Data Communications Management Corp

TSX:DCM

Earnings Call Transcript 2021-Q2

[Operator]

Hello, everyone, and welcome to DCM's Second Quarter 2021 Conference Call. We will be hosting a question-and-answer period after the call. So please refrain from asking any questions until that. As a note, we will be recording the call, and a copy will be posted on our website after the meeting ends. I will now transfer the line to DCM's CFO, James Lorimer.

[James E. Lorimer, CFO & Corporate Secretary]

Thank you, Fernando, and good morning, everyone, and thank you for joining us today for our second quarter 2021 conference call. Speaking on the call this morning will be Richard Kellam, our President and CEO; and Sharad Verma, our Senior Vice President of Strategy; and myself, James Lorimer, CFO. We are pleased to offer this call in a more informal and hopefully personalized format by adding video and a slide presentation, and would welcome your feedback after the call.The prepared remarks on today's call will be followed with a question-and-answer period as per mentioned. We'd also like to remind everyone that Richard 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 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. We'll also be referring to certain non-IFRS measures, and these can also be referred to in our publicly available filings. We will be adding a brief video from Richard along with a summary of our results and key initiatives for 2021 on our website following the call. Our detailed information will be published on our website and SEDAR. You can also follow us on LinkedIn to review some of our business insights on relevant market trends and customer case studies.With that, I would like to now turn it over to Richard.

[Richard Clarence Kellam, President, CEO & Director]

