Calian Group Ltd

TSX:CGY

Earnings Call Transcript 2019-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to today's Calian's First Quarter Results Conference Call. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to your host for today, Mr. Kevin Ford, Chief Executive Officer. Mr. Ford, Please go ahead.

[Kevin Ford, President, CEO & Director]

Thank you, Sarah. Good afternoon, ladies and gentlemen. With me today is Jacqueline Gauthier, our CFO, and we'd like to welcome you to Calian's First Quarter 2019 Conference Call. Despite mixed results this quarter, we have achieved several positive metrics, with our largest quarterly revenues in the company's history as well as 20% growth in the profitability of our BTS division. The SED division continues to be very busy in all segments with a focus on current projects and new technology innovation. In support of our customer retention pillar, we are very happy to report this quarter the rewin of our Canadian Army Simulation Centre contract with an initial value of $93 million, and with options factored in, an aggregate contract value for the full 9-year period of approximately $170 million. With a duration of up to 9 years, this win has helped grow our contracted backlog to $1.3 billion, which is a very strong foundation to support our growth agenda. Factoring in the CASC contract, our contract signings exceeded over $200 million this quarter. Again, another strong sign that our sales efforts are working.I will now ask Jacqueline to review the quarterly numbers. Over to you, Jacqueline.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Thank you, Kevin. As Kevin mentioned, results for this first quarter are mixed. Our BTS division saw continued improvements in revenues and EBITDA from strong performance and demand in all of its market segments. The SED division reported a slower quarter than the prior year, driven by a few projects moving to the right and a slightly less favorable revenue mix in the quarter. However, these results do not change our outlook for the year as we continue to expect strong performance from both divisions. We also expect contributions from our most recent acquisitions, IntraGrain and Secure Tech to increase in the remaining quarters due to seasonality of their business, where the first quarter activity is typically minimal.Net profit for the quarter was $0.43 per share compared to $0.54 in the prior year, impacted by: SED results; the negative impact of seasonality of IntraGrain and Secure Tech acquisitions; the amortization of intangibles and the accretion of interest expense related to these 2 acquisitions. If we were to exclude the negative impact of IntraGrain and Secure Tech in this first quarter, net earnings per share would have been $0.50.For the first quarter of 2019, revenues were up 5% from the prior year. The general business environment in 2019 is strong in both divisions. The company's healthy backlog and its recent acquisitions should provide for a solid year.SED revenues were down 16% this quarter. Although the division continues to work with a solid backlog of work, some ground system contracts are still ramping up. Product sales continued to provide solid recurring revenues, and interest continues to grow with some of our newer products with new customers entering the mix. SED's other business units continued to be busy in a range of activities. IntraGrain activities did not play a major role in revenues this quarter as its business is seasonal and most of its activities will be reflected in the third and fourth quarter.BTS revenues increased 13% this quarter. The acquisitions account for only 4% of the growth, with the remainder achieved through organic means. All service lines showed solid increase in demand for their services with existing customers and saw the benefit of various new wins.Gross margin continues to show an overall positive trend and was up again this quarter. Gross margin in SED, although less than in the same quarter of the previous year, was still respectable. It reflects solid execution across all business units, impacted by customer-driven development projects, that until fully developed, result in lower margins. In addition, the influx of new resources to fulfill project requirements continues to have an impact as these resources continue to be trained and ramped up. Gross margin in BTS continues to show improvements, with most of the uplift being attributed to solid execution on existing contracts, with new acquisition only accounting for approximately 0.2% of the increase.Operating expenses have gone up. The costs have increased over the prior year due to the inclusion of the acquisition, Secure Tech, Priority One and IntraGrain, as well as continued focus on selling and marketing efforts and service line evolutions, improvements and expansion in our facilities, the expensing of share-based compensation in addition to certain onetime costs. We will continue to challenge discretionary spending. However, continued prudent investments are required to support the evolution of the company's service lines.Our net cash position is now at $8 million following the acquisition of IntraGrain. Cash position in the near term will be impacted by additional working capital requirements at SED and the remaining payments due on our acquisitions.Finally, please note that certain information discussed today is forward-looking and subject to important risks and uncertainties. The results predicted in these statements may be materially different from actual results.I'll now turn the call back over to Kevin.

