CGI Inc (GIB) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the CGI conference call. I would now like to turn the meeting over to Ms. Paule Dore, Executive Vice President and Chief Corporate Officer of CGI. Please go ahead, Ms. Dore.

Thank you, Operator. Good morning, everyone. Thank you for joining our conference call to discuss our third quarter of fiscal 2005 financial results. With me today on the call are Serge Godin, CGI's Chairman and Chief Executive Officer; Andre Imbeau, Executive Vice President and Chief Financial Officer; Michael Roach, President and Chief Operating Officer; Jacques Roy, Senior Vice President, Finance and Treasury; and David Anderson, Senior Vice President and Corporate Controller.

This conference call and the accompanying slides are also being broadcast on our website at www.cgi.com. If anyone has not yet seen a copy of today's releases issued earlier this morning, it can be viewed on our website as well.

Additionally, we have published our Q3 MD&A, which was posted this morning on our website and it being filed with SEDAR and EDGAR.

In our press release and accordingly, during the course of this conference call, we will make forward-looking statements regarding future events and the future financial performance of the Company. We wish to caution that such statements are forward-looking and that actual events or results may differ materially.

We report our financial results in accordance with Canadian GAAP. However, we also use non-GAAP performance measures, namely adjusted EBIT and cash net earnings from continuing operations. These non-GAAP financial measures are detailed in our MD&A and should be considered as supplemental in nature. We refer you to our third quarter MD&A, our fiscal 2004 annual report and other documents filed with securities commissions in the U.S. and Canada, which identify factors that could cause actual results to differ materially from forward-looking statements.

CGI disclaims any intent or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We remind you that all of the values expressed during this conference call are in Canadian dollars unless otherwise stated.

I would like to remind participants that we wish them to limit themselves to one question at a time, as we would like to ensure that as many participants as possible have an opportunity to ask questions.

Now, I'll turn the call over to Andre, who will review the financial highlights of our quarter and then Michael will comment on operations and Serge will share some thoughts on our latest strategic plan. Andre.

Thank you, Paule, and good morning everyone. You may have seen that we have streamlined the presentation of information in our MD&A. We hope that you find this new format helpful and less repetitive. We have placed emphasis on year-over-year comparisons in line with industry practices and will address sequential change where there are material developments to explain.

We are pleased to be reporting the results of another strong quarter. Compared with the previous quarter, there was a significant increase in revenue, earnings and earnings per share as well as in profit margins and operating cash flow.

Regarding revenue on slide 5, revenue in the third quarter was up 11% year-over-year to $951.2 million. On a constant dollar basis, revenue was 14.6% higher with external growth amounting to 10% and internal growth to 4.6%.

We are now on slide 7. In the third quarter we generated net earnings from continuing operations of $56.6 million, up 28.8% over last year. The year-over-year improvement in earnings reflects mostly the acquisition of AMF as well as new contracts signed in recent months.

The net earnings from continuing operations margin improved sequentially for the fourth consecutive quarter since the acquisition of AMS to 6% from 5.8% in the previous quarter. Earnings per share were $0.13 in line with market consensus.

Cash net earnings from continuing operations, which are net earnings from continuing operations before the amortization of intangibles amounted to $77.3 million in the third quarter. On a per share basis, this amounts to $0.18 versus $0.14 a year ago. While cash net earnings are not a GAAP measure, we believe that they provide better visibility of our ability to generate cash from our assets.

We are pleased that growth in net earnings from continuing operations and growth in cash net earnings, both significantly [up in] revenue growth. This reflects ongoing [increases] in operating efficiencies.

Turning to slide 8, cash provided by continuing operations. Operating activities were $188.5 million in the third quarter of fiscal 2005, significantly ahead of a year ago. For the first nine months, operating cash flow was $357.9 million. Our strong cash flow has enabled us to achieve a strong balance sheet. We have repaid most of the debt relative to the AMS acquisition. At quarter end, our net debt to capitalization ratio was 1.8%. In the first nine months of the year, we bought back for a total of $75.8 million and we disbursed $35.7 million for a number of one-time items relative to the AMS acquisition.

Our DSO, or days sales outstanding, improved to 46 days from 61 days a year ago. This achievement demonstrates our ability to manage our receivables very closely.

Moving to slide 9, during the third quarter CGI signed $1.025 billion in new contracts, renewals and extensions for a total booking in the first nine months of the year of $2.91 billion, 24.6% higher than booking in the same period a year ago. Our backlog of $12.9 billion with an average remaining term of 6.9 years provides good revenue visibility.

CGI expects to achieve approximately 17% growth in revenue and net earnings from continuing operations in fiscal 2005. This represents a slight decrease from previous guidance, due to the timing and closing of new large outsourcing contracts and to the timings of revenue ramp-up for recently announced outsourcing contracts. This guidance assumes that market conditions will remain the same and is based on current foreign exchange rates.

At this time, I would like to turn the call over to Michael Roach to discuss some of the operational highlights. Michael.

Thank you, Andre and good morning everyone. Moving to slide 11. Third quarter results demonstrate the effective teamwork of CGI members within and between business units as we continue to focus on delivering the best of CGI to our clients. With AMS now integrated, we are realizing increased bookings and operating efficiencies in line with our expectations. This is reflected in the year-over-year organic growth of 4.6% for the quarter.

I am pleased to report that we are achieving good progress in all three geographies, a significant increase in operating cash flow and a continuing improvement in margins.

Moving to slide 12. The revenue mix in the quarter was 55% from outsourcing, comprised of 42% from IT outsourcing and 13% from Business Process Services, or BPS. Some 45% was from Systems Integration and Consulting, or SI&C. We plan to gradually increase the percentage of our revenue coming from outsourcing.

