Calian Group Ltd

TSX:CGY

Earnings Call Transcript 2023-Q2

[Operator]

Greetings, and welcome to Calian's Second Quarter 2023 Conference Call. At this time all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.

I will now turn the conference over to your host, Jennifer McCaughey, Director of Investor Relations. Ma'am, you may begin.

[Jennifer McCaughey, Director of Investor Relations]

Thank you, Ali, and good morning, everyone. Thank you for joining us for Calian's Q2 2023 Conference Call. Presenting this morning are Kevin Ford, Chief Executive Officer; and Patrick Houston, Chief Financial Officer. As noted on Slide 2, please be advised 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. As a reminder, all amounts are expressed in Canadian dollars, except as otherwise specified.

With that, let me turn the call over to Kevin.

[Kevin Ford, Chief Executive Officer]

Thank you, Jennifer, and good morning, everybody. I'm going to get right into our Q2 results. We closed another record quarter, generating revenue growth of 19% with contributions from both our organic growth initiatives as well as strong performance from recent acquisitions. This impressive performance was a result of double-digit growth in three of our four segments. Our gross profit reached $52 million, up over 30% compared to the same period last year and also represents a record level for a single quarter. Gross margin surpassed the 30% mark for a fourth consecutive quarter, and margins increased 3 basis points from the second quarter last year, showing our ability to adapt and deliver consistent performance despite the challenging macro environment, inflationary pressures and supply chain issues.

Adjusted EBITDA reached $17 million, in line with the same period last year and represents the highest level for the second quarter. EBITDA margin was down compared to last year due to increased personnel costs as well as strategic investments as we continue to scale Calian towards our $1 billion aspirations. We will continue to monitor the pace of investments to strike the balance between growth and profit margin.

During the quarter, we continued to demonstrate our M&A pedigree and consistent deployment of capital with the announcement that we entered into a definitive purchase agreement to acquire the assets of U.S.-based, Hawaii Pacific Teleport. This acquisition will bring us blue-chip roster of long-term customers, trusted relationships with satellite operators and managed service providers that we can leverage for cross-selling, a strong mix of recurring revenues and accretive margins. We initially expected the transaction to close by the end of our fiscal Q3, but it looks like it may take a little longer. We now anticipate it will close before the end of our fiscal year.

I would also like to highlight our continued push to win new customers and extend our relationship with existing clients. This quarter, we recorded $147 million in gross new contract signings with approximately $78 million from contract renewals and extensions and $69 million for new customers. We exited the quarter with a robust backlog of $1.2 billion, of which $262 million is planned to be realized for the balance of this year.

With these new contract signings, a healthy backlog and a stronger second half expected, we remain confident in our ability to post our sixth consecutive record year and as such, have reiterated our full year guidance. For now, let me provide an update of our results by business segment, and I'll begin with IT & Cyber. In the second quarter, ITCS increased its revenues by over 50% to $49 million, driven primarily by our expansion of the U.S. market with the acquisition of Computex in March 2022, coupled with our continued strong performance in our overall Cyber practice. In fact, our recurring monthly revenues continue to grow at a steady pace.

This revenue growth was partially offset by lower volume from our on-demand talent and government solutions as we are in the process of backfilling contracts that have recently come to an end. In March, we marked the 1-year anniversary of the acquisition of Computex. Looking back the last 12 months, we have generated revenues of approximately $110 million, greatly surpassing our initial expectations of $75 million, thus making this acquisition highly accretive. Gross margins increased significantly from 33% in the second quarter last year to close at 40% to acquisitive revenue at higher margins, coupled with higher-margin cybersecurity services. Similarly, EBITDA was up over 30% to $7 million or a margin of 15%. This margin was down compared to the same period last year due to investments in sales and delivery capacity.