Thank you, James. Good morning. Good morning, everyone. Thanks for joining the call today, and I see we've got several people that have joined the video link. So again, let us know how it works. Happy to try kind of new technology for delivery on the quarter here. In my first full quarter with DCM, our leadership team was really very focused on establishing plans to accelerate our transition from a print-first to a digital-first company, as we outlined back at our AGM. And as I recently shared at that AGM in June, we've got 13 management projects within 5 key strategic pillars. For those on the web link, you can see the pillars around talent and business intelligence, OpEx, client engagement, technology-enabled services. We believe [indiscernible] 645 not only helped us build a bigger business, but also a better business. And while consumer movements during the second quarter were slower to return than normal, we very much continued to stay focused on that theme of building a better business.Our SG&A expense in the quarter was $14.9 million. It was down 3% from a year ago and the prior quarter. Now despite a charge of approximately $2 million in mark-to-market adjustments long term incentive...So if we exclude that, and again, James will give you a little more color when we talk to the finance section of our call today. But if we exclude that mark-to-market adjustment, our SG&A was actually down $2.6 million or down 16% versus last year and versus the prior quarter.And going a little bit more detail on productivity improvements, for the first time in many years, our headcount now sits below 1,000 associates, which is a reduction of over 130 since the end of 2020. So you can see we're continuously or relentlessly focused on continuing to build this better business. And this continued focus on building a better business resulted in average revenue per headcount of $260,000. I look back over the last number of years, if you go back to 2015, we were $213,000 in revenue per headcount.So these reductions, along with other operational [indiscernible] 848 efforts underway, really position us very well for improved margins in the second half of the year with an expected recovery to the economy.Second quarter is typically the seasonally weakest of the year for us. And this trend obviously continued in 2021. Obviously, we had extended COVID-19 closures and restrictions that impacted our production, and we report revenue on production. So as clients really were taking more of a wait-and-see approach before replenishing stocks, our product shipments actually were about comparable to last year. So if we look at the shipment revenue relative to production revenue, it actually helped lower our inventory, which improved cash flow as we'll see in a couple of slides.Now with consumer movements in the economy still restricted outside of central retail and you may remember, certainly, shareholders know that about 25% of our business is financial services and a lot of branches still closed. So our revenues were impacted by 13.7% in the quarter compared to quarter 2 2020. It came in at $55.2 million on the quarter.In quarter 2 2020, we also benefited from noncore sales of COVID-19-related PPE products very early in the pandemic. And there were a lot of supply chains that were significantly disrupted. That actually created some artificially high revenue for us last year. And with more and more retail and offices now opening up across the country, we are seeing increased optimism in our client outlook. And it's indicating a pretty strong second half of the year for us.Product mix continually very good in the quarter. However, with revenue headwinds and shortfall in production compared to shipment, [indiscernible] impacted slightly. Our gross margin was 28.7% of revenue and gross profit, as you see in this chart, was $15.8 million.Leading us to EBITDA. We delivered adjusted EBITDA of $7.3 million or 13.2% of revenue. And as I said, earlier $2 million -- we had a $2 million mark-to-market adjustment that we had to make. And also, our compensation from the government was $2 million less than year ago. So again, you exclude that $2 million mark-to-market and that slight adjustment or the difference rather in government incentive, and you can see our number was pretty much what we planned kind of in that $9 million to $10 million range versus $7.3 million delivery, okay?So looking at cash flow. We continue to be very pleased with our cash flow performance. And cash flow from operations and continued working capital improvements generated $16.4 million, up 7% on from last year. We were at $15.3 million less this time last year, so very good improvements. Solid improvements in cash flow in the quarter.Moving on to have a look at our debt and debt reduction, great progress on debt reduction through the quarter. We repaid $1.9 million in promissory notes that were previously outstanding and $1.5 million of our amortized fixed term debt. Total debt at the end of June 2021 was $39.1 million, down quite significantly. So down 19% versus year-end 2020 or a reduction of $9.1 million from year-end. So great progress on continuing to pay down debt.Now a couple of additional highlights on the quarter include: the first is, we've talked a lot about our digital solutions, and we continue to accelerate our pace of digital development in the second quarter. And really to enhance our offering of tech-enabled services to our clients and improve that and drive that workflow capability. So this includes continued development of our DCM Flex platform, plus standing up our digital asset management solution, which we call [ Assemble ]. And the second, just going a little deeper on DCM Flex. Some really very pleasing progress we're making as a team here. As we reviewed our AGM, our objective was to grow our tech-enabled service offering to 75% over the next 4 or 5 years. So 75% of revenue, up from about 30% just slightly over 30% where we are today. I'm actually really pleased to report that our commercial team, our customer technology team, and really most important, our client base are all highly engaged in this initiative. We're getting accelerated momentum in this space. Again, we've only been at this acceleration for 100 days, and we're already seeing a lot of opportunity from a client penetration perspective. But our commercial team has already built up opportunities north of $20 million in pipeline to drive that penetration. So again, I'm really pleased with our accelerated pace of the digital. In a very short time, the entire enterprise has pivoted quickly to drive this digital -- this print first to digital-first journey, okay?So as we look out through the second half of the year, as long as the economy continues to open with the pace that it is now and consumer movements follow it is opening quickly, right, we are seeing a consumer moments moving back to some level of normalcy. We are very optimistic in building a bigger business in the second half.Our pipeline of new opportunities and our request for proposals, our RFPs that we capture in our forecast, and we've got a very robust CRM solution or CRM system, is currently up over 25% versus same time last year. Now I want to be clear, this doesn't necessarily mean that our business will be up 25%, but it's a really very clear leading indicator that client activity is rebounding.And I can tell you that our commercial team has had a busy summer, much busier summer with client connects and client contacts. So we're extremely optimistic about the second half. As I said, we've got a very active pipeline. And assuming the economy continues at pace and this pipeline materializes, we'll have a strong second half of the year from building a bigger business perspective.Okay. So I'm going to turn it back to James before we move -- so I'll go a little deeper on finance, and I'll be back for Q&A. Thank you.

[James E. Lorimer, CFO & Corporate Secretary]

