CGI Inc (GIB) 2006 Q1 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. Please go ahead, Ms. Dore.

Thank you, operator. Good morning, everyone.

With me to discuss the first quarter of 2006 are Serge Godin, CGI's Founder and Executive Chairman, Michael Roche, President and CEO, and Andre Imbeau, CGI's co-Founder as well as its Executive Vice President and Chief Financial Officer.

This call is being broadcast on www.CGI.com. Supplemental slides as well as the press release we issued earlier this morning are also available for download. Additionally, our Q1 MD&A is posted on our Web site and has been filed with both SEDAR and Edgar.

Please note that some statements made on the call will be forward-looking. Actual events or results may differ materially from those expressed or implied. The 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 report our financial results in accordance with Canadian GAAP. However, we also use non-GAAP performance measures (indiscernible) adjusted EBIT and cash net earnings. Those non-GAAP financial measures should be considered as supplemental in nature. Also, all figures expressed are Canadian dollars unless otherwise noted.

Now, I will turn the call over to Serge, who will make some brief introductory remarks, to be followed by Andre, who will review the financial highlights of our first quarter. Finally, Mike will make some concluding remarks. We will try to leave as much time as possible to answer your questions, but we will have to limit the call to 45 minutes, no more, given that we have our annual shareholders meeting right after.

Serge?

Thank you, Paule, and good morning, everyone.

Recent surveys conducted by market research firms show that a much larger proportion of organizations will increase their IT spending over the coming quarters. This is good news, as systems integration and consulting services markets are expected to grow by 45% over the next year.

As for outsourcing, the trend continues to be very strong. It is an untapped market that will offer tremendous support (indiscernible) and their numbers are really impressive.

I have been leading CGI (indiscernible) the past 30 years, and I must say that I've never seen such a vibrant market as the one I'm seeing today. There are tremendous opportunities within our grasp and we want to ensure that we will take advantage of that. This is why we have announced today's organizational adjustment. While our executive committee will be comprised of the same people, namely Paule Dore, Andre Imbeau, Michael Roche and myself, I will become Executive Chairman of the Corporation and Mike, Michael Roach will become President and CEO. Mike and I, jointly with our colleagues Andre and Paule, will continue to share responsibilities related to the relationship with all of our stakeholders. However, Mike will interact more closely with our shareholders, sharing with them increased operational insights, while I will devote more time to highly strategic and very large initiatives with our existing and new clients, as well as acquisitions. In his new role, Mike will continue to report to me. He's moving to Montreal and this adjustment is effective today.

Going forward, consolidation in IT and Business Processors Services will continue and we intend on remaining a very active consolidator, building more critical mass in the U.S. and Europe. There are several interesting large outsourcing opportunities, and we intend to take advantage of it. However, as the deals are getting larger and more complex, we are experiencing longer selling cycles. If it was between 6 and 18 months in the past, it is now between 12 and 24 months. The good news on this front is that there is a lot of activity.

Now, I will turn the call over to Andre Imbeau to review the financial highlights.

Thank you, Serge, and good morning, everyone.

This morning, we reported Q1 revenue of $898.5 million, slightly lower than Q1, 2005 on a constant-currency basis. However, we posted 7.2% growth in net earnings from continuing operations, compared with the first quarter of 2005. Year-over-year, revenue in the first quarter mainly reflected normal fluctuation in the level of work received from our outsourcing clients and the previously announced termination earlier in fiscal 2005 of a contract that was not meeting our profitability standards.

Our net earnings margin from continuing operations improved sequentially for the sixth consecutive quarter since the acquisition of AMS to 6.3% from 5.7% in the same fiscal quarter of 2005. Q1 cash net earnings before the amortization of intangibles increased to $76.8 million or 8.5% of revenue, compared to 7.8% in the first quarter of 2005. On a per-share basis, it's $0.18 versus $0.16 a year ago. While cash net earnings are not a GAAP measure, we believe that this provides better visibility of our ability to generate cash from our assets.

Adjusted EBIT, a useful measure of operational effectiveness, decreased to $78.7 million in the first quarter, representing a margin of 8.8% compared with 9.3% a year ago. The year-over-year change mainly reflects the [cap] relative to an investment being incurred to develop our offering to the brokerage industry, as well as the earning impact of two clients merging and the develop work received from also (indiscernible) contracts.