In the quarter, we signed new contracts valued at $61 million, including GPT companies, Resound Networks, and two new customers in the health care space, Burlington Ontario Health and Connected Care Health in Ontario. For the balance of the year, we are optimistic that we will see improvements in the supply chain and deliver orders currently in backlog. We expect the momentum in ITCS to continue and are confident to post another record year of double-digit top line growth. For modeling purposes, note that Q4 revenues will likely be lower than Q4 last year as we had significant deliveries in the final weeks of the quarter last year.

Yesterday, we announced that Sacha Gera, the President of ITCS, has resigned. Sacha has accepted a CEO position of a local software company here in Ottawa, which is a great career opportunity for him. We are disappointed to see him go as he's made valuable contributions to the business in the short time he was here, and Sacha will remain with us until the end of May. We wish him well in his new journey. We will run an official process to find his replacement. And in the interim, the strong leadership team within our ITCS segment will ensure the continuity of our day-to-day operations and maintain momentum in both Canada and the U.S.

Turning to our Health segment. In the second quarter, revenue declined 4% to $44 million, due mainly to lower onetime projects related to COVID-19 last year. These projects alone represented a decrease of $8 million or 19% over the same period last year. Excluding this impact, the Health segment would have demonstrated double-digit organic growth of 15%. We were able to do this through strong demand from long-standing customers as well as strong momentum for our Contract Research service in our Pharma division.

In fact, our Contract Research services achieved a stronger quarterly revenue performance for a second consecutive quarter. Gross margins and EBITDA margins decreased slightly to 24% and 16%, respectively. In the quarter, we signed new contracts valued at $25 million. Amongst these new signings were some key wins, the first being a multiyear service contract with Immigration, Refugees and Citizenship Canada. The second is an exciting development in the pharma space by securing our first market access contract supporting the innovative breast cancer product developed by Sientra.

And finally, our solution to offer in-person medical service to assist police organizations continue to gain traction in Western Canada. For the balance of the year, we expect to return to positive organic growth as the COVID-19 impact will taper off. Our existing customers are seeing continued demand, and our pharmaceutical contract research organization services are gaining increased traction. However, our margins will continue to be temporarily under pressure as we continue to make investments to increase capacity to fully utilize existing customer contracts as well as investments to drive new business. When we look at our health business today, with the impact from COVID-19-related business behind us, we have a run rate business of approximately $180 million of reoccurring revenues, much higher than our Health segment was before COVID. This baseline of business will serve as a solid base as we look to eclipse the $200 million mark.

Turning to our Advanced Technologies segment. In the second quarter, we returned to organic growth. Revenue increased 18% to $47 million, primarily driven by the deliveries against ground system projects we have recently won, coupled with seasonal AgTech product deliveries and ongoing robust demand for our GNSS antennas. In fact, GNSS products generate double-digit growth again this quarter. This growth comes from new large-scale customers as well as increased demand from existing customers as they include our products into more of their offerings.

Last quarter, I spoke about supply chain issues, which caused orders to be delayed. While we made some progress in the final month of the quarter, we continue to see delays in certain components and weren't able to address it in our Q2. We are optimistic that we can make further progress in the second half as we chip away at our product backlog. Gross margins improved from 28% to 29%, due to a better mix of higher-margin business. The contribution of more Calian products will continue to drive higher gross margins in the longer term. Conversely, EBITDA margins decreased from 14% to 12% as we continue to invest for growth in various initiatives, including sales and marketing, R&D and additional capacity.

In the quarter, we signed new contracts valued at $48 million. Key wins included contracts with data remediation with the Canadian Forces Support Training Group and more than $6 million in orders for our GNSS antennas. We also announced the appointment of Darrell Wellington to lead our GNSS business at Tallysman. For the balance of the year, we expect to continue to improve our top line given the anticipated even supply chain restrictions, delivery of ground system projects recently won and strong demand for our GNSS products.

