Data Communications Management Corp

TSX:DCM

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the Investor Call for Q1 2019. [Operator Instructions] James Lorimer, Chief Financial Officer of DATA Communications Management, you may begin your conference.

[James E. Lorimer, CFO & Corporate Secretary]

Thank you, operator, and good morning, everyone. Thank you for joining us today for our First Quarter 2019 Conference Call. Speaking on the call this morning will be Gregory J. Cochrane, Chief Executive Officer; and myself, James Lorimer, Chief Financial Officer.Also joining us on the call today are several other additional members of our executive team, including Mike Coté, President. The prepared remarks on today's call will be followed by a question-and-answer period. We'd also like to remind everyone that Greg and I at DCM can be available after the call for any follow-up questions that you might have.A reminder that our Annual General Meeting will be held on Wednesday, May 29, and your Board of Directors and many of your senior management team will be pleased to meet with you at that meeting.Before we begin, I'd like to remind everyone that we will refer to forward-looking information on today's call. This information is subject to certain risks and uncertainties as outlined in the forward-looking information disclosure in our press release and more fully within our public disclosure filings on SEDAR.With that, I'll now turn the call over to Greg.

[Gregory J. Cochrane, CEO & Director]

Thank you, James. Good morning, shareholders. I want to provide an overview of the following: Our first quarter of 2019; our first quarter initiatives and drivers for the business; and lastly, an outlook for our near term. So let's begin with our first quarter 2019 financial results.Revenues for the quarter were $78.5 million compared to $88.5 million in the first quarter of 2018, a decrease of $10 million or 11.3%. Now this decrease was largely expected as our company benefited in the first quarter of 2018 from a onetime increase in volume from a long-standing customer, which generated approximately $4.9 million higher revenues in that period compared to the current quarter.We also have decided to not pursue a low-margin customer contract renewal given our focus on improving gross margins, which contributed to a decrease in revenues by approximately $1.4 million this quarter. The balance of the year-over-year change pertains primarily to timing of work, in addition to some softness in spend from certain customers.Adjusted EBITDA was $7.9 million in the first quarter of 2019 or 10% of revenues after adjusting for the impact of adopting IFRS 16, which became effective in the first quarter of this year. This compares to $6.4 million in 2018, representing a $1.5 million or 23.4% increase compared to the first quarter of 2018.Before adjusting for the adoption of IFRS 16, adjusted EBITDA was $5.4 million or 6.9% of revenues from the quarter ending March 31, 2019. Once again, this decrease is primarily attributable to the unusually strong volume in the first quarter of last year from 1 customer. We had budgeted this already in our 2019 plans.So let's turn to our first quarter initiatives and drivers. We continue to focus your company, our company's efforts on providing additional products and services to our core client base. In addition, with the enhanced retail and consumer insight capabilities that Perennial brings to DCM, we are capturing new client business due to the innovative ideas and exceptional executional capabilities we're presenting to clients. Our pitched and pending sales pipeline is that at a historic high with both current and new clients.Continuing to pivot. You know I've talked about this as we pivot towards more of a marketing service company. I'm very pleased to say our business solutions team was recently awarded a significant multiyear agreement to provide innovative technology solutions to a large provincial health services network.DCM was selected as a key technology partner to support the province's integrated clinical information systems, providing automated identification solutions, including scanners, printers, patient identification solutions; consumables, including labels as well as ongoing support and consultation services. This long-standing customer of DCM in our traditional business has trusted us to consult, evaluate, recommend and execute a business solutions platform, which will dramatically modernize the way this province delivers health care services to its customers.By recommending the appropriate technology and business processes to this client, DCM is now seen as a total enterprise solutions supplier instead of a print and production vendor. We began to record revenue in the second quarter of 2019 under this agreement. We recently announced the sale of our loose leaf binders and index tab business to a wonderful partner, Southwest Business Products Limited, and at the same time entered into a long-term supplier agreement with Southwest as a preferred vendor of binders, index tabs and related products. This initiative aligns with our strategy to focus on products and solutions that are core to our top customers and to source noncore offerings from other leading providers where it makes sense.Consistent again with this theme, in early March 2019, we initiated plans to outsource our Broussard, Quebec stationery production to a long-standing Tier 2 supplier. DCM also expanded its pre-existing supply agreement with this partner. And effective May 1, 2019, we