Consistent with this direction, our revenue from outsourcing services in the third quarter increased by 6.4% year-over-year. Revenue from Systems Integration and Consulting increased by 17.3%, reflecting the acquisition of AMS last year, new contracts – mainly in the government and health care, as well as in the financial services sector.

Geographically, 62% of revenue was from Canada, 31% from the U.S. and 7% from other regions, mainly Europe. Revenue was ahead of a year ago in all three geographic regions. This is a reflection of the strong demand that exists across our markets.

I will quickly review activities in our three key geographic markets. In our Canadian operations, revenue during the quarter increased 7.5% from a year ago. This reflects outsourcing and systems integration and consulting business signed in the past year and a catch-up business with BCE after a deferral of business in our second quarter. In June, we signed a $35 million, 10-year, end-to-end outsourcing contract with Uni-Select. Also in June, we entered into a strategic alliance with Desjardins to jointly service the Canadian credit union sector.

In our U.S. operations, revenue increased by 11.1% from a year ago, and the U.S. pipeline remained strong. The revenue increase reflects new Systems Integration and Consulting business. This includes two additional agreements for our Advantage 3 business solution for financial management of state and local governments with Los Angeles County and the Commonwealth of Kentucky. We also won a U.S. $14.5 million contract with the Centers for Medicare and Medicaid to develop and support its payment reconciliation system.

In the Business Process Services line of business, we signed a two-year, $22 million contract renewal to administer multi-family housing contracts in Ohio for the U.S. Department of Housing and Urban Development. At the end of the quarter, we signed a strategic outsourcing contract with Boston-based John Hancock Life Insurance Company whereby we will be responsible for infrastructure management services. This U.S. $166 million contract builds on our strong relationship with Manulife Financial which merged with John Hancock last year.

We are well-positioned to support this fast-growing industry leader cost-effectively by leveraging our leading business solutions and global delivery model. To provide you with a broader perspective on this, I should point out that our business with this client has grown from an annualized run rate of $5 million 12 months ago to approximately $70 million today. This is a further indication of our ability to win competitive outsourcing contracts in the U.S. post-AMS and shows our ability to grow organically with our existing clients.

Early in July we announced that the Union Bank of California had chosen our Application Service Provider or ASP Proponix Solution to support its domestic trade business. This is a very strategic win, as it validates a number of key elements in our go to market strategy for financial services. Because this solution was sold as an ASP, it provides for ongoing incremental revenue and contributes to our backlog. This type of agreement also improves margin by leveraging our existing assets such as our intellectual property and data center infrastructure. This business solution is now being used by financial services clients in three important geographic markets, namely Canada, the U.S. and Australia.

Regarding our European and Asia Pacific operations, in the third quarter revenue increased 52.1% compared with the same period one year ago. This reflects organic growth, including the outsourcing contract we signed with Cott in the U.K. last year and a number of expanded and new contracts related to the integration of AMS.

In summary, we remain confident that our $7 billion pipeline proposals for large outsourcing contracts is solid, and its contribution to future results remains a matter of timing. As you know, this pipeline is already discounted to take into account our win ratio.

At this point, I would like to turn the call over to Serge who will share information on the Company’s outlook. Serge.

Thank you, Mike, and good morning everyone. We are moving to slide 14. We are pleased to confirm that we have completed our three-year strategic plan which was formally approved yesterday by our board of directors. Driving towards our vision of building a world-class information technology and business process services leader, helping our stakeholders to win and grow, we will continue to focus on our selected industry sectors.

These are financial services, telecommunications and utilities, government and health care, retail and distribution and manufacturing. We will also continue to grow our critical mass in our selected geographic markets and we aspire to significantly increase our operations in the U.S. and Europe, thus positioning ourselves to qualify for strategic and large systems integration, consulting and outsourcing engagements in these markets.

We will achieve this by focusing on our proven, four pillar growth strategy. Two of these pillars are relative to organic growth, namely winning systems integration and consulting assignments, and assigning large, long-term outsourcing partnerships. The two other pillars are relative to the acquisition of large corporations and acquisition of niche players.

In a nutshell, our growth strategy is to continue to be a consolidator of our domain through outsourcing services and a consolidator of our industry through accretive acquisitions. Obviously we will continue to design a creative transaction and given our strong balance sheet and our very strong ability to generate cash, we will favor payment in cash instead of using our shares.

We will continue to differentiate ourselves by further developing our high-end practices, our end-to-end capabilities and our global delivery model, as well as by ensuring the full implementation of our management foundation which is the backbone of our quality system.

The domain in which we operate offers tremendous opportunities as shown on slide 15. Both the information technology and Business Process Services markets are basically untapped markets. According to IDC, the potential IT outsourcing spending by organizations represent $60 billion USD a year in Canada, $682 billion USD a year in the U.S. and $476 billion USD a year in Western Europe. These numbers exclude hardware and software and spending already outsourced by clients. In the area of Business Process Services market, it is huge, as you see.

With today’s market conditions, organizations will inevitably continue to look to full IT and Business Process Outsourcing as a preferred means of improving their efficiencies and competitive position in their respective market. If 10% -- only 10% -- of the potential market is awarded within the next five years, the information technology industry as a whole would have to manage additional revenue of approximately $122 billion USD a year. This additional volume would be absorbed by only eight to ten qualified players that have sufficient critical mass to undertake these large initiatives.

This is truly a huge markets and players that have strong management processes, such as CGI will its management foundation, would be the only ones able to manage this work. After 29 years of existence, CGI has established itself as one of the world’s best performing companies in its sector in terms of growth in revenue, earnings and cash flow.

