Earnings Call Transcript - ALYAF Q3 2020

Operator, Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Alithya's Third Quarter 2020 Earnings Conference Call. Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. I would like to remind everyone that this conference call is being recorded on Thursday, February 13, 2020. I will now turn the conference over to Pierre Bouchet, President at Maison Resonne. Please go ahead.

Pierre Bouchet, President

Good morning, everyone. Thank you for joining us for Alithya's Third Quarter Fiscal 2020 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 related 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, Senior Vice President and CFO. Following their comments, we will open the call for questions. Before we begin, I'd like to specify that this call is intended for the financial community. Please be advised that this will contain statements that are forward-looking and subject to a number of risks and uncertainties that can cause actual results to differ materially from those anticipated. Please refer to the risks and uncertainties section of our MD&A available on our website for more details. 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 some indicators that are non-IFRS measures. Please refer to our MD&A for more details. I will now turn the call over to Paul.

Paul Raymond, CEO

Thank you, Pierre. Good morning, everyone. I'm very happy to be with you today to discuss our latest results. I want to highlight what I feel are three key takeaways from the quarter and how it fits into Alithya's growth strategy more broadly. First, the uptrend in the gross margin continued. Our gross margin remains one of the highest on record. Second, both the adjusted EBITDA and adjusted margin reached their highest level since going public. And lastly, as we scale, we continue to drive integration and operational synergies and savings. Since the acquisition of Edgewater, our SG&A has been declining in both absolute dollars and as a percentage of total revenue. During the third quarter, Alithya was very active on the acquisition front. The acquisition of Matricis in October 2019, Travercent in December 2019, and the addition of Askida post quarter-end will clearly accelerate our growth going forward and reinforce our platforms on both sides of the border. In all, these acquisitions represent a total value of close to $50 million, which we financed with a combination of debt and shares. During the quarter, we also divested our small U.K. operation. Revenues for the quarter were up 13.9% to $66 million. Third quarter revenue growth reflects the contribution from past acquisitions and is partially offset by reduced spending at a few large Canadian customers, the Oracle legacy products and services, and to a lesser extent, the sale of our U.K. operation. In Canada, we've been working hard to mitigate some of the decline through growth with new and existing clients, supported by the increase of higher value-added services and the commercial benefits from our larger scale. In Q3, we added 55 new clients spread across all our geographies. This is a combination of new contracts, new master service agreements, and new clients from acquisitions. Finally, we are proud to announce that during the third quarter, Alithya was recognized with a Customer Service Excellence Award presented by the Organization of Canadian Nuclear Industries, or OCNI. The award recognizes Alithya's ability to consistently meet customers' expectations, with consistent attention to their needs and an excellent record for on-time and on-budget project delivery.