[Kevin Ford, President, CEO & Director]

Thank you, Jacqueline. I really believe that Calian is at a pivot point in the company's history as we continue to invest in R&D and headcount to drive long-term growth for the company. Our innovation agenda is focused on new product developments, developing tools to support our professional services in areas, such as emergency management training, and also entering new customer segments. This quarter, we invested another $650,000 in new product development and continue to increase our delivery and go-to-market resources to ensure that we have capacity required to support our growth. Our M&A agenda also continues to be a focus, with current priorities being the integration of IntraGrain, Priority One and Secure Technologies that we completed last fiscal year. We continue to proactively search for companies to support our growth objectives as we look to diversify our customer base as well as evolve our services. I'm also happy to report that our health service line with our business partner, Bayshore, has successfully completed the startup phase of the health care provider requirement contract with National Defense, launching the in-service phase with -- of this contract with DND, RCMP and Veterans Affairs. At now 69 consecutive profitable quarters, strong cash flows, a continued focus on our innovation agenda and our dedicated employee base, I'm confident we will continue to make progress against all elements of our 4-pillar strategic growth framework. I would also like to acknowledge that this will be Jacqueline's last conference call as Calian's CFO. On behalf of our Board of Directors, our shareholders and our staff, I want to thank Jacqueline for her dedication and years of service at Calian. Anyone who knows Jacqueline respects her work ethic, her passion for growth and her outstanding ability to manage a complex financial, publicly traded organization. She can be proud of her work here and the legacy she will leave the company. I'm happy that she has agreed to stay on for a period of time to facilitate transition to Patrick Houston, and as well, support elements of our growth strategy. I would also like to formally welcome Patrick to the Calian team. Patrick is a seasoned CFO, and I'm confident will bring an excellent toolkit in the CFO role to support Calian's profitable growth strategy. In closing, traditional markets in which Calian operates are stable, and management expects organic revenue and earnings growth in most or all of its service lines for the successful execution of our growth strategy. However, we must caution that revenues realized are ultimately dependent on the extent and timing of future contracts as well as customer utilization of existing contract vehicles. Based on currently available information and our assessment of the marketplace, we expect revenues for fiscal 2019 to be in the range of $330 million to $360 million, EBITDA per share in the range of $3.60 to $3.90 and net profit in the range of $2.10 to $2.40 per share. So with that, I'd like to now open the call to questions. So Sarah, can you please open the lines for questions?

[Operator]

[Operator Instructions] We'll go first to Deepak Kaushal of GMP Securities.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Kevin or Jacqueline, I just had a quick question on the slowdown in SED. Is that related to the record satellite contract that you guys announced previously? And is there any changes -- if so, any changes to the 36-month ramp-up period for that and your expectation for 66% of that to come in 2020?

[Kevin Ford, President, CEO & Director]

Hi, Deepak. It's Kevin. So from my viewpoint, slowdown, not necessarily with regard to SED. I think it's just the reality of what we're dealing with from a project schedule. As we look at the phasing of that program, which we announced last year, the largest ground system contract, as you're referring to for SED, it's really just a schedule/timing issue right now from my perspective. There is a lot of work going on with new technology there that, frankly, is quite exciting. So we're monitoring that project very closely. So I wouldn't categorize it as a slowdown. I think it's just basic reality of the mix of projects, where we're ramping projects up, ramping other projects down. The division right now is extremely busy across all segments, so I don't really think it's a slowdown. I think we're just dealing with more of a timing issue.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Okay, great. And then can you maybe, perhaps discuss, beyond that contract, particularly related to the satellite industry, what are you seeing in that environment of late compared to this time last year?