Over time, CGI became the clear winner in delivering high end services and an undisputed leader in building state-of-the-art solutions for its clients. CGI achieved this in part because it is privileged to have a highly talented and dedicated team of members. Our people share the same vision, which is to be world champion.

The next three years will be exciting for CGI. Our goal is to be not only one of the best companies in our domain, but to be recognized as such. As we have stated in the past, the large outsourcing contracts are the main growth drivers for CGI. Since it is impossible to predict precisely in which quarter we will sign these contracts, we have decided that beginning with fiscal 2006 we will no longer provide specific top and bottom line guidance. Instead, we will ask investors to base their evaluation on CGI’s track record and past experience and every quarter we will provide investors with a commentary on the state of demand and our progress in our key markets. Thank you for your time, and at this point we would be happy to take any questions you might have.

Thank you. (Operator instructions) Your first question is from Scott Penner from TD Newcrest. Please go ahead.

Thank you. I would just like to ask about the guidance, perhaps. Last quarter on the call you were pretty steadfast about the annual guidance despite some concerns from people on the line. I guess I would just like to know a little bit more color as to what has changed since then that you no longer think you will be able to meet that. Thanks.

Thank you, Scott, for your question. When we got that question last time so very precisely, what we answered, if there was no delay in the signing, large outsourcing contract, so then we would meet the guidance. Unfortunately, we have got some delays in there and as I said, it is impossible to predict in which quarter exactly we are going to get that revenue, obviously.

As Mike said in his presentation, we are very confident that the $7 billion pipeline is going to materialize.

Andre, just if I may, you mentioned the 17% growth. Could you either give the numbers that that transposes to or the comparables a year ago that we should use?

I think the comparable to last year is $3.2 billion that you have to use.

And earnings of 44?

And the earnings, the net earnings – we are talking about the net earnings – based on last year it is $185 million.

Okay, so your guidance of 17% is based on the net earnings number?

Yes, what we said.

Okay, thanks guys.

Thank you.

Thank you. The following question is from Paul Steep from Scotia Capital. Please go ahead.

Hi. Serge or Andre, maybe you could talk a little bit about the efforts when you first bought AMS you had said about trying to return the company back to the operating margins you had previous to AMS. Maybe you could talk a little bit about the efforts that have gone in so far. It still seems like you have a couple hundred basis points left to capture. Are there more divestitures to come or fill these closures? What should we think about in that regard?

Ask Mike, Michael Roach.

It is Mike, Paul. Thanks for the question. Actually on that front again I would point out that we are actually very pleased with the progress we have made. I think we are now in the fourth quarter in a row where the bottom line contribution has been gradually improving so that as we said at the time, we said it would take a little time to leverage and gain all the synergy. So for the most part, we have captured the operational efficiencies from the transaction. Obviously the side that we will continue to work on is gaining the revenue and business synergies of that transaction and again, the John Hancock is a good example of that, given the additional scale and presence we have in the U.S. market.

So we are pleased with that. Again, if you adjust for the fact that pre-AMS we weren’t expensing our options; we now are. We are getting back to those pre-AMS levels.

Okay, so no –

And I would add to that, we still have to generate the full synergy coming from the combination of the two corporations relative mainly to a set of tools and also the business solution that we develop, to use the full capacity of the CGI delivery model. It is another item that we are working on. And as we [told them our capability], these improvements will be done gradually on a quarterly basis. I think if I recall well, the timeframe was more than four quarters to get there.

Fair enough. And then just a clarification – can you maybe remind us, Mike or Serge, on how Innovapost has been ramping up? The target, I guess by now, was supposed to be about $400 million a year. Where are we relative to that goal you set a few years ago? Thanks?

Well I think on Innovapost again, we are very pleased with the relationship we have with Canada Post. Canada Post, though, is currently as you know, has undergone leadership changes in there. They are looking at various initiatives, so we are expecting on the longer term, again, good growth opportunities in Innovapost but they are still, I would say that is in front of us. Right now, we are running kind of at a steady state there with previous years.

Great, thank you.

Thank you. The following question is from Richard Tse from National Bank Financial. Please go ahead.

Yes, just a quick one here, Serge. Could you perhaps give us a little bit of color on what is causing the delays in signing some of these large outsourcing contracts? Some examples of what people are saying to you and why these deals aren’t being signed?

We are talking about very complex, so when you look at those kind of contracts you would, in saying that, you would realize that it is very complex and we are talking about – there are a lot of negotiations to have with clients, which is perfectly normal because you are going to sign a 10-year contract, huge contracts, because it is going to include, let’s say everything which is related to IT for a given client and obviously you need to take the time to be sure there is nothing, or everything is very negotiated on both sides. It takes time.

Sort of a quick related question, I will finish off here, is that the size of these contracts, how do they compare relative to what we have seen in the past? Because quite frankly if you look at ’04 we haven’t really seen a mega deal in Canada in the market at all. So are they going to be smaller or are the terms going to be shorter? Can you give me a sense of that?

About the same size as large deals we have already signed.

Okay, great. Thank you.

Thank you. The following question is from Ed Maguire - Merrill Lynch. Please go ahead.

Yes, good morning. Could you discuss your perception of the environment in Europe? There have been some concerns about the economic environment there, and just provide a bit of color as well in terms of your relative comfort in the outlook in Canada and the US as well?

It is Mike, Ed. Thanks for the question. Actually we are very pleased, as we mentioned in my comments. Our European operations are doing very well. As a matter of record, all of our business units worldwide are making money, that is true of Europe. Europe is actually performing very, very well there.

