Calian Group Ltd

TSX:CGY

Earnings Call Transcript 2018-Q2

[Operator]

Good day, everyone, and welcome to the Calian Second Quarter Results Conference Call. As a reminder, today's conference is being recorded. At this time, we'll turn the conference over to Mr. Kevin Ford, Chief Executive Officer. Please go ahead, sir.

[Kevin Ford, President, CEO & Director]

Thank you, Sherlon. Good afternoon, ladies and gentlemen. With me today is Jacqueline Gauthier, our CFO, and we'd like to welcome you to Calian Second Quarter 2018 Conference Call. I'm extremely proud of the team's efforts this quarter, with all the service lines contributing to our success. During my absence, in addition to focusing on the day-to-day delivery efforts, management continue to focus and execute on our key strategic initiatives. I'm currently staying informed by participating in meetings remotely and supporting the team's continued progress towards organic and acquisitive growth. I'm also excited by the recent contract signings totaling over $60 million in Q2 in support of our customer retention and customer diversification pillars of our growth strategy, particularly with Royal Canadian Air Force $20 million contract and additional IT contract with Canadian Revenue Agency and Shared Services Canada. We've also reported record revenues this quarter, and despite some onetime cost in Canadian investment into our future, we returned $0.50 per share to our shareholders. I will now ask Jacqueline to review the quarterly and full year numbers. Over to you, Jacqueline.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Thank you, Kevin. Our strong performance this quarter demonstrates Calian's ability to provide best-in-class services throughout our service offerings with customer that value our consistent level of quality and continue to trust Calian with their initiatives. Net profit for the second quarter was $3.9 million or $0.50 per share, basic and diluted, an 8% decrease compared to the previous year, with year-to-date now at $1.03 per share, a 5% improvement over the prior year. Revenues for the quarter were $77 million, a 15% increase from the $67 million reported in the same quarter of the previous year, with year-to-date revenue up 13%. SED revenues increased this quarter by 23% with several programs in full swing, including RF system projects, product development projects as well as defense and commercial contract manufacturing. Additional signings and contract manufacturing helped grow the backlog in that service line this quarter. BTS increased its revenues again by 12% this quarter, with half pertaining to ISR and half from organic growth with demand with the division's mainstay contracts continuing to run strong. Gross margins for the company was 19.1% compared to 20% recorded in Q2 of last year. SED reported gross margins of 25.2% this quarter compared to 32.7% reported last year. Gross margin in the quarter reflects the dominance of the lower margin RF system projects, new customer-driven development projects and training of our new engineering resources driving lower utilization rates. However, when combined with other projects having high labor sale, our product sale, an excellent project execution, the division maintained a solid level of margin. With BTS, gross margin continues to be significantly above the prior year. This margin improvement is the result of including ISR, which attracts higher margin, and solid execution on existing contracts. Looking forward, with the start of the new health contract, we expect margins in the near term to be somewhat affected by the reset that comes along with transitioning of renewal contracts. We are currently expecting revenues to be at the same level as the prior contract with the add-on of the VAC and RCMP contracts offsetting the typical Day 1 dropoff from the previous HSSC contract. The health contract margins will see a near-term reduction of approximately 1% to 2%, which we fully expect to regain over the course of the next 18 to 24 months as we work through the new performance metrics and customer requirements. Operating expenses increased in absolute dollars and as a percentage of sales. Costs increased slightly above the 11% target due to improvements and expansion of our facility, the expensing of share-based compensation in addition to certain onetime cost. Management will continue to challenge discretionary spending. However, we will continue to invest to support the evolution of the company service line towards improvements and future profitability. As a result of increase in operating cost, EBITDA decreased 3% compared to the same quarter of the previous year. However, year-to-date EBITDA is still ahead by 9% compared to the prior year. Our cash position remains stable at $20 million. 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 will now turn the call back over to Kevin.