closed Broussard, Quebec facility, which primarily produced stationery products, including business cards and letterheads, and relocated the facility's digital print on-demand production to other DCM sites.Let's now turn to our joint venture with Aphria. Over the past several months, the joint Perennial and Aphria teams have been focused on developing go-to-market strategies for cannabis-infused edibles, beverages, topicals and wellness-related products. While the joint venture business plans are being developed, we are closely monitoring the federal government's direction for guidelines on dosage, formulary approvals as well as manufacturing protocols to produce products containing cannabis and CBD, an extract found in cannabis.Let's now turn to our operations. In addition to our focus on sustainable revenue, we have been conscious of improving gross margins. The first quarter of 2019 saw gross margin as a percent of total revenue reach 26.4% or 26% prior to adjusting for the adaptation of IFRS 16 compared to 24.3% in the first quarter of 2018, this despite lower levels of revenue.Our gross margin improvement was in great part due to improved efficiencies in our plans. We continue to review supplier contracts and relationships as well as processes and workflow improvements. We are also realizing success in passing on some of the input price increases to our customers.I'm very pleased to report that both our recent investments in specialized capabilities, specifically the six-color Heidelberg press at Thistle and the Gallus label press in Brampton, Ontario were fully commissioned in March and April of this year. We expect to see continued improvement in margins on labels and commercial print throughout the year, especially as we migrate more commercial print work to Thistle and away from Tier 2 suppliers.Selling, general and administrative expenses. If you can remember, this has been one of our focuses on reducing this. This focus on reducing SG&A expenses as a percent of revenue has been working. I'm pleased to report our SG&A for the first quarter of 2019 was $16.8 million or 21.3% of revenue after adjusting for certain onetime non-reoccurring expenses totaling $400,000 versus $17.4 million in the first quarter of 2018 or 19.7% of revenue, a $600,000 savings. Please also remember, folks, we didn't have Perennial in the first quarter of last year, so there's probably a little additional savings to that as well.We are still continuing to focus on ways to drive down our SG&A expenses and improve those efficiencies. To this point, we are executing on our ERP transition in June 2019. This implementation has been a long time coming but will vastly streamline workflow from sales orders to production plus automate and simplify many management reporting and accounting procedures. We believe the annualized cost savings in improved processes and overheads will be in the range of $2 million to $3 million per year.Corporate initiatives. During the first quarter of 2019, we completed payouts of the promissory notes to both Thistle and Eclipse vendors. And this past week, we be made a further $1 million payment to the Perennial vendor. Coupled with our ongoing debt reduction payments to our lenders, DCM reduced its fixed-term debt and promissory note obligations by approximately $4 million in the first quarter of 2019. We will continue to pay down our debt in 2019 and expect to see a nearly $10 million reduction in our outstanding fixed-term debt by the end of 2019 compared to the end of 2018.In April, we announced the appointment of Mike Coté as President of our company. This change completes the management reorganization we conducted to improve our bench strength in operations, supplier relations and finance. Mike and I will share day-to-day operational and strategic mandates.Since joining DCM in September 2017, Mike has demonstrated a passion to change the way we execute with clients as well as the desire to make us all better operators. Given the pace of change we're experiencing, I welcome Mike, as I call it, a 2 pack, helping me guide the tech transformation of our business.Let me now give you an outlook for our near-term balance of the year. At the outset of this year, your management team set 5 business priorities: focus on core customers; continue to improve gross margins; reduce our selling, general and administrative expenses; pay down debt; and lastly, make strategic investments in technologies that clients request and value to support future growth. The first quarter, I believe, reflects our heightened focus on these 5 business priorities. We do remain optimistic for the year despite the continued presence of price increases on raw materials and secular declines in some of the traditional print and production areas of our business.Lastly, as I've said before, your management and directors comprise a large block of shareholders of your company. We will continue to invest in our company because we believe there's a significant value we can provide our clients and that we can create long-term value for all of us as shareholders. I truly thank you for all your support.Now for a full description of our financial results for the first quarter of 2019, please refer to our unaudited consolidated financial statements for the 3 months ending March 31, 2019 and related management discussion and analysis, copies of which are available on www.sedar.com.That's my report, and we'll open it up for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Scott Nirenberski with Muskoka Capital.