We have been able to secure our position with some of the base clients that AMS had, the additional scale we have in Europe, especially in the UK, has continued to open up opportunities for us on the outsourcing side, and we are, as I mentioned, making money in all of our geographies in Europe. So we are feeling pretty good about our European operations.

The U.S., again, you know we have been working our existing base of clients pretty well as you can see in some of the announcements on the government side, on the financial side. I mentioned the Union Bank of California is a good example of where we are really bringing AMS solutions that we acquired to the market, now in a model that leverages the additional benefit of CGI.

I kind of went over that one quick, Ed, but what it is basically saying is we are selling that in an ASP so the client is paying us on a per letter of credit that they issue. We have a five-year revenue stream so we have go recurring revenue and we validated that that solution can work in three or four major countries in the world: Canada, U.S. and Australia, it will certainly work in the UK.

Therefore, we think that we can continue to leverage those solutions plus bring to them what CGI has. So we are not really seeing a big economic downward pressure. We think the market is still pretty healthy out there, and for us it is just again a matter of timing and hard work to get our solutions out to the client base.

Just to quickly follow up on Richard’s question. In terms of some of the factors that are causing deals to be more difficult to predict, how much of an element is competition and how much of what you are seeing is really just related to the nature of trying to close larger deals, and how much of it do you think may be just a tougher competitive environment?

Our pipeline is composed of all kinds of opportunities, Ed. The contracts we were talking about, they are contracts for which we are in negotiation with the clients. So you could conclude that those contracts are already won.

Okay, thank you.

We are not talking about the competitive situation here.

Thank you. The following question is from Wojtek Nowak from First Associates. Please go ahead.

Just as a complementary comment here, very, very often and what we do prefer is to go on a sole-source basis in meeting our clients, talk to the clients – very, very specific clients – and then presenting our outsourcing concept. Then, obviously, once in a while the competition is going to be invited. I am talking about full and large outsourcing contracts here. So once in a while clients are going to invite competition, but we like to sign sole-source deals. Okay?

Thank you.

Hi, good morning. Could you please comment on the systems integration and consulting market, in general? Can you perhaps compare what you see in the Canadian market versus the U.S. market?

It is Mike again. I think they are vastly different markets, just obviously not only given the size but our relative size and presence. The Canadian market, we continue to do well there. It is the Canadian market. It is not – there are not a lot of spikes and valleys, it is consistent there in terms of demand. The financial services and government I would say are probably the most active for us in Canada relative to systems integration consulting.

On the U.S. side, again the market seems to be fairly healthy there. We are concentrating obviously on those verticals in the U.S. where we have a good footprint, a good relationship and that would include, again, government, financial services and probably in the U.S. a little more in telco, because AMS had some pretty solid relationships in telco and we are working those very, very hard in terms of SI&C and also ultimately outsourcing.

Great, thanks. And can you perhaps give us some more clarity on the sale of the rights which appears on your income statement?

You know, it is related to – it is the financial sector, and it is related to a financial institution that we gave them the right to access our client base, working in that field. That is why we call it ‘sale of rights’. It is qualified like this.

Okay, thanks.

Okay.

Thank you. The following question is from Martin Cecchetto; UBS. Please go ahead.

Yes, thank you. The first question would be a follow-on to Paul’s question on net margins. So the net result, do you see net margins potentially increasing from here, and can you quantify how much, even if you just assume no revenue growth?

As we said, and I think you have seen it on the quarterly basis for the last four quarters, we did improve our net margin on a quarterly basis relative to the improvement of our own operation. We believe that we will continue to do it in the future.

Even without the top line growth?

Yes, as I said, in the process we are still working to improve our way to manage the operation and also to generate the full synergy of the combination of AMS and us for the operation side.

Also, we are still working to improve the use of the delivery model of CGI for some situations, and mainly looking at the business solution that we have. So it will generate improvement on the bottom line.

Thank you. And just on top of that, last year you mentioned you saw some seasonality in the upcoming quarter, in the September quarter. Can you talk about how much you expect that to impact this current quarter and why we should be confident that there are going to be some revenue increases sequentially here?

I think our guidance that we provide, the adjustment we made take into consideration that slowdown on the fourth quarter, mainly related to the System Integration and Consulting business where the vacation period on most of our business units are get impacted by the vacation of our people. So it does impact the top line, a little bit less on the bottom line because we manage that with a provisional reserve related to that period. But it does impact.

Can you give us a bit of an idea of how much of an impact it would have on top line, just on the seasonality.

I think what Andre is saying is with the guidance, you could probably calculate that, Martin.

Okay.

Thank you. The following question is from Cynthia Houlton - RBC Capital Markets. Please go ahead.

Hi, just a follow-up question first on the sale in the credit union, bank alliance. Can you just give a little bit more color? Is that something that you were planning for the quarter, is that something that – I guess the decision of the sale – if we could get a little more color on the timing and the rationale? Or, was this something that was expected?

It is Mike. The timing, I guess, was really driven by when we could reach a satisfactory agreement between the two parties. It was anticipated in terms of us looking again at all of our lines of business on an ongoing basis on how we could drive more client and shareholder value here. As you know, we divested our U.S. credit union business. We took a hard look at the Canadian business and felt that this arrangement with Desjardins really created a win-win for our clients and for solidifying an ongoing partnership that we have with Desjardins.

So I don’t think there was anything particular about the timing, Cynthia, it was when we were able to conclude an agreement that we were both happy with.

And then just a follow-up on a change in guidance on a go-forward basis. Can we just understand a little bit more the rationale of not providing guidance on a forward basis?