Thank you, Richard. Richard would provide us some color on our P&L and our outlook for the year and some updates on some of our strategic initiatives. I'd like to provide some additional color on our progress regarding a little bit more P&L info, our free cash flow progress, paying out of debt and some other balance sheet and P&L items of note.You can see here a summary of our P&L for Q2 2021 compared to Q2 2020. The major difference in revenue is really COVID-related and particularly where we felt it was in the financial services, retail and government sectors. Despite that, as Richard said, we had strong product mix and our gross margins are staying pretty close to 30% and just shy of 29%.While our SG&A expenses were high as a percent of sales, as we see revenue return to more normal levels, that percentage will go down. And as mentioned previously, we've seen some very positive trends in our SG&A expenses.Here's a snapshot for our P&L year-to-date compared to last year. Again, really the same kind of trends driving the change in revenue. And again, largely because of our financial services, retail and the government sectors being slower than normal. But as we return to a more normal pace, we expect some recovery there. But we believe we're really well positioned for recovery given that we've made a very concerted effort over the past number of years and particularly over the last year on cost reduction initiatives and operational effectiveness initiatives.Our business continues to generate strong free cash flow. We showed a summary here for the last 3.5 years of our cash flow from operations. And you can see our CapEx and intangible investments other than in 2018 and 2019 when we are investing significantly into our ERP project, have been fairly modest, particularly last year as we pulled back our spending in the face of COVID. We expect to see some additional CapEx this year as we move our ambassador Mississauga facility into Brampton, and that's well underway. And we also expect to see some additional investments in intangible investments as we need to build out our tech capabilities.But what I'd like to really draw your lines to drive your eyes to on this particular page is our free cash flow conversion ratio. Consistently over the past 1.5 years, it's been in excess of 90%. And that allows us to really tackle our debt and also make payments on the various lease repayments we have for facilities and equipment leases. Our balance sheet has certainly improved significantly as we've talked about previously. Again, we've shown this over the past 3.5 years. Our total senior and subordinated debt in 2019 had almost $80 million. And currently, it's just shy of $40 million.On a net debt basis, we're even better. We've got a modest amount of cash in the bank. The way our ABL revolver works is that any funds that we receive really go into paying that down. And so we had a very modest draw on that at the end of the quarter. Historically, over the past couple of months, our ABL facility has been anywhere from a couple of million drawn to a $2 million kind of cash balance. So we're really pleased with how we've been improving our working capital.From an operations perspective, we did complete the closure of our Edmonton facility at the end of June, and we moved all that work to Calgary. We'll see some -- lot of savings through the balance of the year, but some nice savings next year. Our Mississauga plant is well on path to the consolidated is well on path to be consolidated into our Brampton plant. We've already started to move some jobs. The big bulk of that is going to happen in the fourth quarter, and we're working diligently to get that completed by the end of...In July, we rebranded our perennial team as a DCM marketing strategy in creative group, and we aligned them better with our functional groups and vertical markets within the group -- within the commercial team, and we're having some great success there in terms of the service offering that they're providing and the insights that they're providing to our teams.With that, I'd like to introduce you to Sharad Verma, who's our SVP of Strategy.

[Sharad Verma]

Thanks very much, James, and good morning, everyone. I want to take a few minutes this morning and build off the initial slide that Richard presented earlier in the call. As you can see, we're taking an ambitious, thoughtful and rigorous approach to transforming DCM into a digital-first business. I want to provide some additional context to the 13 change management projects that Richard referenced.The 13 projects span our collective objectives of talent, development and management, business intelligence, driving performance, driving customer engagement and technology innovation. Under the talent objective, our focus is on making DCM a desirable place to work. Better leaders who can drive performance and build teams are critically important. In turn, an engaged team of associates ensures strong performance and of course, ensuring DCM is a representative of the diversity in Canada, all leads to a very strong and desirable employer brand.With respect to business intelligence, our objective is to be more knowledgeable about the markets we serve, the opportunities that are available to us as well as our own business performance. We are pleased with the progress we are making in extracting valuable business insights from our recently implemented data warehouse, which draws data from our ERP implementation. Our 5-year strategic vision and plan is setting the stage for us to capture these market opportunities. There are a number of projects we are working on that directly look at the performance of the business. James and Richard mentioned plant consolidation and integration. We continue to identify additional opportunities to manage our costs. We're looking at items such as cost of sales, inventory, supply chain and pricing in addition to moving our clients to the DCM Flex platform as a means of increasing gross margin.And finally, we have a project team that is looking to create additional efficiency in our operational processes. We know that we have an exceptional client base. DCM serves 70 of Canada's largest 100 companies, but we also know there is a lot of hard work to be done. COVID headwinds have reinforced the need to engage with our clients more readily. We continue to work on our sales and customer experience team competencies. They are our frontline, and we need to ensure that we have the best of the best. We have a broad project looking at approaches to accelerate our top line growth, including new logo acquisition, organic growth opportunities and product development.And finally, we're also framing out our environmental, social and governance strategy looking at our environmental and community activities, which will help add depth to our work on the DCM brand. As we continue the transformation to digital first, we know that we need to tell our story to the marketplace.And finally, and perhaps most importantly, we have a cross leadership team effort to detail our overall digital transformation strategy and plan. There are 2 parts to this. First, we're enhancing our current digital footprint, and Richard alluded to our progress on DCM Flex. And we're increasing our customer uptake of the DCM Flex platform. The second is the development of new product areas, including our digital e-services capabilities and, of course, [ Assemble ], our digital asset management solution.As a leadership team, we understand that a winning strategy is only as good as our collective ability to implement and operationalize the plan. As you can imagine, there is a significant amount of detail as we work through our change management initiatives. Over the course of the past 100 days, there has been considerable effort in both shaping these projects and starting the implementation and realizing quick wins. The identification of more than $20 million of tech-enabled opportunities speaking to our early focus and success. We know that to win, we have to continue the hard work we've undertaken over the past quarter to truly become digital first. As a team, we are fully committed to continuing to accelerate our pace from our print-first organization to a digital-first enterprise. Thank you. I'll hand it back to Fernando now, who will manage the Q&A session.

