Calian Group Ltd

TSX:CGY

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Calian's Third Quarter Results Conference Call. As a reminder, today's conference is being recorded. I will now like to turn the conference over to Mr. Kevin Ford, Chief Executive Officer. Please go ahead, sir.

[Kevin Ford, President, CEO & Director]

Thank you, Sophie, and good afternoon, ladies and gentlemen. With me today is Jacqueline Gauthier, our CFO, and we'd like to welcome you to Calian's Third Quarter 2018 Conference Call. Once again, the Calian team has delivered excellent results for our customers and our shareholders. Having this consistent track record of profitable growth does not happen without a high performing team committed to execution, and I want to thank them for their support. This quarter has also been a very exciting for us on very numerous fronts. At our SED division, the signing of our largest satellite ground systems contract in our history, combined with our continued investment in innovation, focusing not only on our core satellite sector but as well new areas such as cable and agriculture technologies, positions us well for the future. At the BTS division, the closing of the Secure Technologies acquisition, the successful launch of our new DND Veterans Affairs and RCMP health services contract and numerous contract wins across health, training and IT services, demonstrates that the strategy to embrace our diverse service offerings is on track. I will now ask Jacqueline to review the quarter and full year numbers. Over to you, Jacqueline.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Thank you, Kevin. Our 4-pillar growth strategy of service line evolution, customer retention and diversification and continuous improvement continues to be a driving force of our success as each service line continues to make progress in each of these elements, resulting in EBITDA improvements of 11% for the year. As well, net profit for the third quarter was $3.9 million or $0.50 per share basic and diluted, an 11% increase compared to the same quarter of the previous year with year-to-date now at $1.53 per share, a 6% improvement from the prior year. Revenues for the quarter were $73 million, a 9% increase from the $67 million reported in the same quarter of last year, with year-to-date revenues up 11%. SED revenues increased this quarter by 2% and 9% year-to-date, with all business units continuing to be busy in the range of activities. Product sales continue to provide solid recurring revenues, and interest continues to grow with some of our newer products. EPS increased its revenues again by 13% this quarter, 12% year-to-date, almost exclusively from organic growth, with demand with the division's mainstay contracts continuing to run strong in all service lines. Gross margin for the company was 20.4% for the third quarter and 19.6% on a year-to-date basis compared to 19.2% and 19.1% reported for the same period last year. SED reported gross margins over 30% this quarter compared to 28% reported last year. Gross margin in the quarter reflects the greater proportion of labor, compounded by certain RF system projects nearing completion, where the retirement of projects risks allowed the realization of higher margins. On a year-to-date basis, gross margin in SED was 26% compared to 27.8% reported last year. The gross margin for the year-to-date period was impacted by development projects with new customers that until fully developed result in lower margins and also the addition of new resources that initially attract lower utilization until these resources are trained and ramped up on projects. With BTS, gross margin continues to be significantly above the prior year. This margin improvement is a result in including ISR, which attracts higher margins, but also from uplift attributed to solid execution on existing contracts, specifically with regards to the health contract. And after having completed the first quarter under the new contract, we are cautiously optimistic that we have maintained the margin, and we now believe we will not see significant margin decreases from the reset that comes along with transitioning of a renewal contract. With regards to the revenues, we continue to expect similar revenue level as with the prior years, with the add-on of the VAC and RCMP contracts offsetting the typical Day 1 drop-off from the previous HSSC contract. Current revenue levels for these contracts are between the $70 million and $75 million per year. With regards to the large SED contracts signed during the quarter, we have completed our review of the time line for execution and have now revised our revenue projections to the right, with a significantly higher portion of the contract being delivered in 2020. As well, we want to reiterate that this contract follows a lower gross margin profile due to the size of the endeavor and the high nonlabor content in revenues. Operating expenses increased in absolute dollars and as a percentage of sale. COGS increased above the 11% target due to improvements and expansions of our facility, the expensing of share-based compensation, in addition to certain onetime costs. Management will continue to challenge these discretionary spending, but we must continue to invest to support the evolution of the company service line. Finally, our cash position remains stable near $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 to deliver solid returns to our shareholders. As well, we are happy to announce the closing of a small acquisition in the health space, Priority One, which specializes in psychological assessment and selection services to the Canadian law enforcement community. We believe the market for psychological services will continue to grow, and this acquisition strengthens our services in this critical area. With positive financial metrics, Calian is uniquely positioned to leverage our strong financial position to continue to invest in both organic and acquisitive growth. We continue to invest time and effort in assessing future acquisitions as well as ensuring completed acquisitions are integrated successfully into Calian. Across all of our service lines, we are confident that there are opportunities that align to our acquisition criteria. However, we must caution that revenues realized are ultimately dependent on the expense and timing of future contract awards as well as customer utilization of existing contracting vehicles. Based on currently available information and our assessment of the marketplace, we expect revenues for fiscal 2018 to be in the range of $300 million to $315 million and net profit in the range of $1.95 to $2.20 per share. Finally, and 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 back in the office expecting to be full-time in September. With that, I'd like to now open the call to questions, Sophie?