As I said when I made my presentation, if you look at in the past the growth driver of CGI is really linked – in terms of the growth rate – to the timing of the closing of those big deals. Let’s say when we signed a few years ago that big deal with Canada Post, before that a big deal, a very big transaction with Bell Canada; Desjardins was the same thing. And then, for those very large initiatives it is very tough to predict exactly in which quarter.

This is exactly the business in which we are, so we have been announcing those contracts and for some of you who have followed us for a few years now, you are going to remember that a few years ago that we had announced a hot summer, because we had been told by a client that we would get a very large outsourcing contract. Unfortunately, it took longer than expected, for very good reason, it took longer than expected to sign a contract. So it means that it took us a couple of quarters to finalize all of the negotiation and then recognize a revenue.

Back then, we were penalized because we were not able to recognize those revenues. So this is exactly what we have in mind, because we are – this pipeline is very strong, robust. It is tough to predict in which quarter exactly it is going to happen. Okay?

When you look at the best way for all of us to look at it, including our investors, is probably to look at the track record of CGI, the best performance and so when we look at what we did from 2003-2005, if you calculated that yourself you are going to see, it could be relatively easy for everybody to base their judgment or their evaluation on that past experience.

On a quarterly basis, so it is impossible – nobody is able to predict exactly when and we do not want to be penalized for that.

Thank you. The following question is from Peter Misek – Canaccord Capital. Please go ahead.

Yes, thank you. I just had a couple of questions. Can you give us some details on the cash that you generated this quarter? You seemed to have had an unbelievably strong, positive change in non-cash working capital. Could you give us some details on that? That is my first question.

It is coming in part from the improvement in terms of days sales outstanding, and so it was a good part of that.

But days sales outstanding accounted for the bulk of the $120 million improvement year-over-year?

Yes, significantly.

Because we went from 61 days to 46 days. [Inaudible] on that part.

That is a great improvement. Can you give us an idea of what free cash flow type expectations of cash flow from operations expectations we should – should we assume that DSOs are going to stay at this level? Is that what internally your guidance is, or do you think they are going to edge upwards?

As we said in the past, the cash will vary on a quarterly basis. If you look at us, for the last four quarters, you will see that there is a variation on a quarterly basis. There are some quarters where we have better improvements on the cash side, and I will say to provide you with the full guidance on that would not be possible.

Okay, just some other questions. On your BPS business, it appears that revenues grew 3.3% year over year, and contract bookings grew 11.5%. That 3.3% growth appears to be a little slower than the market and the bookings appear a little bit bigger. Can you help me understand what kind of growth rate we should be thinking about? The same as bookings going forward? What caused the difference there?

Again, I think on that score, just a couple of points. We have appointed the new president of the BPS operations, I don’t know if you saw the release we did, Michael Denham has joined us. He will now be focused solely on the Business Process Services business. Joe Saliba, who was operating that business as well as our Europe, Asia Pacific has moved to London and will focus solely on Europe and Asia. So just a point on that.

As far as the bookings go, again as I mentioned before, we are concentrating in a number of areas. One is the insurance claims business. That has been a tough business, I think the good news is that we have seen an increase in claims in Western and Eastern Canada, given the different weather conditions there. We have also done some selective restructuring in the Ontario market where claims have been down. Our margins in total were very strong in the quarter. The HUD contract, I think, was the major booking that accounts for that 11% increase that you mentioned there, Peter.

Thank you. Just a couple of last questions. On the retail and distribution side for your verticals, it appears that it was weak year over year. Any reason for that weakness? Market trend? Or, should we see a rebound in this?

No, I wouldn’t read anything into that other than, as I mentioned earlier, we are working hard at those verticals that we have really acquired with the merger with AMS which is the financial and telecom.

My last question is, I sense some frustration with management regarding guidance and expectations, et cetera. I mean, given the free cash flow and cash flow growth that you guys have really turned around, you mentioned the last conference call you would not consider an income trust. Can you just help me understand why you would not consider it when you guys are generating this kind of cash now?

As I said in my presentation, we are looking at it on a long-term view and trying to consolidate the industry. We would favor, obviously – and having followed us for years now, because we were building this Company – we optimized the use of our currencies in paying those acquisitions. We need it to position the Company to win those larger IT and BPO initiatives. So we need it to grow the critical mass.

It was, in order to grow the Company at that pace and to be among the world champions, we needed to use much more currency. So in the past – over the last 10 years, I mean. So in the future, we are going to, with the capacity we have to generate cash today, with a very strong balance sheet, we are going to favor the use or continue to consolidate the market through more leverage from our balance sheet to pay in cash instead of using our shares as a currency.

Then, talking on this strategy, on the four pillars of growth, the idea is to leverage from that situation to continue to build our critical mass. Then from an accretive point of view, again it should create a lot of value plus other programs such as the stock buyback we have announced. Then obviously we are going to continue to optimize from value creation, the situation of the Company.

Thank you.

Okay.

Thank you. The following question is from Malcolm White; CI Mutual Funds. Please go ahead.

I believe that Peter addressed the income trust question, but again with your free cash flow yields, what about an enhanced dividend? Again, your balance sheet is pristine. Looking at your net debt to cap ratio, surely there are other alternatives. As a current shareholder, there certainly is some frustration out there when you take a look at the valuation compression you are getting next to comparables, and ultimately where your stock is trading on a free cash flow yield. Can you help me here?

We are going to continue to monitor the situation very, very closely and analyzing all of those possible scenarios and so as we said, yesterday we approved our strategic plan that was approved by the board of directors. We continue to monitor those situations very, very closely. The big advantage we have is cash is there and so we see a lot of opportunities in front of us, and all of the alternatives we are looking at is always to increase value, to create value.

Do you think investors understand this? I was just taking a look at the year-to-date performance of CGI and I was actually surprised that Bearing Point has outperformed CGI on a year-to-date basis, given all of their problems.

