Earnings Call Transcript - ALYAF Q1 2022

Operator, Operator

Welcome to the Alithya Q1 Fiscal 2022 Results Conference Call. Today's conference is being recorded. I would now like to turn the meeting over to Rachel Andrews, Vice President of Communications and Marketing. Please go ahead.

Rachel Andrews, Vice President of Communications and Marketing

Good morning, everyone, and thank you for joining us for Alithya's First 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; Claude Thibault, Chief Financial Officer; and Claude Rousseau, Chief Operating Officer, who will all be present for the ensuing question period. Before we begin, I would 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 subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. Please refer to the cautionary note on our presentation and to the forward-looking statements and 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 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. Now, I would like to turn the call over to Paul Raymond. Over to you, Paul.

Paul Raymond, CEO

Thank you, Rachel, and good morning, everyone. I'm very pleased to be here today to discuss a record first quarter performance in which we exceeded all internal and external expectations. As demonstrated by our strong bookings in the past quarters, our teams have surged ahead into fiscal 2022 by capitalizing on our high-value digital transformation offerings. Our plan to retain our valuable professionals during the pandemic is paying off by enabling us to transform bookings into accelerated profitable organic growth. Over the past 18 months, our management team has proven its ability to maintain a steady course through uncharted waters. This is directly responsible for our successes in the first quarter of 2022. We look to the future with great optimism and confidence as we embark on an ambitious new chapter of expansion and recruitment to meet the growing demand for our services while ensuring the retention of our more than 3,300 professionals and keeping an eye on the global pandemic. I will discuss this in greater detail shortly, but first let's take a look at the three key highlights of our record first quarter performance. Please turn to slide 2. First and foremost, we achieved industry-leading organic growth in bookings in this unprecedented environment. We continue to strengthen Alithya's position as a trusted adviser and strategist in digital transformation, and we expanded our presence to new customers and new essential service industries. This has enabled our teams to post outstanding organic growth in all our geographies, both year-over-year and sequentially. Second, we are on track with the integration of R3D Consulting, our latest game-changing acquisition that closed this past April 1. R3D's operations are highly complementary and are integrating seamlessly into Alithya's current structure, allowing for short and mid-term synergies. Additionally, the two 10-year contracts with Beneva and Quebecor that accompany the acquisition have already generated significant high-value revenue during the first quarter. Third, our leaders are doing a great job in recruiting and retaining the best people. As Alithya continues to expand its operations in North America and Europe, a growing demand for our transformation services requires new and creative approaches to finding highly skilled IT professionals to support our clients' needs. Therefore, we've opened a subsidiary office in Morocco, where we intend to leverage that country's rich and readily available talent pool. We've already started recruiting highly skilled individuals based out of Morocco, and they're already contributing to significant global projects entrusted to us by our clients. To put all this and more into greater perspective, let's break down our first quarter successes with respect to our various practices and geographies. Please turn to the third slide of our presentation. Let's start with Canada. As I mentioned during our fourth quarter call, we set sales with the wind at our backs for the first quarter of this new fiscal year with the contribution of strong bookings, new logos, and Alithya's latest acquisition R3D. That momentum continues today, as this portion of the business generated $20 million of revenue in the quarter. While adding revenues from R3D obviously results in sequential growth from the fourth quarter to the first quarter, I would like to point out that R3D itself is also reporting strong organic growth both year-over-year and sequentially. We are also seeing important growth from the ramp-up of the 10-year contracts associated with that transaction. Successes like that are a testament to the winning formula applied by our management team, who continue to pursue new opportunities for acquiring quality companies, with a cultural fit and potential for combined accelerated growth. This acquisition strategy is complemented by the strength of sustained organic growth, which is a category where Alithya leads the industry in Canada. Our first quarter saw revenues increased by 78% in Canada year-over-year and 50% sequentially. Even when we exclude the R3D impact, Alithya experienced organic growth in all sectors. At this point, I will turn the call over to another Claude, Claude Rousseau, our Chief Operating Officer, so that he can present to you the progress made so far in connection with the operational integration of R3D, as well as an overview of the synergies we can expect to achieve. This is the first time our COO joins us for the analyst call, and I am convinced you will find great value in his commentary.