Claude Thibault, CFO

Thank you, Paul, and good morning. Since Paul has already covered our top line growth drivers, I will focus on some profitability and balance sheet metrics. Gross margin increased 22.6% in the third quarter, increasing to $20.2 million compared to $16.4 million in the corresponding quarter last year. As a percentage, gross margin increased to 30.4% from 28.3% for the same quarter last year, up 210 basis points year-over-year. Gross margins benefited from the acquisitions of Edgewater, Matricis, and Travercent, as well as the larger contribution of higher value-added services. More specifically, our U.S. gross margin remained strong, while our gross margin in Canada showed improvement, both year-over-year and on a sequential basis, over the second quarter. Our long-term strategy to move towards higher value-added services and increasing the use of permanent employees continues to drive gross margin higher over time. In the third quarter, SG&A expenses amounted to $17.7 million, up 7.8% from $16.5 million last year. The increase can be mainly explained by the additional expenses from our acquisitions, offset by lower expenses from the divestiture of U.K. operations and certain nonrecurring items. On a sequential basis, compared to the second quarter of the current year, SG&A expenses decreased by 4.5% from $18.6 million to $17.7 million. Management continues to target decreasing administrative expenses as a percentage of total revenues, as consolidation synergies materialize and larger scale allows for more leverage. During the third quarter, we identified and realized additional consolidation synergies and savings, which accounted for $0.8 million of expenses recorded in the quarter. On a full-quarter basis, meaning if these reductions had all been realized at the beginning of the quarter, the total SG&A savings realized amounted to approximately $1.1 million on a recurring quarterly basis. The acquisitions, combined with the growing contribution of higher value-added services, resulted in our adjusted EBITDA rising more than 166% in the third quarter from $1.3 million last year to $3.5 million this year. Growth in adjusted EBITDA also reflects a positive impact of $0.6 million from the adoption of IFRS 16 on leases, which was partially offset by a combination of recurring and nonrecurring expenses related to being a public company and expanding the business. Of note, both in absolute dollars and as a percentage, our adjusted EBITDA has increased sequentially for the past five quarters, from $0.9 million in the second quarter of 2019 up to $3.5 million this past quarter. The net loss in the quarter was $1.8 million or $0.03 per share compared to a net loss of $5.4 million or $0.12 per share for the same period last year. This improvement was driven by increased EBITDA, partially offset by increased amortization of intangibles and depreciation, and decreased income tax recovery when compared to the same quarter last year. Now turning to our liquidity and financial position. Operating activities generated $8.1 million in liquidity in the third quarter, a marked improvement versus a use of liquidity of $9.7 million last year. Despite completing two acquisitions, representing a total value of over $30 million, we ended the third quarter in a healthy financial position. At December 31, we had $10.2 million of net bank borrowing compared to a net bank borrowing of $8.7 million at the end of fiscal 2019. We now have $45 million in total long-term debt on a gross basis.

Paul Raymond, CEO

Thank you, Claude. As discussed, the acquisition of Travercent in December 2019 is an excellent example of our strategy in action. We were able to complete this acquisition and integrate it successfully by leveraging our existing U.S. platform. The operational integration process went smoothly because of the highly complementary and self-contained nature of the Travercent business with our U.S. operations. Travercent brings us additional scale in the U.S. health care sector and expertise in Oracle cloud-based ERP technologies, which will help offset the decline we are seeing in our Oracle legacy products and services. It's a similar story with the acquisition of Askida. Our established scale made this acquisition easier to integrate operationally. Askida gives us additional expertise in software testing, quality assurance, and advanced application development and modernization, which we can leverage throughout our network. We are pleased to welcome the 110 professionals from Askida into the Alithya family. Both these acquisitions are highly profitable and will be immediately accretive to our results. We are focused, more than ever, on our 3- to 5-year growth objectives. We continue to expect gross margin expansion supported by acquisition, higher-value services, increasing the number of permanent employees, and scale. We have faced challenges on the organic front in Canada in the past year. However, we are actively working to add new clients, new higher value-added services, and growing scale through niche acquisitions to reduce our exposure to IT investment cycles of large customers. The recent success with our acquisition program does not deter us from the objective of resuming organic growth in the near term. It remains an integral part of our business plan, as demonstrated by the addition of dozens of new clients in the quarter. The acquisition of Matricis, Travercent, and Askida has brought in annualized revenues of approximately $35 million. We end the quarter with a strong balance sheet and are well positioned to continue to pursue our acquisition strategy and deliver on our long-term vision to become a North American leader in strategy and digital transformation.

Operator, Operator

Your first question comes from the line of Deepak Kaushal with Stifel.

Deepak Kaushal, Analyst

Can you hear me?

Paul Raymond, CEO

Yes.

Deepak Kaushal, Analyst

Paul, I just wanted to ask you a bit about the Canadian market. You talked about reducing reliance on some of the major Canadian customers you've had in the past and diversifying your customer base. Can you talk more specifically about what's going on with those big Canadian customers? Is this reduction part of your shedding of the lower margin business? Or as part of this reduction are there changes in how they're procuring services from service providers?