Probably, I don’t want to comment on – which one did you say?

Bearing Point.

I never understand when you talk about competitors.

I think it should be –

But you are not talking about the same kind of situation so ---

No, I think it is more the context. CGI has had a far more stable operating history. On a go-forward basis, CGI is clearly not offering guidance so investors need to look at other aspects of the business model to receive value and gain confidence that is there. I used Bearing Point as an example of a competitor that ran into much operational difficulties yet their stock has recovered but CGI is negative year-to-date.

Ultimately the question that comes here is, in that strategic plan, what is there for shareholder value? The buyback has been okay, but in my opinion could be more aggressive.

You are right, it is one of the scenarios, it could be more aggressive. But we continue to monitor that very, very closely.

And I will say, based on the strategic plan that Serge was talking about, we want to use the maximum cash we generate to support the growth and generate better returns on the shareholder equity side, so using more cash instead of shares for a transaction. We still believe that we can generate good return for our shareholders based on that.

I still do not understand that strategy, especially given where 10-year Canada Bonds are trading right now, it is up 4%.

But the return on equity, we do generate more than 9% at this point. I think we do generate well.

When we looked at the performance of the Company, at least the fundamental performance of the Company, we are doing very, very good. In fact, it is not one of the best – it is the best in the industry, when you look at it in a three-year period and do your calculation yourself.

We are confident though that the space itself – and I am not talking about CGI, I am talking about the entire space -- so that on the same period there was no value creation from a value point of view on the stock. We are looking at it and then since CGI and the numbers are speaking for themselves here, so obviously as I said, we are monitoring the situation very, very closely; analyzing all kinds of scenarios to improve that situation.

Thank you. The following question is from David Wright - BMO Nesbitt Burns. Please go ahead.

Thank you, good morning.

Good morning.

A question on the BPS market again. I was wondering if you could comment on what sort of growth rate you would be happy with in that business and how long do you think it will take to get that business growing at that rate?

As I mentioned, David, the BPS business is very important to us. We have just appointed – in fact he starts next week – a new president in that area to really, again, flush out and validate what we ought to look at in terms of, over the next three years. I would like to give him a little time to look at that. Suffice to say we do see growth opportunities there. We are committed to the BPS business, as outlined by that appointment and we think the prospects are good there. We believe that the margins on that business should be as good or better than what we generate in our IT space.

So he really just needs some time to set out a new plan?

Well I think we have taken a look and said that – I think we would like to really take a hard look at where we best apply our four pillar strategy to the BPS operations, and that is one of the mandates that Michael has taken on.

And the length of contract negotiations in that marketplace, is it generally nine to 16 months, and therefore it could easily take a year before we see an impact to the business?

Well that would depend on which pillar of growth that we utilized. If we were to do an acquisition it could be sooner, but normally the timelines there are very similar to the IT.

On AMS contracts, does the revenue recognition and the cash flow on those contracts, are they different than an average CGI type contract? In other words, will you make an announcement of a two-year, $22 million contract? Is that a software sale where most of the revenue is recognized in the first quarter or so, and then there is ongoing maintenance but it is a much smaller portion, or is it spread out in equal amounts over the life of the contract in general?

Hi Dave, it is Dave Anderson speaking.

Hi.

The way that we do the revenue recognition is the same in both jurisdictions so there is no difference there. If there is software, any hardware, et cetera that is part of the total solution, what we would take a look at is – especially if there are licenses – is to amortize that or to recognize that over the period of the total SIC effort that has to be expended on the contract. So it is prorated and blended into the P&L that way.

So that the revenue flows, on average, for AMS is somewhat similar to the rest of your business?

It is an identical revenue policy that we have.

Okay, great. Thank you very much. The sale of the rights seems to be an unusual situation. Is that something you are contemplating doing more of in the future, or is that really a one-time opportunity that you took advantage of?

It is a one-time opportunity. The idea was to offer our existing clientele an additional platform which was coming from Desjardins.

Right, okay. Thank you. And then another unusual thing, it has been amazing over the years that you haven’t really had much in the way of changes to contract costs and that. In this quarter you had an impairment of $9.6 million. I wondered if you could outline what that was pertaining to that was unusual this time, compared to so many other times?

It is Dave again. With regard to the revenue or the income that we had recognized on the sale of the rights, because we are changing the economics of how we are going to be receiving the income and the cash flows, potentially, with those clients in the future, what we did was look at what a revised cash flow would be, and from that to determine whether or not there would have been any impairment that needed to be done on both the original contract cost that we have – which was the value of the incentives and the balance sheet investment – as well as the business solution that we had designed for the credit union business.

With the revised cash flows, we thought it was prudent to take a reduction in the valuation or a write-down on those investments.

So the net effect here is that you reduced the intangibles, which is an ongoing thing, and yet recognized immediately reduced costs in the quarter?

That is correct, so that the actual gain which we had identified in the MD&A, the $1.4 million, and then we do the after-tax effect of it; you are dealing with less than $1 million that flows through the bottom.

A final item was on the very last page on the MD&A on the guarantees, there is a number there that continues to creep up to now $80 million. You think that is your maximum exposure. What is going on there that the amount is creeping up from last quarter?

If we could maybe take another question, and we will get back once we have a chance to double check.

Okay.

Thank you. The following question is from Robert Mana - Kramer Rosenthal. Please go ahead.

Hi, it is Robert Mana from Kramer Rosenthal. Serge, given your comments earlier in the conference call about using more cash than stock to make acquisitions, maybe it would be helpful if you reviewed for us some of the criteria and business lines or geographies that you are considering acquisitions. Because I have to tell you, with the return on invested capital that you have, I much rather prefer as a shareholder to see you invest in the Company rather than going out and making additional investments. One a question, two just a comment. Maybe you can help us understand that better.