Claude Rousseau, COO

Thank you, Paul. I'm very, very happy to be here today to shed more light on our operations and answer any questions that may follow. I'd like to begin by giving a little more context on our latest and game-changing acquisition, namely R3D, in April 2021. Let me remind everyone on the call, that the acquisition includes two long-term contracts, totaling approximately $600 million in combined revenues during the initial 10-year terms. This represents minimum volume commitments of $60 million per year. As with previous acquisitions, our objective is to gradually transform R3D's revenue mix by increasing revenues from permanent employees relative to subcontractor revenues. With the integration of R3D, we are rapidly scaling up our operations in order to effectively compete for the industry's largest and most complex digital transformation projects and cloud migration, which are increasingly in demand by our customers. We've also reevaluated our footprint and adjusted office space to create synergies as a result of the acquisition. We recently reorganized our government and private sector businesses to integrate the new leaders joining us from R3D. The capable men and women leading these two sectors in Canada have been very busy. As announced earlier this summer, we recently won two major multi-year contracts, delivering high-value services including one with the Quebec government and another with a major Canadian financial institution. Our specialized teams are continuing to grow in specific industries, where there is demand and understanding of the order value of what we do. For example, our visionary Higher Education practice has filled a void to provide universities around the world with tailored digital transformation plans that will enable them to provide digital access to a wide variety of services for their student populations. This practice is a great example of how our people are shifting deep industry and technical expertise into new projects. To support all of this growth, as Paul mentioned, the opening of our office in Morocco will allow us to attract more talent capable of contributing to all the demand we are seeing. By leveraging Alithya's remote working framework, these new recruits will help bolster the expertise of teams across all our geographies and help advance the innovative work of our Digital Solutions Center. In just two years since its founding, Alithya's Digital Solutions Center has grown to encompass a dedicated team of more than 600 skilled professionals and our new Morocco office will help add to that number as we continue to expand our operations globally. We have an abundance of projects to inspire our new colleagues and are always focused on recruitment efforts aimed to convey to candidates that at Alithya we are big enough for all of them to work on major projects, yet small enough to ensure they will remain in the heart of the action as important members of the development teams. Alithya has been a strong Oracle partner for over 25 years. Our Oracle practice continued to grow and recent major wins have provided us with opportunities to demonstrate how our teams effectively deliver Oracle Cloud solutions for ERP as well as corporate performance management, human capital management, and supply chain management systems for a complete planning experience from financial to operations, labor, and human capital for greater transparency and cohesive decision-making. Since the acquisition of Travercent in December 2019, the delivery of Oracle solutions to the healthcare sector has remained one of our strategies. In recent months, we successfully implemented multiple Oracle Cloud suite solutions for large healthcare providers across the United States. We are extremely proud of our Alithya Oracle healthcare practice, which is proving to be one of the best-in-class throughout the US. As for our Microsoft practice, Alithya was recently named to the prestigious Inner Circle group for the 16th year in a row. In a year, our deep business transformation abilities are applicable to every company and virtually every industry on the planet. It's extremely rewarding for the Alithya US team to be recognized by Microsoft itself. Paul, back to you.

