this acceleration over the next year?

Paul Raymond, President and CEO

We have been examining this for a considerable time. We've mentioned that our selling, general, and administrative expenses as a percentage of revenue are expected to decrease as we scale. We completed three acquisitions in the last two quarters and integrated R3D over the past year. Currently, we're operating at a run rate exceeding $0.5 billion. By projecting our revenue, we are in a solid position. With the increased activity on the M&A front, we are identifying numerous opportunities for cost synergies, primarily through the elimination of redundant back-office support positions. We are experiencing many synergies and consolidations as a result. In our Q4 numbers, we included some severance costs associated with these changes. Our goal is to reach the industry average of around 20%. Currently, we are close to 22%, specifically at 21.8% for the quarter. We believe we can reduce this below 20% for our existing business, and that is our objective. The team is dedicated to achieving this, and we see significant potential in this area right now.

Claude Thibault, Chief Financial Officer

Just if I can add, we are not providing specifics on this for a few reasons. We're managing significant growth. So it's not like we can just make decisions without that taken into consideration. And some of the gain in percentage will come from our ongoing growth. So you got to balance the two, and there is timing as well. When will we be taking those actions and so on, but we're not providing specifics in terms of and timing.

Paul Raymond, President and CEO

Maybe, Nick, I can give you a couple of real examples of how we're seeing that. So one example was the rent, as you mentioned, as we bring in new businesses, we don't need more offices. So that one is an easy one. Some external services that we've used in the past, we now have the scale to do them internally and then save a lot of money. So there are things like that, leveraging offshore which we did not do in the past, but which the pandemic has enabled us to do and especially with our Morocco operations now. So there are a lot of opportunities, which we would call low-hanging fruit right now based on that growth that we've had that we're looking at. But as Claude said, we need to balance that with managing the growth because there is no plan on slowing down.

Nick Agostino, Analyst

Okay. That’s all for me. Appreciate that.

Operator, Operator

Thank you. Next question will be from Gavin Fairweather at Cormark. Please go ahead.

Gavin Fairweather, Analyst

Hey, good morning. It sounds like you're continuing to see very strong demand across the business. But just so to ask given all kind of the recessionary fears here, can you give us a snapshot maybe into the top of your funnel? Are you still seeing that growing kind of at the prebooking stage? Or are you seeing any kind of signs of hesitation across any of your practices or regions?

Paul Raymond, President and CEO

Good morning, Gavin. No, actually, we're not seeing and our concern isn't the coming recession. Our concern is more the inflationary pressure in finding people. I mean based on past experience and especially in what we're seeing now the funnel, I mean if a recession were to hit, our customers would be accelerating digital transformation to try to save money, become more efficient, to launch new products, be more creative. So no, we're not seeing any kind of slowdown in our funnel activity. Actually, the new acquisitions are opening up new opportunities for us because of the cross-selling that we're seeing in our existing customers and the new customers that they're bringing to the table. So no, very optimistic going forward, Gavin.

Gavin Fairweather, Analyst

And then maybe just on capacity utilization kind of by region, thinking Canada versus the U.S. I mean you've been speaking to being kind of at capacity in Canada for some time. Maybe zeroing in on the U.S., given the strong bookings, do you still have some headroom in the Oracle and Microsoft practices to accommodate kind of the strong bookings that you're seeing with your current FTEs?

Paul Raymond, President and CEO

We've experienced impressive bookings, with growth evident in both our Microsoft and Oracle sectors, as shown by the U.S. figures. Our Oracle practice is now global, just like our Microsoft practice, allowing us to expand beyond the U.S. We have Oracle teams in Canada, as well as Microsoft teams. This geographical expansion enables us to source talent for U.S. projects not just from the U.S., but also from Canada and Morocco, increasing our capacity wherever our operations are located. The pandemic has facilitated remote work, and our customers are receptive to this approach, particularly in today's inflationary environment where competitiveness is crucial. By utilizing our offshore capabilities, we enhance our competitiveness and improve margins over time. We're also seeing significant opportunities through our academies, where we successfully hire students directly from college, even those without an IT background, and provide training on our platforms. This initiative is yielding excellent retention rates, and we're looking to accelerate it further. It represents a valuable investment in bringing new talent into the industry, effectively creating another method for finding qualified personnel.

Gavin Fairweather, Analyst

And just as a follow-on on the labor front, I mean I've been hearing with some of the hiring freezes just over the past kind of one month or six weeks that has been a moderate easing of the labor crunch. I mean maybe early days, have you started to see any kind of green shoots on that front? Curious for your thoughts on that.

Paul Raymond, President and CEO

No. Like I was saying, Gavin, on our side, it's more we're finding opportunities for synergies in the back office. But the people that we have are in very high demand. So some of our people were moving from non-billable roles to billable roles. Sometimes it's replacing an outside provider with an internal individual because we have the scale to do it now. So from that perspective, we still have several hundred open positions in the business that we're working aggressively that the staff. We have a recruiting machine. We have about 80 recruiters in the company. That's all they do full time for global recruiting. We're very active on the international recruiting front as well. So that really is still going on all cylinders on that front.

Gavin Fairweather, Analyst

And then just lastly for me, I mean, obviously, a key part of the business case for the Vitalyst acquisition was kind of cross-sell maybe early days on that front as well. But can you give us an update on how that piece of the strategy is coming together?

Paul Raymond, President and CEO

Yeah. It's coming together very well. Gavin, actually, the week following the announcement, we had one of our existing customers who called Microsoft for some training, and they said, Well, you know you should be calling a Vitalyst. So the week following the announcement, we actually had our first opportunity, one of our existing customers that came in through the back door. So that's working very well. We see a lot of opportunity there. And again, we see opportunities for efficiencies there as well because most of the people were located in the U.S. And now as that business grows, we can locate anywhere. So again, we see some opportunities there to grow that business faster and become more efficient in how we deliver the services.

Gavin Fairweather, Analyst

Thanks. I’ll pass on.

Operator, Operator

Thank you. At this time, we have no further questions. Please proceed with your closing remarks.

Paul Raymond, President and CEO

Thank you, everyone for being with us this morning. Again, I'll reiterate that we're committed and focused on our three-year strategic plan. We enter fiscal 2023 with confidence and optimism. And we look forward to discussing our first quarter results of 2023 in August. Have a nice weekend.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.