Thank you for the question. The criteria in doing an acquisition, first of all, the criteria we have in doing acquisitions, it is a must, it is a criteria. No transaction is done here if it is not clearly accretive on both the net earnings and on an EPS basis. So it is a criteria.

The second criteria is, for instance, if we now have a very good presence today in the U.S., it remains that it is a huge and tremendous market so it would be, again, to qualify us for very large initiatives such as the ones we have already signed in the past for CGI – I mean very large outsourcing initiatives, full IT outsource initiatives, it remains that we would still have to grow our critical mass.

Then in acquiring other companies, and this time instead of using or favoring the use of our currency, the use of our shares with the strength of our balance sheet is to rather use our cash to continue to build that critical mass. Always, again, by doing acquisitions which position us to augment, to qualify us for those large initiatives. Clear, clear, clear. It has to be accretive on both EPS and on net earnings. It has to help us in our quest to become a world leader, namely in the full IT outsourcing business and in the BPS Business Processing outsourcing business.

The key geographies we are looking at is obviously U.S. and Europe and in Europe, obviously and when you look at the operations we have over there; U.K. we had a lot of success over there, we have been developing and growing our operations over there substantially and the growth is there both on the top line and the bottom line.

We also have in these geographies, we have certain locations where we already have to date very large clients. Not future clients; it is already there. Such as Germany, for instance. We are already there and very profitable. Maybe for acquisitions of [inaudible] we would look at these other locations in order to again, reinforce our position with very large clients. Does that answer your question?

It does. I guess I am disappointed to not hear you mention building up more of your Indian and offshore resources, it is the fastest growing aspect of the overall –

It goes without saying that obviously, from that point of view both in growing our offshore and near shore centers of excellence including India, and also those centers of excellence we have in Canada, so it goes without saying it is going to grow, obviously it is one of the priorities we have.

Maybe since you just had your board meeting yesterday, you could talk about the strategic goals, you can help us understand what the head count growth in India or offshore locales will be over the next year?

That is a very good question. As you know, we are the only player in this industry offering not only the offshore alternative, we are also offering to our clients with what we call the Cafeteria Approach, so it means that we always present to the client the three options, which are off shoring, near shoring and home shoring.

I will explain what we mean by that. If you are a client, for instance, based in New York and today the work is done out of New York, then maybe you are going to, between the choices of selecting the options of doing the work offshore or near shore, out of Halifax, for instance. It is amazing the number of people choosing near shore activities.

Today, when you look at the number of people, if we have 850 people in India, because we have asked clients to make their choice, so it is amazing the number of people who choose to do the work out of Canada – for U.S. clients, I mean.

That is helpful, thank you.

Maybe I could just go back to the question that David had asked us around the guarantees. The reason that the number creeps up a little bit is because we have been doing divestitures over a period of time. Maybe by way of an example, tax indemnifications that we have to give the buyer of those operations, for when CGI happened to manage those activities, those are part of this number. Those will expire over time so we will actually see this as we do more divestitures increase, and then we will see a decrease as those types of indemnifications expire.

Thanks.

Thank you. The following question is from Paul Bradley - Frasier McKenzie. Please go ahead.

Hi, yes, I will just keep this very quick. First of all, on the DSO improvements I wondered how this was achieved? It is a fairly dramatic drop within the period. I just wondered how you had done that.

Thanks Paul, and thanks for noticing. A lot of hard work in the operations, in the finance. Essentially if you look at – we have always, as a Company, focused heavily on DSO and cash. When we merged with AMS and when we do any mergers, normally we end up merging when an entity that doesn’t have the same kind of operational visibility and in a lot of cases, attention to structuring customer engagements and contracts, to the payment terms that we normally accept.

So essentially what you have seen over this period of time is on go-forward contracts, we are bringing to those contracts an engagement, the payment terms and standards that we adhere to and in addition, we try to work with the existing long-term engagements that we may have acquired to restructure some of these payments so that we get back closer to our payment terms.

We also, as I mentioned, have a very high visibility on this thing. We review them from an operational and a finance perspective on a monthly basis and it continues to pay dividends for us. Andre?

Just to add that we also have a set of tools and we do monitor every business unit with our management ratios, and the management of the contracts and work in progress, we look at it very closely. There is incentive to manage that well.

I think it is the benefit of our [inaudible] and we did demonstrate that for the last 10 years that we have improved our way to manage that item in our operations.

Well obviously it has material impact on the cash flow. Where I just wanted to check then, would I be correct in assuming the DSOs were much higher in the US than they would have been in your operations elsewhere?

You know, if you look on the Q304, we were at 61 days and now we are at 46 days. If you look at CGI Q204 we were at 47 or 48 days. So it is just a matter of –

Right. Not too much more to be squeezed out of that aspect of working capital, then?

Well, we never give up.

And I am assuming it forms part of people’s bonus arrangements to meet targets on DSOs and so on?

Yes, we linked all of that back into the overall performance of the business unit and the individual leaders.

Two other quick questions. You have had a number of people ask you questions about the BPS business. You talked about the ASP offering, proponents on the letter of credit I guess it is. Is that something that specifically is where you have software solutions that you can sell to the market on an ASP basis? Is that something you are specifically looking at increasing as a proportion of your business? Because it would appear to have very good leverage and very high margins.

That is exactly right, that is the point I was trying to make is if you look at AMS pre-CGI, they did not have a large infrastructure, data centers. They were focusing more on licensed revenue. What I was trying to explain was what we have now started to do is to look at the capabilities and the assets we have, combine that with what they have, and bring a broader range of alternatives to the combined client plate.