[Scott Nirenberski]

Just a few questions. So curious about -- so last first quarter of '18, you had the one big pull-through of a customer, which was $5 million. On the other $5 million decline year-on-year, you said that was largely due to a customer, a low-margin customer that's been -- that's just gone away. Is that correct? Would they be substantially all of this decline? Or most of it or...

[Gregory J. Cochrane, CEO & Director]

Actually, if you look at the $10 million, Scott, $5 million was a onetime customer, $1.4 million was the customer we chose not to engage with and then the rest is timing, just timing on new business. We look at our business 2 ways: 1 core business, new business. And the core business declined, what we thought. The new business, while we have the orders, it just was timing and we're seeing some of those orders now appear in April as an example. So that was just timing.

[Scott Nirenberski]

Got it. Perfect. All right. And market looked good on the gross margin front. So I assume that a lot of that is mixed and it's also, I guess, lost business that you don't want anyways, like the example you just cited. Is that fair to say?

[Gregory J. Cochrane, CEO & Director]

Yes. I think, Scott, it's really 3 things. We started out -- and let's focus on our core customers. We have thousands of customers, but 160 of our customers constitute 90% of our revenue. I've got to tell you, we have such an envious position in terms of the market dealing with so many great customers and big ones. Let's focus on them but let's provide them more than just print production and I kind of -- we have to make a decision that we can't service everyone at the same level. So let's spend our time on the bigger ones and let's spend our time with enhanced services. So that was conscious.Second issue was business processes. We are just ripping through this place right now on just how much more efficient can we do this. Under the guidance of ERP, I think it's easy. As many of you who are stalwart shareholders like myself, ERP's supposed to be this nirvana. It will be. It will be a big help but quite frankly, business needs to just get sharper and better in the processes. So we've had people in, our own people in here to look at everything that we're doing. First thing, it's called discipline. Mike Coté brought this to our sales force. As you know, we changed the compensation process and program for our sales professionals in 2017, where folks are getting paid on gross margin, not on the dollar 1 revenue. Well, that had a significant impact in terms of improving margin. We didn't see a lot of that last year more because the price increases that were coming through on paper was so hot and heavy, we just couldn't react fast enough. But you're starting to see it now. So I know that's a long answer but it's really 3 things that are really driving that. Hopefully that helps you.

[Scott Nirenberski]

Yes. I was actually going to ask about the impact from the change in commission, your current structure to see sort of where we were on that. It sounds like we'll see a lot more of that this year because it won't be masked so much by the paper and input cost increases. It is that fair to say as we move through the year?

[James E. Lorimer, CFO & Corporate Secretary]

Yes. I think -- Scott, it's James. We're certainly seeing those input pricings moderate a little bit. We have had 1 paper price increase so far this year. We are expecting another one, but we had 4 major rounds last year. So we see it certainly moderating compared to last year.