[Kevin Ford, President, CEO & Director]

Thanks, Jacqueline. Looking ahead, and with significant wins this quarter, our team is excited about continuing to work with our tenant customers. These wins will also poise Calian to continue delivering solid returns for our shareholders. However, we must caution the revenues realized are ultimately dependent on the expense and timing of future contract awards as well as customer utilization reducing contract vehicles. Based on currently available information and our assessment of the marketplace, we expect revenues for fiscal 2018 to be in the range of $290 million to $310 million and net profit in the range of $1.90 to $2.20 per share. As well, before opening the floor to questions, I'd like to provide an update on my health situation. Recovery is going well. I am now connecting remotely to the office on a part-time basis. I expect that in the next few weeks, I will continue to ramp up back to full-time status. When I do start back full-time, we will issue an update to shareholders to confirm this is the case. In the meantime, the governance put in place while I recover will continue to operate until I return to full-time status. I want to extend my thanks to all who have reached out with best wishes for recovery. Finally, a reminder that the company continues to execute against its approved strategic plan, something we are confident we'll continue to provide a platform for long-term growth. I ask that, and we'd appreciate if, for the remainder of this call, that questions be focused on company performance or any general questions on the company that you may have. With that, Sherlon, I'd like to now open the call up to questions.

[Operator]

[Operator Instructions] We'll have our first question from Benoit Poirier, Desjardins Capital.

[Benoit Poirier]

Glad to hear your voice and that you are recovering, so nice to hear you. Just first question. Jacqueline, could you talk just a little bit about the ramp-up for the HCPR contract with respect to the RCMP-Veteran affairs. You mentioned that the revenue could go down by about $1 million. And just wondering kind of the run rate and what we should be expecting going forward.

[Jacqueline Gauthier, CFO & Corporate Secretary]

So Benoit, just to start off, this is not unusual. When we have a large contract that goes to a renewal stage, there's usually some positions that end with the contract and are not renewed on Day 1, so we were fully expecting that. There were a few more positions that we were expecting, and we're working with the customer to get some of those positions back on track. So right now, what we're seeing is the reduction in our previous health contract will be compensated by the new contract, the RCMP, in fact. So right now, we're seeing about the same level of revenue in total with the 3 contracts that we used to see with the 1 contract.

[Benoit Poirier]

Okay. Perfect. And is my understanding right to say that there will be opportunity to ramp that up over time?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Correct. We're already working with the customer, reviewing the positions that were canceled, and some are coming back. It's difficult to know how quickly, but we do expect that the ramp-up will commence shortly and will go on for probably 6 to 12 months.

[Benoit Poirier]

Okay. And I assume that it's already part of your guidance for the year, right?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Correct. We've put in our best estimate today.

[Benoit Poirier]

Okay. And looking at SED, you made some comment about the increased pool of expert labor resources and the opportunity to improve margins. Could you talk a little bit about this opportunity, Jacqueline?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. SED has seen a significant increase in the demand for the software part of their business. And in the course of the last 12 months, they've actually hired over 50 new individuals in the SED facility. And obviously, when we hire, they're usually more junior individuals. They require training. They require understanding what we do at SED. So it takes a certain amount of time before they ramp up. So we're kind of facing that right now. But what it means is that in the future, we're going to have additional resources to actually drive additional revenues at a decent margin.

[Benoit Poirier]

Okay. So when you look -- you also mentioned lower margin on the RF system project. Currently, margin -- gross margin is running at about 25%. So does it mean that there's an opportunity to increase the gross margin north of 25% with higher volume, Jacqueline?

[Jacqueline Gauthier, CFO & Corporate Secretary]

There should be. If you look at our Q1, margins were significantly better, and it was less material in that component. So when you look at that, you can see that it can vary significantly from quarter-to-quarter. We had a lot of material flow-through this quarter, which have impacted the margins.

[Benoit Poirier]

Okay, okay. And could you maybe give us an update on the M&A opportunities you foresee these days? You mentioned a line on organic growth and M&A opportunities in the press release.