[Operator]

[Operator Instructions] And we'll take our first question from Benoit Poirier with Desjardins Capital Markets.

[Benoit Poirier]

Congrats for the acquisition. And also, Kevin, I'm glad to hear that you'll be back full-time in September.

[Kevin Ford, President, CEO & Director]

Thank you, I appreciate that.

[Benoit Poirier]

Yes. So for the acquisition of Priority One, could you talk a little bit about the opportunity here in terms of the synergies, in terms of revenue and also the potential to integrate that and serve the Canadian forces?

[Kevin Ford, President, CEO & Director]

Yes, so maybe I'll start with that, and I'll let Jacqueline jump in for any other additional comments. Yes, from my perspective, the psychological services, and if you look at our historic health services contract with national defense, we have been providing services in this area for a number of years, over 10 years, with our defense contract. And we continue to see demand, not only in defense but obviously with our Veterans contract and RCMP. This acquisition opens up some new customers for the area. It brings us good, solid backlog of 3 or 4 really key contracts and also brings us some intellectual capital around best practices and psychological assessments in specific areas. So we think it is going to strengthen our capability. It's going to give us access to new customer basis and as well contribute to our backlog, which continues to grow just through the long-term nature of some of the contracts this company has. So we're pretty excited. Again, I don't want to overstate it. It is a tuck under. But in the same context, they're going to really help evolve our service offerings in the psychological services area. Jacqueline, any thoughts or comments?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. So the company is generating roughly $2 million of revenues every year. So it's not a significant acquisition, but it does give us access to quite a few mental health practitioners, so I think that's a great win for Calian. Obviously, it's a small acquisition, so we're going to integrate them relatively quickly. They really don't have a lot of back-office to speak of, so it's not like it's going to generate significant synergies. But I think it's the ability to have access to these mental health practitioners that was attractive to us.

[Benoit Poirier]

Okay. Perfect. And Jacqueline, with respect to the health services contract, it seems that you now have more color about the potential contribution on revenue. You were referring to $70 million, $75 million. Is this the amount that we currently -- you're currently working on? Or this is something that will grow to these levels in the coming quarter?

[Jacqueline Gauthier, CFO & Corporate Secretary]

No, that is currently what we're seeing right now.

[Benoit Poirier]

Okay. And just looking at the contract renewals, also you've been quite successful in the quarter, getting new contract, the one with the Royal Canadian Air Force. Just wondering -- and also the big contract for SED. I understand there is no change with respect to the fiscal '18 outlook, but I know it's early for fiscal '19. But looking at your bidding rate, what could we foresee in terms of driven growth going through fiscal '19 with all those wins?

[Kevin Ford, President, CEO & Director]

Well, for me it's a good question, Benoit, and we're working through that now as we finalize our budgets going into next year. And as you know, we'll restate our guidance coming into next quarter -- not restate, we will state our guidance for the fiscal year 2019. I think for me, if you take a look at the momentum over the last couple of years, and I'm happy to see it in our guidance this year, that we've upped our guidance to move over the $300 million threshold as a company. I'm very confident we're going to continue to maintain the pace that we have been telling our shareholders now for over 2 years, the 5% organic combined with the 5% M&A, look we got that 10% growth. So I'm pretty confident that we can continue to sustain that momentum moving forward. That being said, between now and November, we'll reassess everything and then come back with our full year guidance in the November time line. But I'm very optimistic right now that we're -- as you said, with those wins, with the M&A activity that we're doing, we're both positioned not only for the short term, but frankly, longer-term growth here as for the pace I've been trying to step for the company since I took over as CEO.

