Alithya Group Inc (ALYA) 2023 Q2 法說會逐字稿

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as for our gross margin, it continues to trend in the right direction, and the ongoing integration of our latest acquisition is notably expanding the capabilities of our global delivery teams. Therefore, despite incurring costs associated with acquisitions, salary increases, inflation and more, we are pleased to have posted results indicating good control of our spending, particularly considering the 3 acquisitions of the past 3 quarters alone. We are well on our way towards our 2024 strategic targets.

There is much to discuss in respect of numerous initiatives our leaders and employees are implementing, but let me briefly outline 3 key financial highlights that helped put our second quarter fiscal 2022 performance into perspective. First, we take great pride in reporting the adjusted EBITDA jumped to $9.4 million for this past quarter, which significantly exceeds consensus and is a good indicator of the potential of our platform. Second, a revenue growth of 23% or $129 million, fueled by cross-asset utilization and the acquisitions of Datum and Vitalyst. And third, we're beginning to reap the benefits of a series of measures that we implemented in response to an ongoing global labor shortage. Alithya has embraced a longer-term approach based on a line set of competitive compensation, robust training, abundant career development opportunities and internal mobility. We also continue to grow our offshore capabilities to ensure our preparedness to respond to client demand.

Private and public sector clients are currently working with our global delivery teams for some of their projects and our recent acquisition of Datum has opened the door to further contribution from delivery teams in Eastern Europe and India. Forging the path to continued success for Alethia begins with striking a balance between the best combination of cost and efficiency. That's what we refer to as right-shoring. Accordingly, we have been diligently creating capability centers in key geographies that allow us to leverage additional talent pools and lower cost and enter new markets for both project-based work and managed services.

As outlined in our long-term strategy, our business continues to evolve. Today, 26% of our business is subscription or IP-based or derived from fixed fee client initiatives. This segment provides significant value to our clients and to Alithya. It is also important to note that we continue to report our repeat revenues, our revenues from repeat clients. And in the second quarter, 8 0% of our revenues came from clients that we also serve during the same quarter last year. When combined with the addition of 34 new clients in the quarter, we believe this healthy mix of existing and new business provides us with both stability and growth opportunities. As you may be aware, most of our clients are in the essential services sectors. They view digital transformation as a gateway of competitiveness. We need to be able to support them regardless of the inflationary pressures, recession fears or whatever other external local or global event comes our way. Our clients recognize the value that our experts bring and continue to turn to Alithya as their trusted adviser and partner to help accelerate their digital transformation projects and to find efficiencies in their own organizations. The positive impacts of all these factors in our Q2 performance reinforces our focused and disciplined approach towards the execution of our long-term plan.

I will now pass it over to Claude for more financial metrics. Claude?

Thank you, Paul, (foreign language). Good morning. Over the past few years, since becoming public, we've had quarters with strong organic growth and quarters with no growth. We've had quarters with strong gross margins and quarters where gross margin was a challenge. And over time, our SG&A steadily increased, even if mainly driven by our strong growth in acquisitions. As such, as Paul mentioned, our second quarter marks a clear shift in Alithya's financial results as we're presenting today's strong performance on all 3 levels together, namely organic growth, gross margin progress and SG&A reductions.

Let's look at those numbers in detail. Please turn to Slide 11. Revenues for the quarter amounted to $128. 9 million, an increase of 22.5% or $23.6 million compared to revenues of $105.3 million for the second quarter last year. Vitalyst and Datum respectively contributed $8.3 million and $4.9 million in the second quarter. Excluding the impact of those acquisitions, which occurred on February 1 and July 1, 2022, respectively, and excluding foreign currency impacts, true organic growth was 9.2%. In other words, we recorded good sustained organic growth once again.

In Canada, revenue increased organically by 12.2% to $75.1 million, all due to growth across all of our operations, including continued growth from the 2 long-term contracts signed concurrently with the acquisition of April 2021. In the U. S., revenues increased 41.8% to $49.8 million due again to the Vitalyst and Datum acquisitions, a favorable U.S. dollar exchange rate and some organic growth. As far as our international operations, they also reported a strong quarter in terms of growth, increasing 25.3% to $4 million versus $3.2 million for the same quarter last year, and despite some negative currency impact. On a sequential basis from Q1 to Q2, the overall increase in revenues mainly comes from the Datum acquisition, which was partially offset by the normal usual slowdown in revenues occurring during the summer quarter in all geographies.