Paul Raymond, CEO

Thank you, Claude. Large companies want to do business with larger but agile organizations in order to transform. Alithya is now definitely one of the serious contenders in this landscape. Looking south to the US market, our foresight in implementing prompt and clearly articulated measures to protect our professionals and our clients over the past 18 months showed courage and proved that betting on good people always pays off. Our commitment to persevering and establishing optimal remote working conditions has paved the way to an accelerated turnaround. In the first quarter, our US operations experienced both year-over-year and sequential organic growth. In constant currency, revenues of $31.4 million represent a 17.1% year-over-year increase and a 9.2% sequential increase compared to the Q4 numbers. These increases are due to organic growth in most areas of our US operations, notably in the Oracle business space. Recent clients have chosen Alithya based on our business performance and our capabilities as an organization, whether that be in creating IT solutions or having an industry-leading focus on digital transformation. Our European business also continues to grow, punctuated by an outstanding 59.5% organic increase in revenue in the first quarter, representing a 12.6% sequential increase. Over the fourth quarter of 2021, we began to see general recovery of activity levels and a resumption of business priorities on the European continent. In fact, one of our long-time customers in the aerospace industry, which as we know was significantly impacted by COVID, is also regaining momentum. Turning to slide four, we also increased bookings to a new all-time high. First quarter bookings reached an astonishing $709 million, which includes the $600 million estimated value of the two new long-term contracts signed as part of the acquisition of R3D, namely with Beneva and Quebecor. This record translates into a book-to-bill ratio of 7.1 for the quarter. As for a trailing 12 months, bookings almost reached $1 billion, translating into a book-to-bill ratio of 3.2. As demand for our services and expertise expands, as we can see by the aforementioned bookings, we must ensure our ability to attract the best talent from a highly competitive landscape. According to the latest forecast, digital transformation spending is continuing to accelerate. Customers are seeking partners who can think past the digital sprints of 2021. That means building solutions and services that don't necessarily yet exist in order to further differentiate our customers' organizations in an already crowded market. That task cannot be accomplished without a rich pool of IT experts. Our always-on approach to recruiting top talent will play a vital role in furthering our strategic vision. In conclusion, despite the lingering uncertainties of a pandemic world and health scenarios that continue to evolve on a daily basis, Alithya has tested and proven its agility and ability to creatively deal with those challenges and execute our plan with discipline. We remain committed to becoming a North American leader in digital transformation and to delivering favorable returns to our investors, partners, and stakeholders. This record quarter is a clear demonstration of the sustainability of our long-term strategy to building a great company. I will now give the floor to Claude Thibault, our CFO. Claude?

Claude Thibault, CFO

Good morning. I invite you to turn to the fifth slide of our presentation for certain first quarter fiscal 2022 highlights. Based on discussions we've had with some of you, you will notice that we are providing today a greater level of detail on certain operational figures in order to better understand our financial performance. Revenues were already covered by Paul and Claude. The key metric here being overall organic growth Q1-over-Q1, excluding R3D, at a constant currency of 23%. Of note, the negative impact of the US dollar depreciation on revenues compared to the first quarter of last year is almost $4 million. While the R3D acquisition results in sequential growth from Q4 to Q1, I would like to highlight, as Paul did, that R3D itself is reporting strong organic growth both year-over-year and sequentially. This overall increase was again driven mainly by industry-leading organic growth in all our geographies, leading to record revenues in Canada and the US, and a solid return to pre-COVID levels in France. Gross margin increased by $7.9 million or 38.9% to reach $28.3 million in the first quarter. Gross margin reported as a percentage of revenues decreased to 27.5% during the same period. However, three important non-recurring elements must be taken into consideration in understanding the progression of our first quarter gross margin percentage. First, the decrease was driven in part by the R3D acquisition, whose revenues historically show a significantly higher proportion from subcontractors, generating a lower overall gross margin percentage. As discussed, we have a short, mid, and long-term plan to address this and bring R3D closer to Alithya's levels. Secondly, the percentage decrease was also driven by a $2.5 million impact from increased cost to completion on one large customer project in Canada. That project involves the development of complex software applications, which may have further commercial value and therefore have a long-term investment dimension. That project is nearing completion and no further cost increases or losses are expected going forward. Thirdly, our gross margin benefited from some governmental wage subsidies both this year and last, with a significant amount of PPP forgiveness recorded in this first quarter of fiscal 2022. Of note, as detailed on top of page 6, when excluding the three elements above which are reported in our filings today, Alithya's normalized gross margin percentage excluding R3D is increasing in all geographies year-over-year driven primarily by higher productivity rates everywhere. Reported SG&A expenses totaled $22.7 million, an increase of $3.3 million or 17.1% from $19.4 million during the same period last year. This increase was primarily driven by the R3D acquisition as well as increases in employee compensation in Canada, partially offset by some governmental wage subsidies. However, when looking at SG&A expenses on an adjusted basis and excluding R3D, they are actually improving on a sequential basis. Also shown on page 6, our adjusted SG&A expenses as a percentage of revenues are decreasing from 26% to 21%. Moreover, overhead from the R3D business is expected to continue declining over the coming quarters from additional administrative and operational synergies. Overall, our Q1 adjusted EBITDA amounted to $7 million, an increase of 114% compared to the same quarter last year. Please turn to slide 7. As in previous quarters, the amount of non-cash depreciation and amortization, totaling $4.9 million, is greater than the quarter's accounting operating loss. Our accounting net loss of $2 million for the quarter must also be considered in conjunction with a greater amount of business acquisition and integration costs, namely $4 million related to R3D. Net cash flow from operating activities amounted to a positive $500,000 in the first quarter, compared to $7.4 million in the same period last year. Like last year, this positive amount resulted primarily from favorable changes in non-cash working capital items. We ended the quarter at $30.6 million of net bank borrowing, net of our $13.9 million in cash and restricted cash on hand. The increase during the quarter is explained by the acquisition of R3D. Lastly, a quick note for modeling purposes. Our second quarter is typically seasonally soft given the vacation cycles and we believe this year may see similar impacts. Thank you. Turning back to Paul.