Paul Raymond, CEO

Thanks for the question, Deepak. I think my first comment I'd say on that is we're not losing any market share in those customers that we're talking about. It's really a variety of subjects. Some customers are changing. One has been very public in changing their approach. Others, to your point, some is a lower-margin business that we're shedding, and others is just the change in the buying cycle. Some of these projects with large customers are very big, and of course, the decision cycle is longer. We've been talking about this for a few quarters. So we haven't been waiting on the sideline for this to change. Instead, we've been very aggressive with other customers and adding new customers. We mentioned last quarter in terms of new customers we added, and again this quarter, with 55 new customers, we're confident that we will catch up to that eventually.

Deepak Kaushal, Analyst

Okay. Is there any light at the end of the tunnel for some of these major Canadian accounts? Like, 6 months, 12 months?

Paul Raymond, CEO

Like I said, we haven't lost any market share. Yes, we haven't lost any market share, so as the spending resumes at some of those, we're going to get our fair share. In the meantime, we're not waiting. We're securing business in other places.

Deepak Kaushal, Analyst

Okay. Great. And just on the M&A front, between Matricis and Travercent, are you able to give us a sense of what percentage of your business is tied to the health care sector today, including those acquisitions that are outside Canada?

Paul Raymond, CEO

No, that's a great question, Deepak. In the U.S., I can tell you, we had some health care business on the EPM side with our own existing Oracle pre-Travercent. However, I don't have the exact number for that one because we didn't track it that way, we tracked it by practice. But Travercent was 100% health care. They were seen as the top provider of Oracle cloud solutions in health care. So they're fair counterpart to our Microsoft business that was top in process manufacturing. Travercent was very specialized. We're very happy with that. Because of that mix, now 75% of our U.S. Oracle business is now in the cloud space, which is the space that's growing the fastest.

Deepak Kaushal, Analyst

Okay. And can you give us a sense of the natural growth rate of Travercent's business?

Paul Raymond, CEO

It's been double-digit in the past.

Deepak Kaushal, Analyst

Okay. And then I had a follow-up for Claude. I'm just trying to understand the pro forma net debt position and leverage ratio, post-Askida and given all the cash payouts for Travercent. I'm getting about $65 million. I think I might be a bit high. Can you give me a sense of what you're looking at in terms of pro forma net debt, net debt to EBITDA?

Claude Thibault, CFO

Well, we provided some details. You need to consider cash, obviously. We tend to look at debt on a net basis. We had very high cash balances at the end of the year to pad for the holiday season. Our gross debt level should be lower in absolute terms, so I'm getting to a lower number than you, actually. We're more around the $40 million range.

Deepak Kaushal, Analyst

Okay. And can you remind me what kind of leverage ratio cap you're comfortable with? Is it 2.5x or 3x?

Claude Thibault, CFO

Yes. Total debt for us should be between 2 and 2.5x. We're not comfortable going much higher than that, unless we have significant and easy synergies, then we could stretch it for a temporary period. Otherwise, we're shooting for 2 to 2.5x, which is times EBITDA. As you know, we're going after profitable acquisitions. So every time we write a check, it usually comes with additional incremental EBITDA. So our multiple doesn't move that much higher. Our recipe, as you know, is to have 50-50 shares versus cash. It will depend on the situation and the shareholder profile of the target. But if you go 50-50 and even the cash portion tends to be 50% on closing and 50% on later dates, the impact on cash upfront is very limited from that perspective. So the leverage of our available borrowing is significant on that structure.

Operator, Operator

Your next question comes from the line of Maher Yaghi with Desjardins.

Maher Yaghi, Analyst

I'm trying to assess how long it's going to take for the Canadian business to overcome some of the pressures you're talking about. You have resumed your M&A strategy, and we've seen the result of that in recent transactions, which is positive. But your base business is continuing to feel the pressure. By our estimate, your organic growth rate in Canada is mid-single-digit in the quarter. If I’m not mistaken, can you tell us when, if there is a path to growth in Canada and how long you think it's going to take to get there?