Lastly on revenues, a quick word on our second quarter book-to-bill ratio of 0.93. A ratio under 1 is normal for our summer quarter. And this year's ratio was actually higher than the Q2 ratios of the previous 2 years. Of note, excluding revenues from 2 10-year guaranteed contracts, which were all recorded to bookings in one lump in the first quarter of fiscal 2022, our second quarter book-to-bill ratio is actually above what --

Now let's take a look at our second quarter gross margin, which increased by 32.6% or by $9.3 million to $37.8 million, up from $28.5 million last year. As a percentage of revenues, our second quarter consolidated gross margin was at 29.3%. This is up 2.3 percentage points over the same quarter last year at 27%. On a sequential basis, comparing Q2 to Q1 of this year, we are showing an increase from 26. 9% in Q1 to again, 29.3% in Q2 for a sequential increase of 240 basis points during a quarter which is typically softer also from a gross margin perspective. The increase in gross margin percentage in Canada is derived from increased revenues from permanent employees relative to subcontractors, increased average hourly selling rates and improved overall project performance.

In the U.S., most gross margin drivers, utilization rates, project mix and performance, et cetera, led to the improvement, both on a year-over-year and sequential basis. And that is before taking into account the expected positive margin impact from our two recent acquisitions.

Now let's look at SG&A. We are beginning to show the benefits of the efficiency initiatives we talked about back in June, particularly considering the additional expenses incurred relative to 3 acquisitions completed in the last 3 quarters and the increased compensation costs that kicked in at the start of this fiscal year. Total gross SG&A expenses in the second quarter totaled $30.4 million, an increase of $5.5 million or 22.2% compared to $24.9 million in the same quarter last year. The increase was primarily due to the expenses coming from the Vitalyst and Datum acquisitions, the salary increases at the beginning of the year, an increase in noncash share-based compensation as well as the negative impact of the U.S. dollar appreciation. More importantly, when looking at the sequential variation of SG&A, we see an increase from $28. 9 million in the first quarter of fiscal 2023 to again $30.4 million in the second quarter or a $1.5 million increase. However, if we take into account the following: one, the negative impact of the U.S. dollar appreciation of several hundreds of thousands of dollars; two, the addition of the Datum expenses acquired on July 1 of $0.6 million; three, the increase in share-based compensation of $1 million which is a noncash item, mainly driven by the timing of business acquisitions; and four, an increase in variable compensation and commissions accruals which are naturally tied to the overall improved company performance.

So if we take into account these 4 factors, we can see that notable sequential net reduction in SG&A in the other categories of expenses. While we need to be careful about the timing of certain expenses and about certain headwinds like inflation, the return of some pre-COVID spending and currency variations, we are quite satisfied with the progress to date of our ongoing expense review efforts with certain initiatives still to be fully reflected. As such, we remain committed to our mid- to long-term objective of 20% of revenues, which will also come in part from continued revenue growth.

Overall, our second quarter adjusted EBITDA amounted to $9. 4 million, an increase of 87.5% or $4.4 million compared to the same quarter last year, and a strong sequential increase as well. Net loss was $400,000, an improvement of $2.3 million versus a net loss of $2.8 million for the second quarter of last year.

Looking at long-term trends on Slide 13, we can see the impact of our acquisitions, and more importantly, of our strong organic growth achieved over the past several quarters. Regarding gross margin, we see a similar trend in dollars. As a percentage of revenues, a number of factors occurred in fiscal 2022, which had put some pressure on our performance. But Q2 of this year marked the third quarter in a row showing a sequential improvement, highlighting our efforts on improving labor mix, utilization rates and general project performance, and also reflecting the higher historical gross margins of Vitalyst and Datum. Our long-term adjusted EBITDA trend also reflects our growth in gross margin improvements and more recently, our relative reductions in SG&A levels.