Turning to our Learning segment. In the second quarter, revenues increased 16% to $29 million, driven by recent investments in technology and geographical diversification, which has increased customer share of wallet and attracting new customers. Gross margins were up to 29% from 27% for the same quarter last year as we continue to leverage our products through an increasing number of customers and benefit from economies of scale. In contrast, EBITDA margins were down slightly as we invest in growth initiatives, including sales and marketing, international expansion and R&D to support our internally developed software used in the delivery of our virtual training and learning services.

In the quarter, we signed new contracts valued at $13 million, and we delivered complex training exercise projects around the globe. This includes projects in France, Turkey, Netherlands, Philippines, Jamaica, Indonesia and Jordan. This is a strong indication of our pedigree and our ability to be a global training partner for defense. For the balance of the year, we see continued robust demand for our services and technology in the military training space in Canada and Europe. And as a result, we believe we are on track to break the $100 million revenue mark for the first time ever for Learning. This continued growth is giving us more confidence to continue to invest to make sure we are well positioned to capitalize on the macro environment where military training has become mission-critical.

With that, I'll now turn it over to Patrick to discuss cash flow, balance sheet and our guidance. Patrick?

[Patrick Houston, Chief Financial Officer]

Thank you, Kevin, and good morning. In the second quarter, we generated $6 million of cash flow from operations compared to $19 million in the same period last year. The main variance this quarter was driven from working capital. Recall that last quarter, we mentioned that we were ahead of where we thought we would be in terms of recapturing cash from our balance sheet. Working capital was negative $6 million for the quarter, which puts us at positive $6 million for the first half of FY 2023. This exhibits strong performance in an environment where we are driving 16% revenue growth on a year-to-date basis. We expect further recapture in the second half despite the continued revenue growth.

Operating free cash flow was $11 million this quarter and represents a 64% conversion rate from adjusted EBITDA. The slightly lower conversion rate was due to taxes paid as we filed and closed off the fiscal 2022 year. We continue to have a disciplined approach to capital deployment with a view of getting maximum return for the amounts invested. In the second quarter, we used our cash to pay debt, dividends and earn-outs on past acquisitions as well as invest in CapEx.

We expect further outflow on M&A agenda in the second half. The first of these being the closing of the acquisitions of Hawaii Pacific Teleport, the second being the scheduled earn-out payments related to the acquisitions of Dapasoft iSecurity, as well as Alio Health. These earn-out amounts are recorded in full on our balance sheet at the end of the quarter. We continue to have a robust pipeline of acquisitions, and we're looking to continue our track record of multiple deals per year. We maintain our dividend rate at $0.28 per share. We continue to see the dividend as an important part of our balanced capital deployment strategy, and we will reevaluate the size of the dividend in future quarters.

We invested $2 million in CapEx in the quarter and continue to manage our spend within our target of $7 million to $8 million this year. As at March 31, our $80 million credit facility was unused and we had $46 million of cash on hand. As a result, we ended the second quarter in a net cash position once again. This cash, combined with our unused committed credit facility, provides us with $126 million of committed net liquidity, and we're able to further expand this with our current lending syndicate if need be.

We've already begun the process of renewing our credit facility to ensure we have the access to sufficient capital to meet our growth aspirations in the years to come. Given our strong cash flow generating ability and liquidity position, we're operating from a position of strength as we continue to execute both our organic growth plans and our M&A strategy. Let's take a look at our guidance for FY 2023. Coming off a solid quarter, we are reiterating our guidance. Note that this guidance has not been updated to include the impact of the acquisition of Hawaii Pacific Teleport. We originally expected the acquisition to close at some point in Q3. However, it looks like it might take a little longer than anticipated due to procedural matters. We do believe it will close before the end of the fiscal year.