[Scott Nirenberski]

Right. And some of the pass-throughs that you're able to do, I realize there's always a timing difference there between when you see it and then when you're able to do it, but it sounds like, based on what you'd said back in, I think, third and fourth quarter, that your newer contracts, you're being a lot more disciplined with those and making sure that you can pass along a certain amount of increases along the way. Is it fair to say that we should start to see some of the impact from your ability to pass along price increases to customers this year and that -- maybe that grows -- the positive impact from that grows as we move through the year?

[James E. Lorimer, CFO & Corporate Secretary]

Yes. I think that's fair. We should continue to see that. We have some contracts that are allowing us to provide increases in the first quarter and kind of straddling the second quarter that will continue to have positive impacts for the balance of the year. And certainly, as new contracts are coming up, we're better aligning our customer contracts with the current pricing environment.

[Scott Nirenberski]

Okay. Okay, great. And then I know you did a lot of work on the SG&A. It looks really definitely like you're keeping it under control. This sort of 17 issue or $17.2 million kind of quarterly run rate, is that a fair way to think about it as we kind of move through the year? I realize there's probably puts and takes with annual salary increases and things like that and different contracts that -- contracts that you have that fall into that line. But I'm just curious to how we should be thinking about that as we -- on a run rate basis.

[James E. Lorimer, CFO & Corporate Secretary]

Yes. We would expect to see that go down on a kind of a quarter-over-quarter basis through the balance of the year, Scott, and particularly as some of our other initiatives start to really have continued impact throughout the balance of the year.

[Scott Nirenberski]

Okay. Great. Great. And then on the new contract, the provincial health care system. I know you can't probably be too specific about it, but is this the type of thing -- I mean, when you think about these large health care systems and the amount of service they could conceivably - can stem from you, you folks -- it would seem to me that, it would be not be unreasonable for these things to become like 5%, 10% kind of customers. Any color you can give around that would be helpful. And I realize it's new and it will take some time to get implemented and ramp up and so forth, but I'm just trying to get a sense of how significant this type of thing is.

[Gregory J. Cochrane, CEO & Director]

Scott, this client of ours will be approximately 5% of our business this year, I suspect, after all is said and done, coupled with what we have recently built for them and their solutions plus the production, the traditional print production work we've done. We see that growing. Again, it's part of the pivot. We go in and we lock-in. It's a multiyear deal, right? So think about this for a second. A provincial organization is not going to do this all in 1 year. It's going to be phased in. But more and more organizations like this are looking for just any type of solution that's going to help streamline the processes and reduce their costs. And so alas, because I know when I first came in here, we had this business solutions group and I couldn't figure out who the heck these people are. So I got the individual and I remember I started November 28, 2016 and in December, I met the head of this and I said, so what do you do? And it's one of these things in large corporations like there are these pockets of gold that are in these veins and you go, wow. We have this group, which was basically reselling equipment or who were basically giving the equipment away so we could get the print. Wow, that's pretty riveting in terms of margins. What other services can you provide, right? So we decided -- we decided right there and then to make this a dedicated business unit. Last year, their sales, just within that group, were up 50% versus 2017. This year, they're obviously, as this young lady said to me, well, I guess I've met my targets for the year. I said, no, no, no, that was a target for the first quarter. So as we make the pivot to a solutions provider in the marketing and communication services business, this is just one part of it. I'm just delighted about it.

[Scott Nirenberski]

Yes, that's great. And presumably, there is, like you said, similar solutions will be needed by other territories, provinces. So is there -- I realize nothing is formulaic on this kind of thing but I would assume what you learned from working with these guys can be, at some level, transferable to other provinces and you can go and begin to pitch them or you probably already are on these types of things, these types of total solutions? [ I was hoping you could ] talk about that.

[Gregory J. Cochrane, CEO & Director]

We are in discussion with 2 other provinces and we also have secured a similar type of deal, not in the same revenue magnitude, with a federal organization as well. But it wasn't -- it's not in the same magnitude. But to answer your question, we see our business solutions group, say, in the next 18 months being anywhere between 7% to 10% of our total revenue.