[Benoit Poirier]

Okay. And last one for me. Could you provide some color about your bidding pipeline in terms of potential new contract win, contract renewal and also comment about the M&A pipeline?

[Kevin Ford, President, CEO & Director]

Yes. So from my viewpoint, the -- as I mentioned many times, Calian having 5 very distinct service offerings, each of the service offerings has a funnel of opportunities that is when you amalgamate all of that funnel at the corporate level, it's very exciting. It's great. You don't ever take for granted the opportunity we have here at Calian to leverage those 5 system engine we've got here. So the funnel is very strong. Again, we just always deal with timing and competition. So at the end of the day while we're strong, there's no guarantee we can win it. But from my viewpoint, I think we've done well. As I said, historically, whether it's a recompete or a new customer that we go after. On the M&A pipeline, we are spending a lot of time here on the M&A. We've spent -- I think I mentioned last quarter, we spent some considerable time since last summer really putting effort into defining an M&A playbook for Calian, working with our Board of Directors, working on our criteria, working on our integration plans to solidify and strengthen our M&A processes so that we not only acquire companies, but we also integrate them successful into Calian. So with that, we continue to look very proactively for acquisitions of whether it's a tuck under or a major acquisition, we're open to all. And I think pipeline opportunities exist, Benoit, and many discussions are happening that we will -- continue to happen and hopefully, you'll see some of those come to fruition.

[Operator]

And we'll take our next question from Edson Lai with GMP Securities.

[Edson Lai, Associate]

I want to talk about the cash flow from ops. I think the year-to-date number was approximately $1 million when, historically, it's been around the $12 million mark annually. So the question is, do you expect a large reversal in Q4? Or will there still be modest cash generation going forward in the next few quarters?

[Jacqueline Gauthier, CFO & Corporate Secretary]

When you're talking about cash flow positive, you're talking about including the working capital movement?

[Edson Lai, Associate]

Yes, yes.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Okay. Well, it's hard to predict where our balance sheet is going to be at and our working capital at any given time. Right now, when I'm looking at the numbers today, I'm seeing very high receivables. I know that we've actually collected on some of those. As we end some contracts, one of the things that we experienced this quarter that we weren't really thinking about, when the government ends a contract, they tend to take longer to pay the last invoice because they want to make sure that they reviewed everything, crossed their Ts, dotted their Is before they make the final payment. Otherwise, they -- it's harder for them to withhold any amount. And similar when you start a new contract, they tend to look at the first invoice very carefully before they release payment. So we got caught in that with HSSC. The 2 invoices is over $12 million of receivables, where they've kind of been slow in paying. These are coming in, so we're fully expecting that by the end of August, we're going to have -- we're going to be back on track, but that caught us offguard in Q3. As well as SED, when they have major contracts, sometimes they can invoice at the end of the month $5 million, $10 million, and those get collected not far into the future. But we can have significant swings that way that really doesn't mean anything.

[Edson Lai, Associate]

Excellent clarity. I want to come back to the Priority One acquisition. It seems like the Priority One acquisition is focused on the front end of psychological assessment and services, or in other words, it's tailored for candidates before they enter the law enforcement community. Does Priority One have a capability to serve these clients after they've entered or left these agencies for things such as PTSD? Or is this an opportunity going forward?

[Kevin Ford, President, CEO & Director]

I would say that if you look at -- sorry, I think the psychological services, I think, right now, the offering of Priority One, as I just said on that front end, specifically looking at entries, looking at folks that are carrying firearms. There's a specific scope that they're very specialized in. That being said, they are psychologists. So at the end of the day, we can look at a broader context for those services. But we really think there's an opportunity then at front end to grow that. If you look historically where we've been on our health services contracts, we do that today. We're working across the military with our psychiatrists and psychologists on numerous basis to support whatever the psychological requirements of that contract. So we're doing that today in -- both in post- and pre-assessments. And what they're going to bring specifically is some best practices on that initial assessment phase, which is something, I think, is going to be good for us going forward as more and more people are looking to do this type of assessments upfront.

[Operator]

[Operator Instructions] And we'll now take our next question from Brian Pow with Acumen.

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

Just my question is on Priority One as well. Just trying to understand sort of the granularity of their revenue and the contractual nature of it, how long the contracts are.