[Unknown Executive]

[Operator Instructions]

[Unknown Analyst]

It's Chris Thompson. Can you hear me?

[Richard Clarence Kellam, President, CEO & Director]

Yes. We got you, Chris.

[Unknown Analyst]

Yes. Great. Just wanted to ask a question about your priorities, you managed -- you mentioned that you have an aggressive debt repayment schedule. But you also talked about both new product and acquisitions. How are you allocating your financial resources between those initiatives?

[James E. Lorimer, CFO & Corporate Secretary]

Sure. Good question. Thanks, Chris. From a debt perspective, our fixed term payments with FPD when we've got 3 facilities there, those are amortizing down about $1.5 million per quarter. And so that's -- the pace actually accelerates a little bit on those, and those will be fully repaid in, I believe, it's April or May of 2023. With regards to our revolver, that's really just there for working capital. And then our Crown Credit Capital Partners facility is really kind of a lump sum payment that's due in May 2023. So we really just have interest payable on those. So as we develop our plans more fully to kind of really expand our digital, we'll be able to share some more numbers. But in the short term, we're planning about $1.5 million in kind of CapEx for kind of existing kind of plant and equipment and consolidation of our Mississauga facility into Brampton this year, and about another $1.5 million in terms of kind of digital innovation expenses.

[Unknown Executive]

We have another question in from Brock Bundey. You explained and shared your digital asset management business plans. Can you share how you plan to train and focus your workforce to grow this part of the business?

[Richard Clarence Kellam, President, CEO & Director]

Yes. Richard here, I'll pick up that one. Brock. Thanks for the question. So we've got a -- we call it our commercial team, right? So our client leadership team, our sales team, we call that our commercial team. We got about 65 commercial leaders across the country. And obviously, those commercial leaders have been engaged for a number of years on selling all of our marketing services, right? A lot of those marketing services are kind of highly customized, individualized print. And certainly, the tech-enabled services we provide in Flex as well, right? So first thing we need to do is upskill that team. So they, first of all, understand digital asset management solutioning and how to deliver value, how to talk the value and deliver value to their clients. I mean there's many clients out there that don't know they have a problem today, right? They don't know they have an issue in terms of managing their digital asset managements and management -- or the digital assets rather. So obviously, highlighting a problem and then delivering a solution. So we've got a very -- in fact, we just completed, we shared with the Board yesterday. We've got a very detailed commercial competency framework our entire commercial team to understand what is required to be successful in a client leadership role at DCM. And it's not only what's required to be successful for today. We call it Ready For Today, but also fit for the future, right? So Ready For Today Fit For the Future. And we've got a very detailed -- model detailed program detailed guide, if you will, to help assess that team. So what is the current capability of the team and what do we need to build and what do we need to buy for. So we've got -- again, it's a great question from Brock, but we've got a very rigorous and disciplined program to drive that kind of commercial leadership model by building skills and, of course, buying skills where we need to buy those skills, okay? So it's certainly clear, it's clear in our sight lines. And again, we've had some great progress over the last 100 days in terms of driving, as I mentioned, in terms of driving our tech-enabled penetration. Actually, we've had some very good progress on connecting with clients on digital asset management solutioning. In fact, we have 14 active conversations right now with regards to assemble with clients. And again, from hardly any 100 days ago to 14 active conversations today. So good progress and kind of clear path to accelerate that from a capability perspective.