Paul Raymond, CEO

Thank you, Claude. We will now be pleased to answer your questions. And Madison, you can open up the line, please.

Operator, Operator

Thank you. We'll go ahead and take our first question from Paul Steep with Scotia Capital. Please go ahead.

Paul Steep, Analyst

Good morning. Hey, Paul, could you talk a little bit about the pipeline in particular both maybe in Canada and the US in terms of what you've recorded this quarter and how we'd want to think about that ongoing growth and further momentum in the business?

Paul Raymond, CEO

Good morning, Paul, thank you for the question. A good way to look at it is that in the past year, we've reported a book-to-bill ratio above one, averaging around 1.2. Typically, in our industry, it takes a few quarters to convert those bookings into revenue. The past quarters indicate the trend we observed. Claude Thibault mentioned that when adjustments for acquisitions and exchanges are set aside, our organic growth is just under 20%. Generally, you can translate the book-to-bill ratio on an annual basis to give an idea of what the next year or quarter will look like, and it's essential to consider it on a rolling basis. We've had very strong bookings over the past year and again this quarter, so we feel confident about the future based on those results. Does that answer your question, Paul?

Paul Steep, Analyst

Yeah. Maybe talking a little bit about Morocco. Just talk about the ramp-up of how we'd want to think about loading into that center and then presumably, the meaningful margin lift that you get from moving things to another geography?

Paul Raymond, CEO

Sure. I'll pass that question over to Claude Rousseau, our COO, because he is very closely involved in the ramp-up of the Morocco office. Claude?

Claude Rousseau, COO

Yes. Thank you. Thank you, Paul, for the question. Regarding Morocco, we already hired more than 50 consultants there. Those positions are complementary to what we are doing in Montreal in North America. And that's the reason we will be more than 100 employees in Morocco by the end of this year. That's the target we have. We already found talented resources and people. We are very pleased with the support. We sent out one of our key people to Morocco in order to open the office and support the transition and ensure the projects and the quality of the projects will be as well aligned with the quality and the value of Alithya. And that's exactly where we are going. In terms of margin, we are working to finalize exactly the final value, but no doubt, it's creating value. But the most important point is not regarding only the margin. That is our capacity to deliver on projects for our customers and deliver quality projects. That's the most important part, Paul.

Claude Thibault, CFO

Yes. I think Paul, just to reemphasize the last point that Claude just mentioned, it is very important for people to realize the number one reason we're opening the office there is to find people. The improvement on the cost is just gravy. The challenge again is finding people in our industry, and there's a great pool of talented people there readily available, and that's the number one reason why we're going there.

Paul Steep, Analyst

Great. And then I guess maybe two to wrap up and I'll pass the line for Claude. Claude, could you just talk to us a little bit about the ramp in the quarter from the new contracts with those two lead clients that came with R3D? And how much that contributed in the quarter? And then, could you also remind us about for the intangible amortization how much of the PPA actually got taken in this quarter, or should we assume that that fully loads into next quarter? Thank you.

Paul Raymond, CEO

I think that question was for Claude Thibault?