[Jacqueline Gauthier, CFO & Corporate Secretary]

Okay. So like I said, the revenue -- annual revenues are just slightly below $2 million. They have about 5 contracts, 2 that are more significant than the other 3. And they have a lifespan of 3 and 4 years. So we've got them for a fair bit.

[Kevin Ford, President, CEO & Director]

And Jacqueline is bang on, on that. And to confirm, we don't think the requirement is going to go away after 3 or 4 years, but we have to go through like if I had another contract, it's like a recompete cycle. But again, we think they're very specialized, and we feel very confident in our ability to continue to perform their services longer term.

[Jacqueline Gauthier, CFO & Corporate Secretary]

And some of the contracts are with new customers and a few are with existing customers of Calian, so it's going to allow us as well to strengthen our relationships with some of our customers.

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

Okay. And like in terms of the nature of their charge -- like how they charge their services, is it on a per patient basis? Or is it just...

[Jacqueline Gauthier, CFO & Corporate Secretary]

Correct, per assessment, yes.

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

Okay. So do they have some ability to crank it up if you add some of your specialists into their network?

[Kevin Ford, President, CEO & Director]

Yes, I think, for us, the ability to scale the services is something we're definitely going to be looking at. We believe the demand in psychological services is only going to increase. And so they are a piece of the Calian capacity chain that we will be applying to requirements, whether it's on our current customer base or new customer base. So frankly, I look at them as a piece of that scaling-up capability. And with our national footprint right now, we're feeling pretty good that -- we know the workforce. They're generally in this area. And as we tie that workforce to requirements, we're pretty confident in our ability to scale. That being said, there is still shortage of psychological capacity in this country, so I think we're going to do well. But there's no silver bullet in fixing that anytime soon.

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

When you look at their service offering, how many sort of similar companies are there to them that you could potentially look at?

[Kevin Ford, President, CEO & Director]

Sorry, are you thinking about a consolidation role?

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

Yes, in that particular area.

[Kevin Ford, President, CEO & Director]

Yes, I think they're -- I don't have the numbers, Brian, right now. But it's -- the opportunity -- and you think you're bang on with the way we're thinking. It's just continuing to add pieces either substantial or tuck-under pieces to our capabilities is where we're going to go. So we're uniquely positioned to play a consolidated role here in the areas that we choose to do so, so we'd definitely look at that as an opportunity.

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

Okay. We've talked before about sort of your goal to sort of try to diversify yourself a little bit away from government pays and all that kind of stuff. So I sense from this that it's still sort of a government organization. But what are your sort of abilities to again diversify away so you're not strictly sort of a government service provider?

[Kevin Ford, President, CEO & Director]

Yes, I would say that if you look at Calian today, and if you bring our division of Saskatoon in, I think you'll appreciate we are not just a government service provider. Our division in Saskatoon, I think it's about 65%, 70% of what it does. It's exported to customers around the world. We have a big government footprint here in a division in Ottawa. But I think we are diversifying. If you look at our wins, we don't announce all of our wins, obviously. And -- but if I look at the 4-pillar strategy and customer diversification, we are diversifying away from federal government. The other thing I want to reiterate that you can still diversify within government. So we're looking at municipalities. We're looking at City of Toronto, Mississauga, Brampton. So even though we kind of wrap it all up as government or a public sector, we're diversifying both within that sector and outside. And then if you bring our SED division in, I think again a unique strength of Calian is our ability to say, well, we can service domestically, but we have this huge customer base globally within our SED division, and those are primary nongovernment. So while we continue to work on it, I think we're making progress on that front.

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

Yes. I mean, I was referring to BTS, not SED. I'm aware what SED does there. So...

[Kevin Ford, President, CEO & Director]

Yes. No, I appreciate that, yes.

[Operator]

And we'll take our next question from Gianluca Tucci with Echelon Wealth Partners.

[Gianluca Tucci, Research Analyst]

I think you guys touched on this a couple of minutes ago on the DSOs. So is it safe to expect a return of normalization in your fiscal Q4?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Today, I wouldn't expect the receivable balance to be that high at the end of September. But again, if we end up invoicing a huge milestone just at the end of September, it may creep up there as well, but it won't be the same invoice. So if you look at our aging, it actually has improved over the last quarter slightly where we have -- we never have more than 5%, 6%, maybe 7% above 90 days. Sometimes those are hold back, sometimes they're just invoicing administrative type issues that need to be fixed. And that number hasn't moved. So it's not that the invoices are getting older, they're just the ones that we invoiced in June, which is significantly higher.