[Unknown Executive]

We have another question that got mailed in. You mentioned the $2 million charge that affected your SG&A in the quarter. Given its impact, can you please explain that charge expense in more detail?

[Richard Clarence Kellam, President, CEO & Director]

James?

[James E. Lorimer, CFO & Corporate Secretary]

Yes. Thank you. Yes, we have mark-to-market charges in the quarter, which are really comprised of valuation of our DSUs and RSUs. I mean, deferred stock units and restricted stock units. And those are both part of our long-term incentive plan. And given the strong share price appreciation we had during the quarter, from -- I think it was about $0.62 [indiscernible]At the end, that was a fairly significant charge in the quarter. We also had a smaller charge in the first quarter. It was probably about $800,000 related to the same types of expenses. So kind of a good news, bad news. I guess, good news that our share price has appreciated and performed quite nicely since the beginning of the year.

[Unknown Executive]

There are no further questions at this time.

[Richard Clarence Kellam, President, CEO & Director]

Are there no further questions? Okay.As James said earlier in the call, myself and James are available after the call or any time for that matter if you've got any questions for us, okay.I'm going to close on this slide, and for those that are on audio, I'll kind of explain it. And it's a slide that we used at our AGM that talks about our transition from a print-first company to a digital-first company. And the importance of delivering -- architecting and delivering that strategy.So if we look at our market valuation, right, our market cap for all the print work we do, we've got an earnings multiple. We took an earnings multiple of 4x earnings, okay? 4x earnings. The range is sort of 3 to 5. So we took a midpoint on earnings. So $1 million of print equals $600,000 in market cap in shareholder value. Now as we look at our strategy and understanding why we're delivering this strategy, importantly, why we're delivering it for our clients and client value and why we're delivering this for our shareholder and shareholder value, our tech-enabled service delivers a market value of approximately 1.5x revenue, right? And that's a stat if you look at comparables from the market for tech-enabled companies. So $1 million in revenue equals $1.5 million in market cap.And then if we look across the far right, our digital asset management, which is a solution, which is a pure SaaS play, $1 million in revenue equals $10 million, taking a conservative multiple of 10x revenue. Again, if you look at other SaaS providers out there are 10, 12, 14x revenue. So we took a conservative multiple. So $1 million of revenue equals $10 million in market cap. So you can see, from a client standpoint, why we're driving this digital-first versus print-first leadership model, higher retention, higher margin. And from a shareholder value perspective, very much higher market cap and market value.So you can see where we're focused as a leadership team, focus as a company. Of course, we need to drive and we need to grow our marketing services and our print. But generating and accelerating penetration of our tech-enabled service with DCM Flex and really making sure we stand up the digital asset management solution and drive penetration of that new platform to our client is critical to success over time. And certainly, that's where our commitment is and our commitment will stay.Okay. So I want to close just on the final slide, which is a simple thank you slide. And I want to personally thank the talented and engaged team at DCM for continuing to drive performance in this dynamic marketplace. It's been a -- we've had an accelerated pace to change over the last 100 days since I joined. Actually, I'm exactly 140 days in today. And we certainly had an accelerated patient team. So thanks to the entire DCM leadership team. And with our focus on talent, as you saw from my chart as well as shared earlier, but our focus on talent and business intelligence, operational excellence and client engagement, and really critically and importantly, our tech-enabled services. I'm super confident in our outlook for success going forward. And as I said many times, our team is and continues to be relentlessly committed on building both a better business and a bigger business and a technology-enabled business.Thanks for everyone listening today, and thanks for being shareholders in DCM. I appreciate it.