With sustained organic and acquisition growth, our continued long-term initiatives to generate higher gross margins and a steady focus on SG&A, we believe, again, we are well on our way to achieving our 3-year financial objectives.

Now turning to liquidity and financial position on Page 15. As indicated in our statement of cash flows, our operations generated $3.7 million of positive cash flow in the second quarter, another metric trending in the right direction. On the other hand, certain timing elements led to negative changes in noncash working capital items of $6.3 million, resulting in net cash used in operating activities of $2.6 million. That, combined with the disbursements and balance of purchase payable relating to the Datum acquisition and combined with the impact of the appreciation of the U. S. dollar and our debt balances in that currency, resulted in an increase of $37.7 million of our net debt to reach $114. 3 million. This translates into a higher net long-term debt to trailing 12 months adjusted EBITDA multiple of 5.4x. However, this does not take into consideration a full year impact of our recent profitable acquisitions. When calculating the multiple on a pro forma basis, incorporating the full 12 months of historical profitability of Vitalyst and Datum. which is how our bank covenant works. The multiple is actually only 3.8x. As a reminder, on an annualized historical basis, Vitalyst and Datum account for close to $20 million of adjusted EBITDA. On that basis, despite the apparent trend shown on Page 15, considering that our current profitability levels, should translate into steady deleveraging. And considering that the timing-driven working capital drag of the past 3 quarters should stabilize, we believe our current leverage remains optimal. Now back to you, Paul.

(foreign language). So to recap, the 3 key takeaways of this quarter. First, we recorded an adjusted EBITDA that amounted to $9.4 million for this past quarter, a record. Second, we delivered revenue growth of 23% or $129 million, fueled by leveraging the valuable assets across our platform as well as the growing capabilities of our global delivery teams. And third, Alithya has a longer-term approach to building its workforce based on the mindset of competitive compensation, world-class leadership, robust training and abundant career growth opportunities.

So before we open up to questions, I'd also like to take a moment to remind everyone that tomorrow is Remembrance Day. And as a veteran myself, events such as the ongoing war in Ukraine, unfortunately reminds me daily of the horrible human cost of war, and the struggles for freedom that continue around the world. Here at home, let us never forget that those with sacrifices have enabled us to mark this day in peace each year. So on that, Anas, we'll take questions.

[Operator Instructions) Your first question comes from Jerome Dubreuil with Desjardins.

Good slide on Page 9 to explain your evolving business model I found. So it shows that you have more of the fixed pricing versus time and material. If you can just explain the strategy here? What this could mean? And if you can also confirm that fixed price can still include maybe inflation escalators for longer-term deals?

Yes. Sure. Thanks, Jerome. Thanks for the question. So as we said, as the business grows, right, we try to move up the value chain with our customers. And more and more of the customers are looking for turnkey solutions. So we can commit upfront, help them with the strategic planning, the architecting of the work and helping them decide on which direction to go, helping them pick a solution and then implementing it and supporting it for them. So we've built the pieces in our platform to be able to do the cradle to grave of the project. So a good example, we spoke about MUFG Bank earlier. So in a typical project, we -- in the past, we would implement a project and leave. Now we actually stay behind and we can train the people in a new platform and even support them through the change management process. So as we do those things, many of those projects either come with a fixed price or a fixed envelope or on a transaction basis after when we're supporting. So it's per head or per call or for -- so we try to move towards that more and more because the client sees more value, we have higher margin, and it's a repeat business that just keeps on going. Datum acquisition is the same thing. They actually have IP or intellectual property that helps us accelerate the transformation of legacy applications to the cloud. So again, when we do those types of things, it's a service fee. So we control the entrants. We control the costs. We can do the work from anywhere. We can structure it in a way to maximize the margin and quality of what we deliver and based on availability of personnel across our platform. So we see that evolving more and more in our business. I'm not sure if that answers your question at all, Jerome that's the long-term plan for the company.

Yes. No, that's great. And second one, just to help us a bit model the growth in the coming quarters. I was wondering if in the third quarter of last year, the 2 large contracts from the 3D acquisition were fully ramped up?