Paul Raymond, CEO

Maher, thank you for the question. I think you need to break it down. Our job is to identify where the issues are and fix them. We had an issue in the U.S. with growth in our Oracle legacy products. We were looking for a way to accelerate the cloud component. We've done that with the Travercent acquisition, which was a great fit, both culturally and business-wise. Given that we have a strong platform in the U.S. to accommodate that, we are confident that we have turned the corner in the U.S. The Microsoft business in the U.S. is stable and growing, so there are no concerns there. In Canada, the same thing. In most of our regions, we have growth, and we had sequential growth in Canada in the last quarter as well. If you look back historically, our large customers, specifically in Québec, were a significant chunk of revenue. When one of those slows down, it impacts the rest. We have been active in adding new customers in other areas. We saw sequential growth in the last quarter in Canada because of that, and with cross-selling also kicking in. That's why you're seeing our margins improving in Canada as well because now we're cross-selling higher value-added services and staying away from the lower-margin projects. Yes, we might let go of some projects that we don't bid on, but the ones we do bid on are much more interesting and profitable, and those are the ones generating strong long-term growth.

Maher Yaghi, Analyst

When you look at your top three accounts, two of them are causing pressure on your top line. How much of your Canadian revenue is now coming from these two clients? Trying to assess how much more further pressure you could get from these clients?

Paul Raymond, CEO

I can't answer that. We have no customers that represent more than 10% of our revenues today.

Operator, Operator

Your next question comes from the line of Amr Ezzat with Echelon Partners.

Amr Ezzat, Analyst

Can you give us more color on the Oracle EPM business? Paul, you mentioned that it's now 75% cloud, 25% on-premise. I'm just wondering what prompted the large decline specifically during the quarter because it seems the overall Edgewater performance over the last three quarters was stable, and then you had that big drop during fiscal Q3. Do you expect that legacy part of the business to decline to zero, or how do we think about that?

Paul Raymond, CEO

There's a few factors to consider. In the U.S., Q3 is always lower than Q2 because of the Thanksgiving holidays. That's one point. But on the Oracle business, the 75% includes new revenues from Travercent. You have to be cautious with that number because it contains their contributions. The legacy work is indeed declining significantly, and there was an announcement at Oracle where they shut down their public sector service division in Canada. So they're restructuring as well. However, our cloud business has been growing double digits, even though it's offset by the faster decline of the on-prem business. We have customers moving legacy applications to the cloud. We are now helping our customers keep their legacy applications while migrating to the cloud.

Amr Ezzat, Analyst

Are you guys disclosing how much revenue and EBITDA both acquisitions are contributing to the quarter?

Paul Raymond, CEO

No, we're not.

Amr Ezzat, Analyst

Could you give some color at a higher level?

Paul Raymond, CEO

We disclosed the historical top line of these targets around the time we made those acquisitions, but we will not provide these details going forward. We're focused on an integration approach. So we start cross-selling the targets' products and services into our existing operations and vice versa.

Amr Ezzat, Analyst

Understood. Regarding the Edgewater acquisition, where are you guys currently standing vis-a-vis those targets?

Claude Thibault, CFO

We see additional savings on SG&A going forward. The short answer is, we keep these targets. We are confident in achieving those levels going forward. As Paul mentioned, we are looking to buck the cycle in future quarters.

Operator, Operator

Your next question comes from the line of Gavin Fairweather with Cormark.

Gavin Fairweather, Analyst

I wanted to just touch base on the Microsoft practice in the U.S. Historically, you've talked about that business growing high single-digit, low double-digit. Just wanted to check in on that practice and see if those growth rates are unchanged?

Paul Raymond, CEO

Yes, the Microsoft business is actually pretty stable. It's growing in both the U.S. and in Canada. We're focused on key sectors in Microsoft. If we look for growth opportunities, we're considering acquisitions in other sectors. The Microsoft business is up about 30% over the past two years, and it's a business dependent on IT. We usually have to assess it on an annual basis due to project variations.

Gavin Fairweather, Analyst

I wanted to touch base on the Askida acquisition that you announced. A piece of that business is automated QA. What extent can you leverage that IP and processes to create efficiencies within your current QA processes with clients?