[Gianluca Tucci, Research Analyst]

Okay. And then I think you spoke to this in your preamble there about the satellite now being more skewed toward fiscal 2020 as opposed to '19. Is that correct?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Correct. When we initially won the contract, we were looking at basically a start in '18, having more or less even revenues in '19, '20 and then finishing it up in 2021. Now that they've actually laid out the plan, there is going to be a longer run-up period and then a shorter time of delivery. I believe there's over 20 units that we're delivering. So the delivery of the units are going to happen in a more condensed period more so in 2020, so there's going to be a significant amount of revenue generated in that period.

[Gianluca Tucci, Research Analyst]

So you can split it between fiscal 2019 and '20. That's about 50-50 prior. Is it now 30-70 given the information that you know today?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes, it's a 1/3, 2/3, yes.

[Kevin Ford, President, CEO & Director]

The 1/3 is significant, right? So I just want to reiterate that, that 1/3 is still -- kind of it's still not insignificant in the context, that we're expecting it to still contribute positive [indiscernible] in 2019. I don't want to give anything -- have anyone worry about our 2019 forecast. It's just we want to make sure because of the size of the contract that people understood the current profile of the project.

[Gianluca Tucci, Research Analyst]

Yes. No, it's just a simple, I guess, recalibration of a pro forma here.

[Kevin Ford, President, CEO & Director]

Okay. Perfect. Thank you, Gian.

[Gianluca Tucci, Research Analyst]

And then just on your BTS margins. You spoke about all of this as well, but are these kind of margins here -- I mean, your EBIT margin was 6.3% in your fiscal Q3 on your BTS. Is that sustainable in at least the short term, the next quarter? Or is it 2? And if so, what's causing that?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes, I think we're going to see similar EBIT or EBITDA margins in the near quarter. I think when you look at the gross margin level at BTS, it's increased significantly. And we don't see any reasons why that would not carry into next year. I think you can definitely forecast a similar margin profile going forward.

[Gianluca Tucci, Research Analyst]

Fantastic. And then just finally on the acquisition from this [indiscernible] Priority One. Is this $2 million in annual sales? Can you give a margin profile on that $2 million? And I'm sure that you guys have done your homework here. I mean, how big do you think Priority One could get in Year 1 in your existing customer base of Calian as a whole?

[Jacqueline Gauthier, CFO & Corporate Secretary]

Yes. Turning to the first question, we don't give margin by subgroup. I would say that their margins are better than what Calian has historically achieved. So it is better, but it's such a low amount of revenue. I don't think it'll have a significant impact on the overall margin. In terms of giving you maybe even a multiple, we paid 2.5x EBITDA, and we have backlog running through 3 to 4 years.

[Gianluca Tucci, Research Analyst]

Got it. Fantastic. And then just on the second part of that question there. Have you kind of gauged on how big that offering could get in your existing customer base in the first year of post-integration or still too early to estimate that?

[Kevin Ford, President, CEO & Director]

Yes, I think, for me, we're working through that, so I'd rather just say it's too early because I'd hate to give you a number that I'm going to be retracting later. Right now, we know the demand is not insignificant with regards to even our current contracts on psychological services. So as far as market size and what we can do with that, we're working through that. But to me, it's a combination of the capacity. But as important, to me, the intellectual capital they bring in conducting these assessments, I think it's unique, and I think it is something we can leverage in other areas for sure.

[Operator]

[Operator Instructions] And Mr. Ford, it appears there are no further phone questions at this time, so I'd like to turn the floor back over to you for any additional or closing remarks.

[Kevin Ford, President, CEO & Director]

Okay. Well, thanks, Sophie, for opening up the call. Again, and thank you to all who've attended today. We appreciate the questions and the interest. Again, we're very proud of what Calian is doing and the results the team is achieving, and we look forward to discussing our next quarter's results with you in 3 months' time. So enjoy the rest of the summer, and we'll talk to you again in November. Take care. And we can close the call now, Sophie.

[Operator]

Perfect. Then this does conclude today's conference call. Thank you for your participation. You may now disconnect your lines.