Claude Thibault, CFO

So on the first one, the first one is talking about the revenues from the two long-term contracts, right? How that's ramping up?

Paul Steep, Analyst

Yes.

Claude Thibault, CFO

Okay. I'm not sure how much detail we want to share here. We are pleased with our current pace. As we noted, R3D is experiencing strong organic growth sequentially. Some of this performance is attributed to the commercial agreements. However, it's important to mention that we are recognizing some of those revenues in the previous Alithya business. Despite some losses there, R3D is still demonstrating good organic growth, partly due to those two commercial agreements. We expect to reach full operational capacity on the commercial agreements within 12 to 24 months, and we are maintaining that outlook, even though we don't typically provide guidance. The most recent quarter gives us confidence in that prediction. Regarding the acquisition completed on April 1, we now have a full quarter of R3D financials recorded. The short answer is yes, the amortization reflects the run rate we anticipate for R3D.

Operator, Operator

All right. We'll go ahead and take our next question from Nick Agostino with Laurentian Bank Securities. Please go ahead.

Salman Rana, Analyst

Good morning. This is Salman Rana on behalf of Nick Agostino. First of all, congratulations on the results. My first question has to do with the new revenue and margin levels. So now with R3D fully in the mix, is this revenue margin level in Europe sustainable, or are there any expected changes to the current profile?

Paul Raymond, CEO

Hi Nick, thank you for the question. So basically, as we were explaining earlier, if you look at R3D, the type of work that they do is very high-value work. However, the way they staff the work in the past was very subcontractor intensive. And as we saw with our own business going back several years, margins on subcontractors are significantly lower than when we use our own personnel and have full responsibility for managing the projects ourselves. So part of the transition and integration of R3D is migrating that ratio from more subcontractors than permanent staff to the opposite. Typically, we do that as we ramp up the new contracts and the new projects, and our plan is to do that over the next 24 months as well.

Salman Rana, Analyst

Okay. That's very helpful. The timeline especially. So my next question is about the proprietary products. Any update on how revenue contribution from your proprietary products has been like? And any plans to add to that existing list of your IP?

Paul Raymond, CEO

Yes. We don't disclose the IP revenue separately yet. We're waiting for it to be a more important part of our portfolio. But yes, we are always looking for interesting targets that bring new IP to us. We really like what we've accomplished so far with our testing IP. And now we're seeing more new verticals by leveraging our solutions that we have today and converting those into recurring revenue in our own IP. So yes, it's on our target list for M&A and it's something that we're investing in today.

Salman Rana, Analyst

Okay. Great. And my next question is about the higher education practice. Now that was a very interesting news release that we got a few weeks ago. Any indications or insights on what the potential TAM you think there is? And how has the pickup there been to date?

Paul Raymond, CEO

So yes, thank you for the question. We see significant potential in higher ed. We're already in several Canadian universities. There are thousands of universities and colleges. When you just go across the border to the South, they have the exact same challenges that our Canadian universities have. And that's why we saw a huge opportunity there as we saw a market that was underserved. Based on the response we're getting so far to that new offering, we're very confident that we can take a leading position in that market as well.

Salman Rana, Analyst

Great. And just one last question as it relates to your US business. Now the new digital transformation wins that you're getting, are those as a result of displacing other IT consultancies, or are these clients completely new to the digital transformation process?

Paul Raymond, CEO

All right. Thank you. So, the question is, if we're displacing anybody. If I look at our growth rate and compared to what the industry is supposed to be, my deduction would be yes. I believe we are taking not only growing based on new market demand but also taking market share away from some other players. The customers are really looking for somebody who is big enough to help them through the digital transformation, but at the same time, has that small agile culture that can essentially turn around and bring in creative solutions to help them do their digital transformation faster. That's what we're seeing and that's the feedback we're getting from the customers. They like us because we're big enough. We have the critical mass to do the big projects. But at the same time, they see us as very agile and creative in how we approach our projects. So we can see it from the organic growth we're witnessing. We looked at the competitors and the companies that we compete against, and no one has this level of organic growth in the past quarter.

Operator, Operator

Okay. We can go ahead and take our next question from Kevin Krishnaratne with Desjardins Securities. Please go ahead.