As a reminder, we expect revenues in the range of $630 million to $680 million. At the midpoint, this reflects revenue growth of approximately 13%. At the end of Q2, our trailing 12-month revenue sits at $627 million. Our guidance assumes a return to positive organic growth with a closer to even split between organic and acquisitive growth. Our strong revenue performance in the quarter means we expect to be at or slightly above the midpoint of the guidance range. We expect EBITDA in the range of $70 million to $75 million. At the midpoint, it reflects EBITDA growth of approximately 10%. After Q2, our trailing 12-month EBITDA sits at $66 million. As Kevin mentioned at the beginning of the call, we're constantly monitoring and adjusting our pace of investment, vis-a-vis, our EBITDA and free cash flow growth. Finding the right balance will be key to position ourselves for another record year of profitable growth in FY 2024. Currently, we expect our full year EBITDA to come in at the low end of the guidance range.

And finally, we expect adjusted net income in the range of $46 million to $50 million. I must caution that revenues and profitability realized are ultimately dependent on the extent and timing of future contract awards, customer realization of existing contract vehicles and potential recessionary pressures. Our guidance does not incorporate any additional M&A and should we close any new opportunities, their contributions would be incremental. Please see our press release and MD&A for a detailed reconciliation of our guidance. I'll now turn the call back over to Kevin to conclude our prepared remarks.

[Kevin Ford, Chief Executive Officer]

Thank you, Patrick. So in conclusion, our Q2 results showcased some key milestones: our highest ever revenues, gross margin above 30% for the fourth consecutive quarter, and continued EBITDA and cash flow performance. Combined with our Q1 performance, this is our strongest first half performance in company history, and we expect the second half to be stronger than the first. Achieving our guidance will translate into our sixth consecutive year of record results in terms of revenues, gross profit and EBITDA. This demonstrates that our business model, including our diversity, is working. We are a growth company with a clean balance sheet and incredible opportunities available both domestically and globally across our four pistons.

We've been making investments in our growth recently, which has temporarily impacted our EBITDA margins. These investments are by design and are positioned to continue to move us forward. We are also laser-focused on continuing M&A pace. We have a solid pipeline and are working hard to close more deals with similar success to the recent transactions. In fact, today, we are preparing and presenting our next 3-year strategic plan to the Board as we will have successfully completed our Imagine 2023 plan by the end of this fiscal year. This new plan includes, amongst many objectives, our path to $1 billion, and we're really excited with what we are seeing and look forward to presenting it to the market at our next Investor Day. Finally, I want to thank our staff for their commitment and dedication. I also want to thank our customers for their loyalty, our suppliers for the collaboration and our shareholders for their continued support.

And with that, Ali, I'd like to now open the call for questions.

[Operator]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from Maxim Matushansky with RBC Capital Markets. You may proceed.

[Maxim Matushansky, RBC Capital Markets]

Yes, thanks and good morning. I want to start on ITCS. Can you expand on the dynamics within that segment that were causing negative organic revenue growth with the on-demand talent and government solutions just in terms of kind of what's going on there? And how much of the decline in ITCS is from the longer lead times you were mentioning?

[Patrick Houston, Chief Financial Officer]

Good morning, Max. Yes, on the on-demand, I think it was the reality of some of the contracts we've won were coming to an end. So we saw those – some of those come to an end this quarter. We're actively bidding on lots of new offers. Obviously, the strike in the government has delayed some of the new opportunities getting finalized, but we're expecting that to pick back up here in the second half. And to the extent we can win at a similar rate as we have in the past, I think you'll see that business line kind of recover back to where it was in the past. So we're seeing this kind of a temporary issue. On the supply chain, yes, I think we've been making progress on the backlog. We're still – the lead times certainly are nowhere near they were pre-COVID, but we're dealing as best as we can, and we're hoping to make some progress on that in the second half in ITCS.

[Maxim Matushansky, RBC Capital Markets]

Got it. And just switching to Advanced Technologies. Should we take the strong revenues, but kind of keeping the 2023 guidance the same? Should we take that to mean that these we're kind of already anticipating when you were setting the guidance? Or was there any surprises in terms of either the magnitude or the timing of the projects?

