Data Communications Management Corp

TSX:DCM

Earnings Call Transcript 2019-Q2

[Operator]

Good morning. My name is Kenzie, and I will be your conference operator today. At this time, I would like to welcome everyone to the DATA Communications Earnings Call for Q2 2019 Results. [Operator Instructions] Thank you. James Lorimer, Chief Financial Officer, you may begin your conference.

[James E. Lorimer, CFO & Corporate Secretary]

Thank you, Kenzie. Good morning, everyone, and thank you for joining us today for our Second Quarter of 2019 Conference Call. Speaking on the call this morning will be Greg Cochrane, Chief Executive Officer; and myself, James Lorimer, Chief Financial Officer. The prepared remarks on today's call will be followed with a question-and-answer period. We'd also like to remind everyone that Greg and I can be available after the call for any follow-up questions that you might have. Before we begin, I'll remind everyone that we will be referring to forward-looking information on the 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, fellow shareholders. I'm going to set up the call as follows: give you highlights on the second quarter 2019 as well as year-to-date financial results; we're also going to look at the second quarter initiatives and drivers for our business, it has been a busy quarter; and lastly, a management outlook for the near term. Let's begin with second quarter 2019 and first half 2019 financial results. Revenues for the quarter were $69.6 million compared to $78.2 million in the second quarter of 2018, a decrease of $8.6 million or 10.9%. This year-over-year decrease was primarily attributed to a production shortfall, which occurred in June, directly related to the launch of our new enterprise resource planning system, better known as ERP. We also experienced some lower revenues from 2 core customers, which were primarily related to timing issues. In aggregate, the quarter was negatively impacted by more than $6 million due to the challenges related to our ERP launch. Let's turn to EBITDA. Our adjusted EBITDA was $4.4 million in the second quarter of 2019 or 6.4% of revenues after adjusting for the impact of adopting IFRS 16, which became effective, as you all know, in the first quarter of 2019. This compares to $4.1 million in the second quarter of 2018, representing a $300,000 or 8.5% increase compared to last year. Now before adjusting for the adoption of IFRS 16, adjusted EBITDA was $1.7 million or 2.4% of revenues for the quarter ended June 30, 2019. This decrease is primarily due once again to the production disruption we experienced with the launch of our new ERP system in addition to some delay in the timing, as I said before, of certain work with certain customers. Let's look at the 6 months. For 2019, revenues were $148.2 million compared to $166.7 million in the first half of 2018, a decrease of $18.5 million or a little bit over 11%. Adjusted EBITDA was $12.3 million or 8.3% of revenues after adjusting for the impact of adopting IFRS 16. This compares to $10.4 million in the first half of 2018, representing an increase of $1.9 million or 17.8%. Now adjusting -- before adjusting for this adoption of IFRS 16, adjusted EBITDA was $7 million for the first half of 2019. Folks, I can tell you right now that second quarter was challenging. For some of you that know me, I'm a big history buff. And I sometimes revert back to Winston Churchill at the start of the war when he said, "When you're going through hell, keep going." Your company's second quarter was a challenging one as we march towards this transformation of this business from a print production organization to a much more agile marketing and business services enterprise. Let's just address ERP right now. On June 3, 2019, we launched our new ERP system across our core DCM business. We've taken 60 years of systems that are all over the map, customized processes, procedures, many distinct to each of our key production facilities in our core business and unifying those into one harmonized platform with integrated financial and production reporting and work streams, has been daunting. But it is absolutely necessary. We are building the new framework and bedrock for this business. In our first month, we experienced operational challenges, which led to a drop in production levels and shipments as we migrated almost 100,000 unique production and inventory items or SKUs for our customers. As I write and as I speak to you today, we are in our 10th week. We've weathered the start-up phase of the system at all of our core DCM facilities. I am very pleased to report the system and reporting works well. Our main focus now is cleaning up a backlog of orders and billings, which were to occur in June and early July, however, were deferred until this month and September. We believe our open order production backlog is more than $6 million higher than normal at the end of July, which we've been working on to clear up. And we will continue doing that through August and September. We expect production revenues and billings to return to normalized levels in the third quarter of 2019 and to also realize our June shortfall in this period. I'd like to now address our JV with Aphria. In June, we mutually agreed to terminate our JV initiative with Aphria. Both parties determined, we have taken the relationship to a point where further progress would be dependent on government legislation and regulatory approvals. Given we both had more pressing priorities in the near term, we wound up the JV on very, very good terms. Our net financial investment in the JV is nominal. Aphria continues to be a significant client as it pertains to our labels and packaging solutions. Let me now address operations, and I want to address it on 2 points. The first is sustainable revenue. As most of you know, I have a 5-point plan and that is focusing on our core