So from a revenue perspective, we've already reached the minimum required from the agreement, and we're still growing. And the focus, as you can imagine right now, and we're seeing as part of the improvement in the margin that you're seeing quarter-over-quarter as we're replacing the subcontractors that came with the agreement with full-time employees. So that's also helping in the gross margin.

Your next question comes from Deepak Kaushal with BMO Capital Markets.

So maybe go to the next one, as and we will come back.

Your next question comes from Amr Ezzat from Echelon Partner.

On the book-to-bill, I know it's hard to make any conclusions on the quarter-to-quarter numbers, but maybe you could speak to us on how conversations are evolving with clients both existing and potential ones in light of a more fragile economic outlook?

Thanks for the question, Amr. It's a question I ask at every meeting that I have with my team and with our clients, Amr. Everybody is concerned with what's happening out there. But in the same conversation, the next thing is that they ask us how we can help them become more efficient. So we're not seeing a slowdown from that perspective. If anything, based on past experience, and I've mentioned this before, we are keeping a close eye on it, but if I look at our bookings, we're not seeing that slowdown. And I think or I believe the desire for ways to become more efficient from our customers is going to increase. So I believe our offshore managed services offerings, fixed price projects to modernize and become more efficient, robotic process automation, we're seeing an uptick in that area. I think we're going to be seeing more of that over the coming -- I mean we still have many, many open positions. We still have a pretty good backlog in the sales funnel. So we're not seeing it so far.

Okay. That's pretty encouraging. Then on the gross margins, it's good to see it rebound this quarter, and I appreciate the color on the shifts to permanent staff from subcontractors. I'm not sure if you're able to tell us where that ratio stands or how far along are we in that process?

Just want to talk about the replacement of some contractors?

Yes, the

Yes, go ahead. Yes. Sure. We're -- the mix is progressing well. The target we obviously said we'd like to get to at least 70%. That's where we were when we completed the R3D acquisition 1.5 years ago. And if you remember, R3D had a very, very high percentage of subcontractors. And we said we'd give ourselves 24 months to get through that, and we're progressing on our plan. We like where we're going, and there's still some room there for more upside.

Okay. So sort of a bit of room, but late innings of that process is fair?

No, I think there's still a lot of room. Coming back to your first question on the recession, if anything, I think that's also going to open up more opportunities for more full-time employees.

Okay. Okay. That's great color. Then on the leverage, yes, obviously, pro forma like 3.8x. I think you've got a couple of earnouts, you -- one which is coming up in December. So how do we think about leverage going forward? Is the expectation for you guys to deleverage or stay at 3.8. So maybe you could speak to what you guys feel is an optimal leverage level?

Well, it's a range, obviously. And we're probably towards the higher end of that range, but it's within our -- as I said in my notes, it's within our comfort zone, for sure. And you know that level of profitability, our conversion to cash flow and therefore, deleveraging is pretty good. So we're quite satisfied with that. And last 3 quarters on the working capital variation, as I said, we've been hit a little bit. So that typically reverses itself or at least at the very least stabilizes. So we can expect better cash flow generation and debt reduction in coming quarters.

Is there -- I recall yes, go ahead, sorry.

No, just to say, overall, as I said, we're -- it's on purpose that we got there. When we make acquisitions, we always have a bit of a choice between issuing shares and using leverage. We did not like where our stock price was. So we turn to leverage to a certain extent. So it's all on purpose. So we are pretty much where we want to be, and it's looking good for the future going forward.

Understood. Then just like a last one on the drag from working cap, like the last couple of years, like your Q3, like your December quarter has been like a positive working capital contributor to cash flows. Is the expectation the same for this year?

You've done your homework. The -- it really depends. We're a service company, as you know. So it really depends when the end of the quarter lands. So the impacts on the accrued payroll and stuff like that. So it's a bit of a crack shoot. I'm expecting a stabilization. I wouldn't go as far as to confirm we're going to have the same numbers, but we should have some relief for sure.

Your next question comes from Nick Agostino with Laurentian Bank.

Yes. Apologies, I joined the call a little bit late. So were you guys -- did you guys call out or maybe in your MD&A, maybe call out what is the R3D gross margin presently?