Kevin Krishnaratne, Analyst

Good morning, Paul. I apologize for joining a bit late and if some of my questions have already been addressed. Following up on the previous question about the strong growth this quarter, can you clarify whether that growth is mainly from new customers or if you're also seeing expansion with existing ones? How should we consider the sources of that growth?

Paul Raymond, CEO

Thank you for the question. We're experiencing strong growth everywhere, across all our geographies and practices with both existing and new customers. Currently, we're performing very well. As I mentioned earlier, last year saw a lot of immediate responses in spending on digital transformation due to the pandemic, but now we're observing more planned and strategic transformations. Customers are taking their time and being more thoughtful in their approach, which is driving growth across all segments. Thanks to our strong track record and reputation, we are recognized as leaders in this field, leading to growth across the board.

Kevin Krishnaratne, Analyst

Okay. Can you discuss the type of deals? Were there many smaller deals or a few significant ones that contributed to the quarter's results? Looking ahead, is there any follow-up work or related projects stemming from the successes in Q1 that we can expect in Q2 and Q3? I notice your cautious outlook in the press release, so I'm trying to understand how we should interpret this quarter's performance and its potential impact on the upcoming quarters.

Paul Raymond, CEO

I'll break down the numbers we just discussed for clarity. Starting with Europe, we saw nearly 60% organic growth year-over-year in France. This growth came largely from existing customers and significant new business as we regained some traction after the cessation of operations by one of our major clients in the region. We're now bringing in new customers and projects to fill that gap. The aerospace sector is bouncing back, and it's evident when you see full planes and crowded airports. This recovery is beneficial for our returning customers. In the US, our transition from on-premise to cloud for our Oracle business has been successful. We achieved record bookings, and our cloud segment is outperforming other areas, with several new logos added. Our reputation as the leader in Oracle cloud for healthcare in the US has led to expansion into financial services and high-tech industries, including Silicon Valley, where we're seen as trusted Oracle cloud integrators. For Microsoft, achieving the inner circle for 16 consecutive years is a remarkable feat, reflecting the strong business we conduct with them in both the cloud and ERP/CRM sectors. Our US operations showed a remarkable 17% growth year-over-year on a constant currency basis, which is impressive organic growth. In Canada, we're also experiencing double-digit growth, excluding the R3D acquisition. Overall, our teams across operations and practices are performing exceptionally well.

Kevin Krishnaratne, Analyst

Certainly sounds good; the tone in the commentary is certainly quite optimistic. Thanks for sharing that breakdown. Maybe just the last one then, just on R3D. Now that they're under the Alithya umbrella, can you talk about what they're seeing in terms of their pipeline and their ability to now compete on larger deals with more resources? Maybe just touch on that? And then, I'll pass the line. Thank you.

Paul Raymond, CEO

Sure. I'll turn that over to Claude Rousseau, who is very closely involved in the integration as you can imagine, so maybe he can give you a bit of color. Claude?

Claude Rousseau, COO

Thank you for that question. We are integrating our capacity, practices, and expertise, which is essential. This integration allows us to create something new beyond what we had before April 1. We are truly building on this foundation. In both the public and private sectors, we are gaining access to resources and capabilities that we previously didn't have, which is why we have more projects than ever. The public sector is performing well, and we are leveraging the expertise from both teams. Our strong leadership enables us to capitalize on our existing strengths.

Operator, Operator

It appears there are no further questions at this time. Mr. Raymond, I'd like to turn the conference back to you for any additional or closing remarks.

Paul Raymond, CEO

Thank you, Madison. Again, we are seeing the unwavering engagement, dedication, flexibility, and diversity of our skilled professionals continue to lead Alithya forward. I'm honored to represent them on this call today. We have exceeded all expectations and are seizing on new opportunities to accelerate profitable growth in all our industries and geographies because of the trust of our amazing clients. I want to remind all our shareholders that our Annual General Meeting of Shareholders will be held as a virtual meeting on Wednesday, September 15, 2021. To access the circular of the meeting documents, you can visit our Investors section on the Alithya website. Thank you everybody for being on the call today and stay safe.