So instead of just buying the license where the client has to pay for a license, he now has to install it in his data center, it may trigger a data center upgrade, he has got to burn capital to do that, for us we have already got data centers, we already own the IP so it means that we can make our existing assets work harder and drive more value. It also means that we have a recurring revenue stream because these are normally at least five years in duration. It is a pay-per-use that the client likes and of course, as you can imagine, the economics on this thing after you get a base number of clients on the solution, the economics start to work pretty well because the incremental cost of adding client 5, 6, 7 and 8 are less than the first three.

So we are looking at the suite of services we have. We are looking at what it would cost us in terms of turning more of these solutions into an ASP model and offering that to our clients.

We think, particularly in the financial services, this is a very interesting business proposition for a lot of financial institutions who find themselves with infrastructures that are somewhat dated and that the cost of doing the transformation for themselves alone is perhaps prohibitive or considerably risky. By moving to this model, the risk is diminished, the cost of moving off of their legacy systems is less and it creates some incremental value for the client and for CGI.

And just to clarify one aspect there, because you have been asked about return on invested capital and you know I am a keen proponent of that particular measure. In these cases, you are not taking on any of the client’s IT infrastructure, they are simply end users of a software application that you are going to offer them over an Internet connection or whatever else?

Yes.

Okay, so you put some investment upfront but the potential leverage to you is very high in terms of the number of people you can get on the system?

Exactly, and what I was pointing out of Proponix, which again is a pretty good measure, here is a system that we have working in Australia and Canada and the U.S. and obviously we would be targeting clients in the U.K. So here is a system that crosses probably 80% or 70% of the financial markets of the world that works across those markets with different financial institutions. So it is a pretty good validation of what our thinking and strategy around that piece of the business is.

And sorry, one last question, because I know this call has gone a very long time. Do you have the sales force that can sell that? Is that your existing group of people that can sell that type of product?

Yes. With our model, we have 107 offices now worldwide. We have a good footprint to pull that through.

Great, thank you very much.

Thank you. The following question is from Scott Penner from TD Newcrest. Please go ahead.

Mike, just one thing. The BCE revenue that shifted out of Q2, $18.7 million, did that all come into this quarter?

Yes, I think as we’ve said, we have caught up pretty well from that delay in this quarter. We had said that it would slip, it did and we said we would pick it up, and we did.

And the 850 people in India, the number that you threw out, is that unchanged from last quarter?

It is essentially – it fluctuates but it is essentially the same. I think as Serge said, we are focusing much more on global delivery. We also are trying to build very gradually over there as opposed to announcing 30,000 or 40,000 people going over there. We do not think that is good from a quality standpoint, from a member retention standpoint.

Through IMR, we have been in India probably longer than a lot of our competitors. I think IMR was in there since 1991. We know that market pretty well and we see a great future in India in the context of a global delivery model.

We firmly believe, as Serge said, we have an inherent, distinct competitive advantage over most of our global competitors and that is our large, dominant footprint in Canada and we intend to leverage that to our advantage.

I think, as I mentioned, some of the Indian firms in fact are trying to get that foothold in Canada, not overly successful in doing so. So our view would be that we will go to market with an integrated, global delivery strategy that has all of the elements. As Serge said, we have the footprint for the onsite work, whether it is done in Canada, U.S. or Europe; We have the near shore with Canada, we have home shore in the U.S. and in Canada and in Europe, because we have a low cost development center in Spain, as an example, that can be leveraged in Europe. And of course, we have India. We have very experienced people, high quality people in India with a turnover rate that is lower than our competitors and we are gradually building that up in the context of global delivery.

Great, thanks for your answer. And just Serge, one last thing on acquisitions. With the template of AMS and perhaps buying a consulting firm and using it as a springboard, is that a template that you see using again for some of your acquisitions in the U.S. and Europe versus, let’s say perhaps paying a little bit more for a BPO or BPS provider?

All of the options are open for us, and you just raised some very, very good questions. We will be open to all of those scenarios.

It is the same profession.

Okay, thanks.

Thank you. The following question is from Steven Li; Raymond James.

Thanks. Just one question, on the strategic plan discussion you used 7% as a net margin target in the past. Do you see your profitability going back to this level next year?

On a three-year period, we would like to continue to improve ourselves gradually, such as we have been communicating in the past. But the idea is when you compare us with the peers, is to be assured that we are always among the top, the best companies, percentage wise.

I will add to that that the 7% was before expensing options.

Yes, you are right.

Just to be sure we do understand well. Because the impact of the options this year does represent about half of 1%. So to be comparable would be more 6.5% as we were before [Collin McKay] or before AMS.

If you look at us –

And we were at 6% this quarter, to be sure we do understand well.

When you compare total to total, when you look at last year just before we did AMS we were around 7%, right? And then because we are a Canadian-based company we had to expense our options for [Raderly] and then any other U.S. players, so the cost for us was 0.5%.

So it means that in being at 6% this quarter, it means that it is on the same basis at 6.5%. Then we are becoming very, very close to the 7% we were before the acquisition of AMS.

So the idea here is to continue to improve and then the objective is to, when you compare again with the other players in our domain, is to be among the best if not the best.

Thank you.

Thank you.

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Godin.

Thank you very much everybody. I would like to thank you for taking part in our quarterly results conference call and I thank you for your continuing interest and your confidence. We look forward to updating you on our fourth quarter and 2005 fiscal year results conference call in November. Thank you very much.

Have a good summer.

Bye, bye.

The conference has now ended. Please disconnect your lines at this time.