[Patrick Houston, Chief Financial Officer]

I don't think there was a surprise. I think we've seen the mix will be slightly different in the second half. I think a lot of the products that we've been frustrated a bit here with the supply chain, we're starting to finally see some progress. As Kevin mentioned, in the last months of the quarter, we started to make some shipments, which was great to see. And certainly, the team now is feeling more confident that they can get some of that out in the second half. So think you might see a bit less revenue, but better margin profile in the second half there as we get some of those products shipped to customers.

[Maxim Matushansky, RBC Capital Markets]

And just final one for me. Just is it possible to kind of give more color on those new projects that are ramping this quarter? Just in terms of the contract timing and maybe the cadence of revenues and then how you expect that to play out through the quarters or years?

[Kevin Ford, Chief Executive Officer]

Yes. Hi, Max. It's Kevin. So I think your question is specifically from an Advanced Tech perspective. So from – really, it's a mix of things. So as I mentioned, we're seeing in our terrestrial area of Advanced Tech, it's going very well. So our GNSS antennas, our AgTech products, our nuclear business, very strong performance across each of those. So that's definitely going to be a tailwind for Advanced Tech this year. Our ground system business, we have won in the past, recent past, some projects which we're delivering. And again, we're going through those now. So again, that's going to be a strong contributor to the back half of the year. And the key thing, I think, as Patrick mentioned, is unlocking some of the supply chain. We have a backlog of product shipments, and we're pretty confident right now we're seeing much more positive signs that we can unlock that backlog and actually move this out in the second half. So it's a combination of a few things, and I would say those are the three primary drivers.

[Maxim Matushansky, RBC Capital Markets]

Okay, thanks. I will pass the line.

[Kevin Ford, Chief Executive Officer]

Thanks, Max.

[Operator]

Thank you. Our next question is coming from Rini Sharma with BMO Capital Markets. You may proceed.

[Rini Sharma, BMO Capital Markets]

Good morning, Kevin and Patrick, and congrats on a good quarter. So my question is twofold. In terms of capacity for further M&A as you wait for the Hawaiian Pacific Teleport to close, what is that looking like for the rest of the year? And then where are you seeing the most opportunities in terms of segments? And what's driving that?

[Patrick Houston, Chief Financial Officer]

Hi. Good morning, Rini. Yes. So I think we're – we still have a lot of capacity. Obviously, I think Hawaii Pacific Teleport, we're anxiously waiting to close that deal, but we've already started working on several other files. We are optimistic there's potential that we could do one more deal before the end of the year, but it depends on timing. And the pipeline is strong, as we mentioned during the call. Certainly, lots of targets in the IT segment that we're optimistic about. So we're pushing that forward. And we're – with Derek coming on board in Health, we've been resetting our strategy in our sights and focusing on next year to find a target in Health. We haven't done a transaction there in a few years. So we're optimistic about doing something in FY 2024 in Health.

Yes. So I think, overall, I think the pipeline is as strong as it's been for a long time, and now it's really just focusing on finding those deals that meet our criteria and keeping the momentum going into next year of doing one to two deals again. But obviously, larger size, that's been our – what we've been telling investors that we want to continue to increase the size of the transactions we're doing with more impact.

[Rini Sharma, BMO Capital Markets]

And are there any like trends that are driving – the underlying trends in IT or Health that's kind of driving your decision to pursue those kind of deals, like macroeconomic trends or industry trends?

[Patrick Houston, Chief Financial Officer]

I mean in IT, certainly, we're seeing a lot of our customers that's putting more and more of their investments toward IT resources. So I think that's giving us confidence that if we do an M&A deal there and then we push for the synergies, that we can realize them. And in Health, I think this is just kind of the next step in our path. We've been very Canadian-focused, but we've seen success in our other segments as we've kind of expanded outside Canada, and I think this is just the next natural step for our Health segment.

[Rini Sharma, BMO Capital Markets]

Okay. Got it. And just on the inflationary pressures that you mentioned this quarter. What's driving that? And like what should we expect for the balance of the year?