Paul Raymond, CEO

Every customer using an ERP platform faces challenges. The advantage of being on a cloud platform is you’re always up-to-date, but you must be up-to-date. When updates occur, organizations typically have to retest their entire systems manually. With the Askida tool, we can automate all that. We've created a user group with other customers waiting for us to show them our approach. There’s significant potential for underserved markets with this automation tool. With digital transformation, a larger portion of modernization projects involves testing and quality assurance. We had previously partnered with companies like Askida for testing; however, now we can address that market as our own.

Gavin Fairweather, Analyst

On the M&A side, you've been active since the fall of last year. Can you give us an update on your M&A funnel and pipeline?

Paul Raymond, CEO

We still have a very healthy pipeline. People are concerned about the integration process, but the last three acquisitions have been very profitable. The operational integration is almost instant as there are few if any cost synergies. We're looking for larger, transformative acquisitions as well. Our funnel is still strong.

Operator, Operator

Your next question comes from the line of Suthan Sukumar with Eight Capital.

Suthan Sukumar, Analyst

Can you provide color around the types of engagements and end markets where you saw strength? Also, how much of that was organic versus driven by acquisitions?

Paul Raymond, CEO

It's a good mix in just about every geography. About half came from the Q3 acquisition—Matricis and Travercent—and the other half came from organic operations. Good balance between ERP and non-ERP customers.

Suthan Sukumar, Analyst

With the Matricis acquisition, are you seeing a step-up in the size of the engagements with them now that they are under your umbrella? Or is it still too early to see those trends?

Paul Raymond, CEO

With Matricis and Travercent, we planned integration in parallel during the due diligence process. We contacted every customer before closing to validate their interest. Every call has been positive, resulting in opportunities that we’re pursuing together.

Suthan Sukumar, Analyst

Could you speak to some of the progress you're having with cross-selling and where you're seeing traction today?

Paul Raymond, CEO

We have traction everywhere, but in some places, it's simpler. For example, with Travercent, when you sell an ERP project, there's always a data analytics or an EPM component. Now all active customers at Travercent are being pitched to from our EPM practice. Similarly, the opposite is true. We're pitching ERP practices to our EPM customers. Askida allows us to add testing to new projects going forward. Some are immediate, and others will come over time.

Suthan Sukumar, Analyst

What is your strategy for integrating the IP gained from recent transactions?

Paul Raymond, CEO

Currently, the IP is specific to a given practice. Over time, as we grow, we will look at consolidating it. For now, the best place to put the IP is with the practice that's selling it today.

Operator, Operator

Your next question comes from the line of Richard Tse with National Bank Financial.

Richard Tse, Analyst

What is your current utilization rate today?

Paul Raymond, CEO

We don't publish the utilization rate, and I'll explain why. Given we've transitioned away from what I would call the staffing business, it varies based on the type of projects. However, it's in very good shape. Looking at gross margins is a good way to gauge utilization rates.

Richard Tse, Analyst

If you're looking for qualified people, do you have to move up on compensation? What are the implications for margins?

Paul Raymond, CEO

We have very competitive benefits. We need to remain competitive to attract and retain talent. We've invested in initiatives like our share purchase plan, introduced the Alithya Leadership Academy, and utilize tools to measure manager and employee relations post-acquisition. Investing in qualified leaders has improved our retention rates, allowing us to attract better talent.

Richard Tse, Analyst

You mentioned earlier that some customers are changing their approach due to a delay in the buying cycle. Can you provide more clarity on this?

Paul Raymond, CEO

In our situation, we've diversified—no customer represents more than 10% of our revenue now, compared to 50% five years ago. We've reduced the impact of large customers on our operations. Some customers have changed their approach for various reasons. We’re not seeing an underlying economic change. We're confident we will replace them with new customers.

Operator, Operator

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

Paul Raymond, CEO

Thank you, everybody, for participating on the call today. We look forward to speaking with you on our next quarterly call. Have a nice day.

Operator, Operator

This concludes today's conference call, you may now disconnect.