[Scott Nirenberski]

Got it. Great. Great. And then maybe just on the competitive front, anything sort of changing or different there in terms of buyers, intensity of competition, pricing, that type of thing?

[Gregory J. Cochrane, CEO & Director]

Hopefully, my competitors are taking the low-margin stuff that I don't want. I don't want to leave the customers in the lurch. I'm not trying to be flippant, it's just -- I just can't believe that this goes on. It's just -- but we haven't really seen it. I am seeing, however, an interesting trend in getting phone calls from a number of what I call traditional print production companies that are maybe in the 7% to 20% of our type revenue. And I think they're having a harder time competing in this community in the market. Because I think the communications space where we play in is going to be dominated by a couple of players and those that are much smaller, the customers are asking for more enterprise solutions with technology platforms, with predictive analytics. And quite candidly, if you're running a $20 million shop -- a $20 million revenue shop, 80,000 square feet and it's your business, you want to bone up and go all right, I'm doubling down and putting the technology, and so it's interesting I'm getting phone calls about that. I'm not really that interested, quite candidly, to put more iron on the floor when I'm making the change to a much more technology and solutions-driven business. I hope that answers your question.

[Scott Nirenberski]

Yes. No, that does. And then insofar as the large potential customers that still in-source a lot of their capabilities, both traditional legacy as well as frankly, newer digital, maybe give us any color if you can on some of those players and their willingness to revisit outsourcing or transition more of their business outside, as you would want obviously.

[Gregory J. Cochrane, CEO & Director]

Yes. We're in discussion right now with a fairly substantial financial services company and obviously, we have competition, but they have finally come to the realization that they've been in-sourcing and they've siloed their business units. And I think what's happened is that with the advent of a new CEO, it's looking why aren't we -- in their business, why aren't we communicating and sharing our services? And I think the model, there used to be a management model where you'd silo your businesses and ensure that whoever is running that certain business was firing in all cylinders. I think people are starting to realize at this point in time that we can have that from the customer base, but back office, we need to share services. So after -- this has been a 2-year conversation with this client. It's a current client. We have finally have broken through and are talking about a shared services model. We do have competition in there, but not the traditional type of competition that you would normally see in a print production world. I don't know if that gives you enough color but...

[Scott Nirenberski]

No, that's -- yes. And just when you say it's not the traditional competitors, who is it, if you can talk a bit about that?

[Gregory J. Cochrane, CEO & Director]

Who the competitors are?

[Scott Nirenberski]

Yes. Who the newer or different competitors are for something like that.

[Gregory J. Cochrane, CEO & Director]

It's almost like we don't really have competitors in that. It will be big enterprise software companies that are trying to sell a really complicated solution. And we have something that's not really drag-and-drop but it's integrated into our DATA online portal. We're already serving the customer through our -- through DATA online, and we can integrate this in and just provide more enhancements and more capabilities to that. And that's really where we're spending a lot of our kind of internal strategy and focus is. How do we deepen those hooks within our existing customers.

[Scott Nirenberski]

Yes. I'm guessing those types of people are probably looking more to sell software solution in combination with services around it, like, classical integration services around it either as a cloud offering or possible on-prem, I guess. But I guess that's going to be a lot more complicated and, frankly, a lot more expensive for the typical customer.

[Gregory J. Cochrane, CEO & Director]

Yes, absolutely.

[Operator]

[Operator Instructions] We have no further questions at this time. I will now turn the call back to our Chief Executive Officer, Greg Cochrane.

[Gregory J. Cochrane, CEO & Director]

Thank you. Thank you very much for hosting this. Fellow investors, thank you. Thank you for your support. As I said earlier, we're focused on our 5 core business initiatives, and we look forward to reporting our second quarter. And as James said, our Annual Meeting is on the 29th, 10:00 a.m. at McCarthy Tétrault. So thank you. Have a good day.

[Operator]

This does concludes today's conference call. You may now disconnect.