customers, and I want to address that; and secondly, improving our gross margins and lowering our SG&A. During the second quarter, our top 10 customers, who represented approximately 40% of our core revenue in the quarter, reported revenues better than 5% versus planned despite some timing issues that offset that growth. Part of this performance is our focus on providing additional marketing and business services to customers. As you all know, this is a critical pivot as we see the traditional print production needs of our clients continue with secular declines. On efficiencies and cost controls, we brought on a seasoned procurement service professional who recently led the procurement team at a large Canadian financial services company. He is making significant improvements in inroads in the way we deal with our core suppliers and the processes and routines we follow. We expect to see at least $2.5 million to $3.5 million of annualized savings together with improved purchasing processes from his team's activities. We also initiated a series of operation team staff reductions across our organization during the second quarter of 2019. These are not related to ERP, I just want to make that very clear. We expect to see an annualized savings of approximately $2.8 million related to these changes. Once ERP is up and running fully, we expect additional operational savings. We continue to critically review each part of our business as it pertains to our target of being the premier marketing and business services company, serving major organizations throughout North America. SG&A. Our focus on reducing SG&A as a percent of total revenues accelerated in the second quarter of 2019. During the quarter, we reduced our SG&A head count. We expect to realize annualized savings related to this head count reduction of approximately $2 million on an annualized basis going forward. Between our operational and SG&A headcount reductions, we reduced head count in the quarter by 75 individuals and incurred total restructuring expenses of $3.2 million. We expect these changes to help strengthen our margins in the second half of 2019. We continue to evaluate our business for further efficiencies, and therefore, other areas of cost savings. Following our ERP completion, we expect also to realize an additional $3 million to $4 million of cost savings in improved processes and lower overheads. Other corporate initiatives. As I said, this has been a busy quarter. Earlier in the quarter, we sold our loose leaf binders and index tab business to Southwest for cash proceeds of approximately $700,000. The proceeds were used for general working capital requirements. We also entered into a long-term supply agreement with Southwest as the preferred vendor to DCM for the supply of binders, index tabs and related products. You've heard me say this before: your senior leadership team believes share ownership promotes a different mindset and supports our cultural initiatives to define responsibility and accountability across the entire organization. With that, DCM launched an Employee Share Ownership Plan, ESOP, to all of our employees in May and June, both unionized and nonunionized employees. To date, we have over 100 employees participating in the plan through regular payroll deductions. We will continue to provide information forms and seminars to include more employees in the program. And your senior management team is actively involved and is committed to ESOP as well. With that, you've also heard me say before that this is our company. And during the second quarter, your senior leadership group was actively invested in your company's common shares. In fact, more than 235,000 shares were purchased by our senior executives and directors during this period. Insider reporting, as you know, can be found on wwwsedi.ca (sic) [ www.sedi.ca ].Let's conclude with the management outlook. To reiterate, I can spell it, but I can't say it, my first quarter letters to shareholders were focused on 5 core priorities. Core customers. Revenue from our core customers is showing promising expansion into more diversified products and services, including a number of wins related to our Perennial team's contributions. Continue to improve our gross margins. Year-to-date gross margin is 24.6% of revenues versus 24% a year ago, despite the unusually weak second quarter we experienced this year. Reducing our SG&A. While SG&A is in line year-to-date at 22.1% of revenues, total SG&A is $2.7 million lower compared to our first 6 months last year. Pay down debt, long-term debt. Year-to-date, we've repaid $6.7 million of fixed-term debt, including $3.9 million of promissory notes related to our 4 recent acquisitions. And debt repayment remains a focus despite some short-term working capital constraint caused primarily by our ERP launch. And then lastly, our strategic investments. Our high-speed presses are fully optional -- operational, which we had purchased last year. We're also enhancing our capabilities for DATA online customers-facing technologies. Your management and directors comprise a significant group of shareholders, and we continue to invest in our company. We believe we can add significant value to our clients and to our shareholders. I thank you for your patience. I thank you for your continued support. As you know, a full description of our financial results for the second quarter and year-to-date, you can refer to our unaudited condensed interim consolidated financial statements for 3 and 6 months on sedar.com. That is my management update. We will open it up for questions.

[Operator]

[Operator Instructions] We do have a telephone question from the line of Ed Sollbach from Spartan.

[Edward Sollbach, Associate Portfolio Manager MM Fund]

When do you expect -- so I'm counting about $5 million in savings you're talking about from ops and G&A. Is that the right number?