No, we didn't call it out. It's merged into our operations now. So we don't call it separate.

Okay. How -- I mean if we think about where the -- where you guys started on that front versus the margins today, how far along on that journey to improve those margins would you say that you are?

On the commercial agreement perspective, we're exactly where we wanted to be. So that's going very well. The other big improvement that we saw year-over-year is the rest of the R3D business, again, replacing subcontractors with permanent employees on projects, and that's also progressing well. And that's why you're seeing some of these improvements in the gross margins on the Canadian side.

Okay. I guess maybe to think along the same line, but a little bit of a different approach. What has -- in prior quarters, the gross margins was always being impacted as obviously, you would see strong sales demand and you had to maintain a high subcontractor number just to be able to meet and service your clients. Should we -- I'm just trying to understand what changed maybe this quarter as far as you guys being able to improve that permanent employee subcontractor ratio? Is it a case of -- should we interpret as the market conditions are maybe slowing down a bit and you're able to I guess, use more of your employees to serve permanent employees to service it? Or are you now able to hire at a faster rate than in prior quarters especially on the -- in Morocco and abroad? And if it's the latter, maybe what has changed on the part of the strategy?

Thanks for the question, Nick. It's a combination of many factors. So maybe to run you through the full scenario, I got to do a bit of a rewind. So if you go back to April 2021, so April, a 1.5 years ago, our gross margins were at 30% or thereabout within a couple of points. They were already 30%. Then we did the R3D acquisition, which was mostly subcontractors. And you saw the following quarter, we said that the gross margins went down dramatically just because of the mix -- the headcount mix. And we've been gradually moving that back to the 30% mark, which we're almost at. By that mix of transforming the type of business and the type of employees from subcontractors to full time. So that's a gradual thing. In parallel with that, the mix of business has also changed. So again, if you go to the Slide 9 that we talked about earlier, 26% of our business today is recurring business, right? So it's either a fixed price projects or subscription type projects or managed services type projects. So that's also changing the margin mix. And throw into that, we now have 5% of our workforce, so almost 200 people working from offshore, right? So again, the margin improvement tied to that new capability that we didn't have a year ago. So all those 3 things combined together are impacting gross margins. I think the -- on a side note, I can't put a number on it yet, but it's something that we're tracking. I think the fear or talk of a recession is probably helping some people decide to become a permanent employee versus a subcontractor, but I can't put a number on that one. It's just based on what I see out there right now and I hear.

Yes. I like that last comment. I think that is interesting in terms of the quarter-over-quarter change. Everything else, I follow. I'm just trying to see if the read-through is a slowing or if the read-through is just more of, as you said, better revenue mix, but also better hiring environment because of a potential recession. So all good there.

I think it's a combination, yes.

Okay. And then my last question. I noticed in an earlier slide, obviously, and I think this came up in the past, the real estate optimization to meet the operational needs when you look at where you are today versus your needs for tomorrow, how much dollars do you think you guys can squeeze out from a real estate perspective?

That's a good question. And the main challenge to answer that is the subleasing market. So it's not very strong right now, as you can imagine. So then we need to go to the end of certain leases before we get to savings. But not sure how specific we want to be considering timing and considering our evolving needs. We always say we're in active on the acquisition front. We've always said that, and we remain on that basis. So -- and the other thing you need to consider is that because of IFRS 16, rent expense does not hit our P& L all that much. Some of it hits our cash flow statement. But I guess if we had to throw a number, if we don't save 50% of our overall spend over the coming several years, we're -- I think we're looking at least at that. Just to give you a very rough feel for that.

Your next question comes from Ren Sharma with BMO Capital Market.

So I just had a question on the cash flow side of things. We noticed that we had a cash flow loss this quarter versus the EBITDA gain. And I know you mentioned that the working capital variance had some a little bit to do with that. Is there anything else that you'd say drove the loss? Or -- and really when are you expecting cash flow to start tracking EBITDA? And what expectation for the conversion rate would be?