[Kevin Ford, President, CEO & Director]

I'm still -- we're still seeing lots of opportunity, frankly, as we -- based on 2 factors, frankly. Number one is that our legacy customer base continues to come back to the SED division, whether it's for upgrades to current systems or for new mandates. So our current base is continuing to be very loyal, and I think that's just been deserved by the fact of the excellent delivery we've had over the years. And then secondly, when you look at the innovation agenda at SED, I think a lot of people continue to look at SED as primarily satellite segment, which I understand because historically, it's been that. Just to remind you, the other segments we serve right now, the aerospace and defense, is again, going very strong. With the acquisition of IntraGrain now and the AgTech piece, we believe we're just at the start of that journey and very excited. That market, by our market research, is growing 12%, 13% a year, and we're just starting to enter in that segment. So we believe there's huge opportunity there as well for the company. So even with our core satellite business, it's good. Our aerospace and defense business is good. And then, now, the AgTech piece, it's -- we're pretty excited about where that could go for SED. And the last point I'm going to make is just on the research and development we're doing at SED. There's other segments we're looking at beyond those 3, so I'm still very positive on where we are with SED across its broad spectrum now of customer bases as we move to not just a satellite core. So hopefully, that answers your question.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Yes, it does. Just going back to timing. I think Jacqueline mentioned seasonality at IntraGrain. But I think in your press releases, you also mentioned seasonality in Secure Tech. I'm just kind of curious, is there seasonality impacting the revenue portion for that acquisition? Or maybe you can give us more of an update there.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes, yes. So they tend -- they sell quite a bit to the government, so they tend to have a very high Q2. So they do a significant portion of their annual revenues in Q2. So both IntraGrain and Secure Tech had a negative impact in Q1, but we are very confident that they are going to pick that up in the next quarters. So Secure Tech in Q2 and IntraGrain in Q3, Q4.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And in terms of Secure Tech, is that something that is standalone versus things like DWP that you acquired in the past? Or are you guys able to integrate and get some synergies around the cybersecurity acquisitions you've made over the past few years?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. So we actually purposely integrated Secure Tech immediately with Calian. So they're part of our cyber team. And both Calian, Secure Tech and the DWP portion are all working together to attack new markets, to get into new markets.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay, excellent. And then Jacqueline, just on the cash flow side. You mentioned some increasing working capital requirements in SED. I'm just kind of looking, over the past few years, EBITDA to cash from ops conversion, it bounces around quite a bit on an annual basis largely due to working capital requirements. What should we expect over the next 2 years in terms of -- if we're taking a round number, then you're doing about $30 million in EBITDA. How much can we expect that to convert to cash from ops and rebuild your balance sheet?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So basically, the main element of our working capital is that large contract at SED that's going to be running for the next 36 months or so. We're expecting working capital requirements between $10 million and $15 million at its peak, so that's going to show up in the next few quarters, for sure. And then once we get past the middle point of that contract, things should start reversing. And we're expecting that, in the last 12 months, we should be working capital positive on that project.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. As we think about capital structure, I know perhaps, maybe this is a question for tomorrow's Investor Day and Mr. Houston. How do you think about debt-to-EBITDA and that kind of ratio in terms of turns? What are you guys comfortable with? Can you remind us?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So we've always said 1 to 2x, and I think that's been the state for a while. It's something we discuss at the board on a regular basis. And I think we will just evolve as we continue to do acquisition and require additional cash. But for now, this is what we're targeting.

[Operator]

[Operator Instructions] We'll go next to Benoit Poirier of Desjardins Bank Capital Markets.

[Benoit Poirier]

Just to come back on the large satellite ground system contract. Just want to make sure that there was basically minimal contribution in Q1. And is the ramp-up still expected in Q2, mostly with the bulk reported or recorded in fiscal '20 next year?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. So we haven't changed the profile of that contract, so it remains the same as what we provided last time. So it's on track. I think it's just that there's quite a few players that are ramping up. We have a lot of suppliers that require to do some set up in getting ready for this contract. So I think right now, everybody is in that phase of getting ready for the first milestone. But there's no indication that things are going to significantly slide to the right on that contract.