[James E. Lorimer, CFO & Corporate Secretary]

Yes. Ed, in our press release, we actually called out about $10 million of annualized savings that we realized kind of in the quarter and in July. The bulk of that is from the restructuring initiatives that we completed in the second quarter. We also completed some additional initiatives in July, and we've also determined that 30 positions that were voluntarily vacated will not be filled. So we think, in aggregate, there's about $10 million of annual savings in the last couple of months.

[Edward Sollbach, Associate Portfolio Manager MM Fund]

Okay. So are there more restructuring charges happening in Q3?

[James E. Lorimer, CFO & Corporate Secretary]

Yes. There's a few individuals that were exited in July, and so we've called those out. Greg also referenced, once we have ERP and a smooth running function, we believe there's probably $3 million to $4 million of additional annualized savings on the other side of that. If you looked at our first quarter result last quarter, which I know you did, that's an increase. Our previous guidance for that was $2 million to $3 million. So we have increased the savings we expect once ERP is up and running smoothly.

[Edward Sollbach, Associate Portfolio Manager MM Fund]

Okay. And when do those savings hit in terms of the $10 million?

[James E. Lorimer, CFO & Corporate Secretary]

Most of those started hitting -- I'd say June was when we started to really realize those. And so really, the -- you will see the -- pretty much the full benefit of those starting in July.

[Edward Sollbach, Associate Portfolio Manager MM Fund]

Okay. I see. And yes, just to go back, I know over the last year, you bought a couple of new presses, the Heidelberg and another one. Like what -- are you getting a return on those? And how are you using them? And things like that? Like are -- because presumably, you should be -- that's new business for you, right? Is -- it's new technology you have? Or how does that fit in the plan?

[Gregory J. Cochrane, CEO & Director]

Right. Well, Ed, let's address the first one, which is a 6-color over at Thistle, and that replaced an old 5-color. So we don't break out by acquisition what the numbers are, but I'll just give you these numbers that our revenue is up slightly on -- at Thistle versus year ago. As you may remember, one of the things that -- the reason why we did that is that we outsource -- DCM outsources approximately $3.5 million to $5 million of classic lithography printing to third parties. So actually, our amount that we've now moved over to Thistle has almost tripled. It's like 2.5x what we did last year because of the capabilities of the 6-color and the coating, the UV coating. So that's working well. The other side of that is that they can now go out and get some more business that is not DCM-related. As you may remember, about 40% to 50% of our work there is union-based. And the second quarter is going to be a strong quarter for them, A, federal election -- I mean the second half, I apologize. Second half is going to be strong, A, because of the federal election. And secondly, this is a bizarre way of saying things, but with the new Ontario government, there is going to be a lot more, what I'd call, communication required for many of the unions and interest groups as well as associations. So we're pleased about that. Let's now address our Gallus press, which is our label, on-demand label. Three things. One, we're not seeing the volume from many of our cannabis customers the way we had forecasted it. Okay, that's fine. They're telling us that they're more back half of this year, fine. I am from Missouri. We'll see what that's like. But what it's given us is the opportunity to bring on some new customers. And we've just recently won a couple of major cannabis clients, which we didn't have in our fold as well as a few other non-related directly supported by this Gallus press. We're still underutilizing the capacity to that, and one of our plans is to keep moving more and more of what we have currently on our other traditional label presses to the Gallus because we can get -- gain much more efficiencies to it, okay? The last point is that, Ed, we've been a bit busy the last quarter doing a few other things, and we still are very cognizant that we have a great opportunity in the spirits business with this. So that is a great initiative that we'll get on to in the fourth quarter. I hope I answered your questions or your question.

[Edward Sollbach, Associate Portfolio Manager MM Fund]

No. That was good. That gave me a lot of color.

[Operator]

There are no further questions at this time.

[Gregory J. Cochrane, CEO & Director]

Thank you very much, folks. A challenging quarter. Your management team and all of us are committed to getting through this, and we will. One of the things that -- I'm going to close off by saying this: One of the things I've realized that we are absolutely mission-critical to many, many of our clients, whether it's in the health care network, financial services or for that matter, the insurance business. Part of the challenge is that, like many and most businesses, we're customer-first. And we've had to go off the process of cleaning up data and getting this done to ensure that our customers get mission-critical work. And that kind of sometimes slows down the process of getting this thing perfect. What I am proud of is that we haven't left any customer in the lurch on that. And so for us, I start to realize how critical we are to our customers' success. That is an important lever that we have in terms of our processes going forward, and it's something I don't forget. I want to thank you all for your support. Have a great day.

[Operator]

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