Well, the conversion of EBITDA to cash flow, basically, there's a few things to consider. There's our acquisition and integration expenses. That's cash spend. So it impacts cash flow. You see this quarter was $2. 7 million because Q2 was an acquisition quarter. We acquired Datum at the beginning of the quarter. So that's a bit of a -- that will track acquisitions. If we don't have any acquisition, that number quickly goes down. Then there is obviously tax -- cash taxes. That's a very low amount. In our case, you can see this quarter is $164,000. That's very small, and that will stay that way for a while to go. We have tax pools we can use. The other one is CapEx. So CapEx, we spent under $300,000 this quarter. That's a sustainable amount in our mind. The other one is repayment of lease liabilities. So you see that further down. That's about $900,000. That's -- we just talked about that. That's going to go down eventually. But for now, it's there until we sublease our space or we come to the end of certain leases. And finally, is the interest. So interest is $2.3 million in the quarter, a combination of the debt level increasing and also the interest rate increasing. So that amount should be trending down as we deleverage we generate cash flow. So if you take our EBITDA number, we're in round numbers, about $10 million, and then you deduct tax and CapEx and interest, that leaves maybe 75% of it, and then it depends on the integration and acquisition costs. .

Okay. Yes. Got it. That's very helpful. And just another question on the OpEx side of things. Are you expecting it to trend going further over the next quarter? Are you expecting it to be sort of seeing a similar trend? And then particularly on the exchange gain side as well as on the share-based compensation side, has anything changed? And do you -- will it be consistent with this quarter in terms of getting more permanent employees versus contractors?

Okay. So when we talk about subcontractors versus employees, that's mainly of a gross margin discussion. If I understood the first part of your question. So the first part, we don't provide guidance, and I've been very careful in my notes to stay away from that. So we have positives to come, and we have a few cautions to look at. So on the positive note, as I said, we have initiatives -- expense reduction initiatives that took place over the second quarter. So that did not have a full quarter impact. So we can expect some additional gains there. And we're still, as we said, keeping a close eye on the spend levels. But we also have a few headwinds, and I also mentioned that, there's inflation, there is some return to pre-COVID spending elements like travel, business developments. So we keep a close eye on that. And not all SG&A is fixed. Some SG& A elements are semi-variable, so they will track to increase performance. So -- but all that combined, we are

how can I say, we're -- we like the trend and we think we should see some stabilization. Yes, the level we had in the second quarter is a good base to work from.

Your next question comes from John with National Bank.

I just want to get more color on (inaudible) position. I know that was closed at the beginning of the quarter, but could you give us some updates on the current integration works? And when do you think the company will start realizing the expected synergies?

Did you say integration?

Yes, integration.

Of our acquisitions?

On Datum acquisition.

Okay. So the -- talking about the expenses, there is not much synergies and efficiencies to be had there. They were quite a small operation, so operating with very low cost. So there's not too many savings to gain there in the first place. But when we talk about synergies with Datum, it's taking place mainly at the cross-selling side, really taking their unique technologies and expertise to our broad customer base. All of our clients sooner or later will need their modernization tools and expertise. They are big in the insurance industry. As we mentioned at the time, we had clients in the insurance industry before. So we started do the cross-selling there, so accelerated growth, higher revenues with great margin. So that's more where we're seeing the integration and the upside, much more so than the actual expenses. The actual expenses.

There are no further questions at this time. Mr. Raymond, over to you.

All right. Thank you, Anas. Thank you, everybody for again for participating today. I'd also like to draw your attention to our inaugural ESG report that was published in September. We're very proud of this document. It outlines the current best practices that the company has put forth as well as the critical measures identified for future implication. So ESG intersects all lines of Alithya's ecosystem, and our business has far-reaching effects on the important economic sectors that we service. And since the company's founding, we've embraced the responsibility of being an agent of change in our industry, and that responsibility extends to helping our clients transition to a more sustainable economy. So if you haven't read it, I strongly encourage you to do so. And I'd like to take this opportunity to thank our clients for the trust that they continue to place with us and to thank our passionate professionals who deliver high-quality service and advice to those clients every day. Thank you once again. Have a great day. Take care.

Ladies and gentlemen, this concludes your conference call for today. We thank your participating

and ask that you please disconnect your lines.