[Benoit Poirier]

Okay. And looking specifically for SED, Jacqueline, revenue or EBIT. How should we look at the ramp-up over the next few quarters? The biggest increase will be done in Q3, Q4? Or are we going to see even a good improvement in Q2 for SED, specifically?

[Jacqueline Gauthier, CFO & Corporate Secretary]

We don't provide guidance on a quarterly basis. I'd hesitate to give any details there other than we feel very strongly that SED is going to have a good year. And we have to cut off on the last day of a quarter-end, and sometimes, things are done; and sometimes, they're just not quite done. So it's very difficult to assess a quarterly number, but we feel confident about the year.

[Kevin Ford, President, CEO & Director]

And just a reminder, Ben. Yes. From my viewpoint too, Benoit, the -- I know the large ground system contract will take a lot of focus over the next period of time as we deliver that and push that project through with the delivery. But I'm also very positive on things that are happening outside the large contract, the research and development and our product developments in certain areas, whether it's outside access or even cable in some of the areas, and then IntraGrain as well. So appreciate the, as they say, the size of that program is -- I think for SED for the year, it's going to be a combination of, clearly, that program as well as, I think, the other projects that are running right now that are really, frankly, quite exciting in the innovation they're going to be bringing to market.

[Benoit Poirier]

With respect to the working capital ramp-up that you talk about, the $10 million, $15 million at the peak, where would you be at right now? Or what remains to be done in terms of ramp-up, in terms of working cap, Jacqueline?

[Jacqueline Gauthier, CFO & Corporate Secretary]

I think we'll be ramping up to that, let's say, $12.5 million by next quarter or beginning of the following quarter. So we're getting into that phase now.

[Benoit Poirier]

Okay. So basically, you haven't ramped up the working cap yet, so there's another $12.5 million, let's say, increase in the coming quarter or 2?

[Jacqueline Gauthier, CFO & Corporate Secretary]

No. We started ramping up, but we'll be at our peak in the next quarter and it will stay there for probably a year.

[Benoit Poirier]

Okay, perfect. And for the guidance, obviously, there's intangible, the acquisition interest expense. Just want to make sure that the $2.10, $2.40 basically take into account the amortization and intangible and accretion interest expense. Am I right here?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. Yes. It includes everything.

[Benoit Poirier]

Okay. And accretion interest expense, is it something that we should see in the coming quarter, or it's basically just a onetime item?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So it gets accrued over a period of 2 years. It relates to the earnouts. So when we set up our earnout liability, we need to discount it, and then we need to bring it back to the full amount at the time that it needs to be paid out. So whenever we have our announcement, it's going to be consistent with the timing of the earnout. So you will see this one on IntraGrain for the next 2 years.

[Benoit Poirier]

Okay. And basically, should we expect kind of a similar amount to be recurring in the coming quarter?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. So we acquired IntraGrain November 1, so we have 2 months in this quarter. So we'll have 3 months in the following quarters.

[Benoit Poirier]

I see. And that would be stable over a 2-year period. Okay, perfect. Okay, okay. Perfect. And any impact from the IFRS 15 in terms of revenue recognition? Is there any impact at Calian?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. So there's -- the main impact is on warranty. So if you've looked at the financial statement, you'll see that for the -- we restated last year. And over the course of the full year, fiscal 2018, we will be recording an extra $0.05 of earnings per share. And it relates to having to record cost and revenue associated with warranties sooner than we did under the old rule. So that's the main impact.

[Benoit Poirier]

Okay. Is there an impact for fiscal '19, though, Jacqueline?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Well, looking forward, it's hard to assess the impact because we'd have to do it the old way and the new way to see exactly what the impact is. Basically, we're using the new rules now. So in theory, if you take that further, we continue to recognize cost and revenue sooner on those warranty projects. So in terms of timing difference, there shouldn't be any, other than the mix of projects we have at any given time.

[Benoit Poirier]

Okay, so it's not like it's providing a big boost on the EPS for fiscal '19, let's say.

[Jacqueline Gauthier, CFO & Corporate Secretary]

No.