[Patrick Houston, Chief Financial Officer]

We certainly had to make adjustments on kind of our fixed cost base with regards to resources last year. Obviously, I think a lot of companies were doing that as we were dealing with kind of the inflationary pressures last year. So I think that's been adjusted and it's kind of in our base now. So now we're readjusting things both from a sales and margin perspective. So I think there's some timing there. But I think the guidance reflects kind of better margins in the second half as the product mix changes. So I think we'll be building ourselves back up to kind of the EBITDA percentage levels we were last year.

[Rini Sharma, BMO Capital Markets]

Okay. Okay, that's helpful. Thank you so much.

[Patrick Houston, Chief Financial Officer]

Thank you.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from Michael Kypreos with Desjardins Capital Markets. You may proceed.

[Michael Kypreos, Desjardins Capital Markets]

Good morning everyone and congrats on the quarter. Maybe circling back to the Hawaii Pacific Teleport acquisition. Can you give a bit more color on maybe some of the competition on the island, the current blue-chip customers that you mentioned and some possible cross-selling synergies that this asset could bring once it closes?

[Patrick Houston, Chief Financial Officer]

Yes, good morning, Mike. Yes, it is a bit of a unique thing. There's not a lot of competitors in the Pacific for this type of service, which is one of the reasons we're excited about this asset. Obviously, the team there has built something unique and the customers realize that. I think from a cross-sell, it's very exciting. We've been at some of the shows already on the satellite side, Pat there and his team. And we're also seeing already new conversations with customers that we weren't having before in terms of offering a more well-rounded solution. So it's still very early. But so far, it's been promising. So we're optimistic that this will expand kind of our footing and space and get us opportunities maybe we wouldn't have been able to get to beforehand.

[Michael Kypreos, Desjardins Capital Markets]

Thank you. That's helpful. And maybe just on the new contract signings. To start the year, you had the two lower quarters compared to last year and especially in the Learning segment. Is there anything that specifically that explains this? Or is it just the seasonality and maybe the year-over-year trend?

[Kevin Ford, Chief Executive Officer]

Yes. It's Kevin. Yes. So really no core cause here. Some of this is just frankly timing and pace with regard to if you look at military spending and military contracts, at times, they can take longer. There's no real cyclical element to that. Anywhere, it can be up, it could be down. So I think right now, I wouldn't read more into that other than we're just dealing with timing and certain elements. The pipeline remains strong from a sales perspective across all of our segments. And I expect that as we continue throughout the year, we'll have still strong sales supporting our record results for this year.

[Michael Kypreos, Desjardins Capital Markets]

Thank you. That's helpful. Maybe just a last one on the resignation of Sacha in the IT segment. Is there a certain timeline and the type of process that you want to run versus internally, externally? Maybe just a bit more color on that. That's it for me.

[Kevin Ford, Chief Executive Officer]

Yes. Yes, thanks. I want to reiterate, we're obviously – I want to reiterate and thank Sacha for his time here, and a lot of great things with the segment. We've built a great team underneath Sacha, and he's built a great team underneath him. So very confident in our ability to maintain the trajectory. And he's got a great opportunity with the CEO level role in another company. So again, I wish him all the best. From a process perspective, the way we run this, for anyone who reports directly to me, we will run a process where both internal and external candidates have an opportunity to apply, and we'll be kicking that off. As soon as we get out of this quarter, we'll be kicking that off very shortly. And standby as soon as we have an update, we'll let our shareholders know our new direction going forward.

[Michael Kypreos, Desjardins Capital Markets]

I appreciate it. Congrats again.

[Kevin Ford, Chief Executive Officer]

Thank you. Appreciate the call.

[Operator]

Thank you. We have reached the end of our question-and-answer session. So I will now turn the call back over to Mr. Ford for any closing comments.

[Kevin Ford, Chief Executive Officer]

Thank you, Ali, and for facilitating today's call. And on that note, I want to thank each and every one of you for attending, and we're looking forward to providing you an update on our next quarterly call. And with that, Ali, we can close the call.

[Operator]

Thank you. This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.