[Kevin Ford, President, CEO & Director]

Yes, Benoit, I'll take that one. So from my viewpoint, the -- working with the team, there's no question, again, as we talked about many times, with the diverse nature of Calian, there is opportunities across our 5 service lines, and I'm confident in that. We continue to work with our Board of Directors on evolving what we call our M&A playbook. We formally documented a playbook now with our criteria that we're looking for as far as acquisitions and continue to put increased capacity and looking at acquisition targets. So there is definitely a pipeline, and we continue to work through that pipeline now to ensure that if and when we decide to pull the trigger on the next acquisition that it's going to be a good acquisition for Calian for both short- and long-term requirements.

[Operator]

We'll have our next question from Deepak Kaushal, GPM Securities (sic) [ GMP Securities ].

[Deepak Kaushal, Director and Technology & Communications Analyst]

Welcome back, Kevin. Good to hear you.

[Kevin Ford, President, CEO & Director]

Thank you, Deepak.

[Deepak Kaushal, Director and Technology & Communications Analyst]

I don't have a lot of questions for you guys today. We covered the M&A side, but maybe more externally-focused rather than internally-focused. In terms of the environment in M&A, what are you seeing in terms of the types of sellers? Are they private equity sales? Or are they -- are sole proprietors trying to get rid of their kind of boutique practices? What are you seeing out there? And what are you seeing in terms of valuation expectations of a trend? That might be helpful to understand.

[Kevin Ford, President, CEO & Director]

Yes, thanks. I'll give my initial thoughts. And then, Jacqueline, jump in as well here. So first and foremost, from my viewpoint, we're seeing, the way you categorize it, Deepak, both types of sellers, frankly. We're seeing the sole proprietors or a smaller group of shareholders, private companies looking for directed strategies or looking for the opportunity to join a company to expand their strategic objectives where they're capital constrained, for example. So we're seeing those opportunities. Now we're seeing a lot of the -- what I call the auction mindset. A lot of companies out there going through a more formal process, whether they're private equity-based or not. And so we're watching both, frankly. As I mentioned, I think, to you before that I'm not a huge fan of auctions just because of the -- not only the process, but we'd like to spend time with our acquisitions, get to know the owners, get to know the culture, get to know the services. And with auctions a lot of time as we still don't have a lot of opportunities. So we're seeing opportunities on both for those areas for sure with a preference from my viewpoint anyway that we'd love to have more of the -- either exclusive or at least an opportunity to work with the owners over a period of time to make sure it's the right fit for both companies. As far as multiples, again, really, it's a mix. It's a mix of what we're seeing. The -- I think as you know, anything with a software or IP-based product, SaaS models, those types of things are -- seem to be demanding more premium. Companies that are primarily services-based, again, depending on where they are, their value proposition, we're seeing multiples are single digits or double digit again depending on the owner's expectations. So I wish I could tell you I'm seeing something consistent across all of it, but it is really almost case-by-case basis with regard to the expectations and the process. Jacqueline, anything you'd like to add on that?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes, I think there's still plenty of companies out there that are fairly valued. When we look at companies, we don't look at just the financial aspects. So we need to be happy with the culture fit, and also the business and what it allows us to do in the future. So we're very careful to make sure that we look at those 3 components when we're looking at potential targets.

[Kevin Ford, President, CEO & Director]

And maybe a closing comment, Deepak, is we're very committed towards looking at both the organic and the M&A elements and taking the time to make sure we do it right. So I don't want anyone thinking in any way we backtrack at all on our M&A. If anything, we pushed it forward to ensure that we continue to look proactively for those opportunities for Calian as part of our growth objectives.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. I get the understanding that it's hard to slow you down, Kevin. So it's good to hear that M&A is still on track. Jacqueline, I did want to clarify on the health care contract, on the margin side. I believe you did mention that the margins would dip in the near term on that contract. Any kind of sense of timing on that? Obviously, it's not impacting your guidance. And then in general, how do you deal with wage inflation on -- for that health care services contract? Is that a big issue to be passed up through to your customer? How does that work?