[Benoit Poirier]

Okay, perfect. And last question for me. If we talk about the Health Services Contract, would you be able to quantify what is the run rate? And any color how the further ramp-up that could be done with the other departments?

[Kevin Ford, President, CEO & Director]

Yes. So right now, that contract, in any given year, and again, it goes up and down. But generally, we're seeing the run rate in that $75 million to $80 million range. We -- the new customers that have come in through the new contract with RCMP and Veterans Affairs are ramping up. I think we've seen more uptake initially on Veterans Affairs, and RCMP is not far behind. So we're still -- the primary customer now still is national defense. And as Veterans and RCMP -- and we want to grow with the contract, number two, understand how to use it nationally. We continue to see increased demand on that -- on those segments as well.

[Benoit Poirier]

Okay, perfect. So $75 million to $80 million in terms of run rate, and Veteran Affairs is more advanced than RCMP in terms of ramp-up, right?

[Kevin Ford, President, CEO & Director]

Yes. And again, just it's a smaller piece of that. The major customer is defense, for sure. And Veterans Affairs and RCMP, as I said, they're just now looking at a national governance around the contract. So we'll see that, expect that to ramp over the next couple of quarters. But I wouldn't put it in any significant way at this point.

[Operator]

[Operator Instructions] From Acumen Capital, we'll go to Brian Pow.

[Brian D. Pow, VP of Research & Equity Analyst]

Jacqueline, just wanted to clarify again. You indicated that the seasonality related to IntraGrain would have impacted net income by about sort of $0.07. Is that what I understood from your comment?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes.

[Brian D. Pow, VP of Research & Equity Analyst]

Okay. And so is it really just in sort of their Q1 that they're, I'd say, in a loss position? And then they ramp up for the balance of the year and be profitable?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So IntraGrain will tend to be in a loss position for Q1 and Q2 and then most of their revenues are in Q3, Q4. And for Secure Tech, they tend to be in the negative position, let's say, Q4, Q1, and then they do most of their revenue in Q2 and the early part of Q3.

[Brian D. Pow, VP of Research & Equity Analyst]

Okay. And do you expect that to change at any time in the future? Or will that always be the case?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Based on the existing business, that would stay similar. But obviously, we're trying to expand in different areas, so that should be lessened in the future in terms of the impact.

[Brian D. Pow, VP of Research & Equity Analyst]

That's good, all right. And then just switching to, again, the working capital. So again, on that SED contract, it sort of peaks at $10 million to $15 million and sort of sits there. So again, that's like a work in progress. Is that the best way to think about it?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Correct. So on that project, we have to deliver approximately 20 units. So we always tend to be a few units behind in terms of getting the payment for the work that's been done. So initially, we ramp up then we continue to do work. But then, we're paid on the previous units. So that's why it stays at the $12 million, $15 million for a year.

[Brian D. Pow, VP of Research & Equity Analyst]

Okay. Can you -- and again, just further on the working capital, can you give us a little bit more insight on sort of the remaining payments on the acquisitions, sort of what you expect this year and next year?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So if you look at the balance sheet, we've got contingent earnouts of about $8 million. I would say that more than half of that will be paid in the next year, and then the remainder the following year. Probably 60% this year.

[Brian D. Pow, VP of Research & Equity Analyst]

All right. Look forward to seeing you tomorrow. Hopefully the flights will allow us to get into Toronto, so enjoy your travel today.

[Kevin Ford, President, CEO & Director]

Yes. Thanks, Brian. And we're getting pinged here all over the place from people trying to get into Toronto. So if anyone's traveling today, I might suggest you get to the airport or jump to a train for those that have that option. Okay. Any other questions, Sarah?

[Operator]

And now it appears we have no further questions at this time.

[Kevin Ford, President, CEO & Director]

Okay. That's great. So thank you, everyone, for attending the call today. I appreciate the questions. And I guess, next call will actually be Patrick and I sitting here talking about the next quarter results. So I look forward to that discussion and I'll talk to you then. So Sarah, with that, we can close the call.

[Operator]

Thank you. And again, ladies and gentlemen, that does conclude today's conference. We thank you all for joining.