[Jacqueline Gauthier, CFO & Corporate Secretary]

So just to confirm, yes, the margin, we're expecting to see a bit of a dip in the next year, fully ramping it up. Based on history, we know that was in an 18, 24-month period. We tend to go back to the margins we had on the previous contract. So that's kind of the time frame we're looking at now, and we'll know better as we get into the new contract and start working with the customer every day. Sorry, the second part of your question was?

[Deepak Kaushal, Director and Technology & Communications Analyst]

In terms of wage inflation, if we start seeing wage inflation on the headcount base that you're providing to the government, how does that -- does that pass through? Or do you have to absorb that? How does that impact margins for you guys?

[Jacqueline Gauthier, CFO & Corporate Secretary]

In the contract, there's a clause that allows us to go back to the customer and validate that in certain categories of practitioners. There's been a significant spike in the compensation. And as long as we can show that, that's a trend in the industry, then we are allowed to increase our bill rates. So it's a negotiated clause with the customer. So we can assess the pass getting that.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And that happens on a retroactive basis? You have to apply and then get a catch-up on that? Or how does that work? Is there a lag? Or...

[Jacqueline Gauthier, CFO & Corporate Secretary]

We're proactive. So the minute we start seeing that there's a trend happening, we will contact the customer. And typically, it doesn't take that long before those new bill rates are approved because they know if [indiscernible], they won't get [indiscernible].

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. Great. And then just finally to reconfirm. So the dip in margin you expect over the next year in health care services contract is already factored into your guidance, correct?

[Jacqueline Gauthier, CFO & Corporate Secretary]

That's correct.

[Operator]

[Operator Instructions] We'll go next to Brian Pow, Acumen.

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

Like the others said, welcome back, Kevin.

[Kevin Ford, President, CEO & Director]

Thanks, Brian.

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

I just want to chat about the gross margins a little bit more, specifically on the system engineering side. And when I look at the sort of year-over-year difference, Jacqueline, can you comment or give me a sense of sort of the year-over-year difference? What sort of relates to the RF system projects and what relates to your ramp-up of these development projects?

[Jacqueline Gauthier, CFO & Corporate Secretary]

I would say it's probably -- and actually, there's a third component, which is whenever we take on contracts with customers to help them develop new product, typically, those at -- are at a lower margin initially until we fully ramp up to producing units on those products. So we've got a little bit more of that in the last little while than we might have in the past. So I would say it's about 1/3, 1/3, 1/3 for each of those components.

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

Okay. And with the ramp-up again in these development projects, was that impacting Q1 numbers? Or it really started more in Q2?

[Jacqueline Gauthier, CFO & Corporate Secretary]

No, it impacted some of the Q1 numbers. I think the big difference between Q1 and Q2 is the increase in nonlabor that is in the Q2 numbers.

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

Okay. Great. That's very helpful color. And then my second question, just related to our guidance. As you've given us a range, can you maybe indicate to me sort of what would it take to hit the top end and sort of what are you thinking on the low end there?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Okay. So heading into the last 6 months of the year, one thing we don't control is how quickly the customers turn around and actually give us signed contracts. If those -- if some of the contracts that we're adding into our guidance come in earlier in -- like in the next month or 2, then we feel that we can hit the higher end of the range. But if the customer takes a few more months to finalize the contracts, then that means we've lost a few months, and we're going to be towards the lower end of the range. As well, there's a little bit of uncertainty with the health contract. We're going based on just a Day 1 information that we have, so that is also going to move over the course of the summer.

[Operator]

And at this time, we have no further phone questions in the queue. We'll turn the conference back over to Mr. Ford for any additional or concluding remarks.

[Kevin Ford, President, CEO & Director]

Okay. Thanks, Sherlon, and I want to thank you all for joining today. We're excited by the results with regard to highest Q2 on record. From a revenue perspective, we're seeing positive momentum across all of our service lines and look forward to talking to you again in a couple of month's time as we look at reviewing our Q3. So thanks for your time today. And with that, Sherlon, we can end the call.

[Operator]

That does conclude today's conference. Thank you for your participation. You may now disconnect.