Moving now cash flow, cash provided by continuing operating activities was $63.4 million for the first quarter, compared to $102.5 million in the year-ago quarter. Had it not been for large client payments received after the quarter's end, cash flow levels would have been in line with Q1, 2005. Cash and cash equivalents at the end of the quarter were $262.9 million. Our DSOs, our Days of Sales Outstanding, was reduced to 50 days from 51 days a year ago. We continue to manage our receivables very closely and are constantly looking for ways to drive them down.

At the end of December, we had long-term debt of $253 million. In order to fund the BC shares repurchased, we drew down approximately $750 million in January from our newly extended $1 billion line of credit. We booked just over $2 billion of new business during the quarter. Our backlog of $14 billion has an average remaining term of 7.8 years. This figure includes the additional $1.1 billion from the BC contract extensions, which we signed on January 12.

One final note -- this morning, our Board approved the renewal of our Normal Course Issuer Bid, enabling us to buy back up to 10% of the public float, or 29.3 million shares, over the course of the next year.

At this point, I would like to turn the call over to Michael Roach to discuss some of the operating highlights. Michael?

Thank you, Andre, and good morning, everyone.

In the interests of time, from an operational perspective, I will focus my comments on two of our geographic markets, Canada and the U.S., as well as on the BPS as a line of business. In Canada, we continue to leverage our strong brand and competitive position to gain visibility into a growing number of business opportunities across all five verticals. In particular, we are seeing increased strength in the government sector, primarily at the provincial level, and throughout the financial vertical, both in banking and insurance. Our seven-year, $90 million outsourcing contract with Royal Sun Alliance announced this morning is a tangible example of this activity and our competitive position in Canada.

Turning to our U.S. operations, we are pleased with the level of market activity, growth in our sales funnel and with a number of very strategic winds during the quarter. One of these strategic deals was our successful negotiation and contract signing with the Commonwealth of Virginia. This sweeping initiative will transform the state's business and information technology program. It comes under a seven-year term that is worth up to $300 million initially with two optional renewals for three years each. The program will be initially introduced into the executive branch of government with potential applications into the judicial and legislation branches, as well as education. We will realize significant cost savings as well as additional revenue for the Commonwealth, all while securing appropriate margins and returns for CGI.

This initiative has clearly helped elevate market awareness of the increased depth and transformational capabilities of CGI, post our acquisition of AMS. It also serves as a powerful calling card and reference for similar initiatives across the government space. We continue to expand and cross-sell our acquired and embedded expertise in their new areas of the market. For example, following the acquisition of Silver Oaks, a firm focused on the multibillion-dollar spend management market, we have begun to offer this service to our Canadian clients through a newly established Canadian practice.

In addition, we continue to expand and evolve our global delivery model through new sites such as our Onshore Center of Excellence in southwest Virginia, which will serve U.S.-based clients, both commercial and government. We've also continued to consistently grow our India presence to the point where we believe we will pass the 1000-member mark later this quarter. Investments like these will contribute to further profitable growth over time.

Not briefly, with respect to our BPS business, we were very active in quarter one, announcing two key wins and completing the divestiture of our switching business for $28 million. We announced the BPS contract with the State of New York to administer multi-family housing under the U.S. Department of Housing and Urban Development, or HUD, valued at US$44 million over five years. CGI is now the largest HUD business processor of its kind and the leading contender for future HUD contracts. As well, we signed a multiyear, 30 to $40 million U.S. contract with Medco Health Solutions, a leading pharmaceutical pharmacy benefit manager in the U.S., under which billing, payment reconciliations, enrollment processing and IT hosting services will be performed by CGI.

On the contribution side, all of our business units and lines of business were profitable in the first quarter. We continue to aggressively pursue all opportunities to increase both our margins and cash position across the operations.

In closing, I would like to reinforce the commitment I bring to my new role as CEO to continue to work as part of a great team to grow CGI into world champion. I also look forward to having the opportunity to spend some additional time with shareholders and analysts to share my perspective and enthusiasm for the industry in general and for CGI in particular.

Thank you. I will now turn the call back to the operator for your questions.

Thank you. (OPERATOR INSTRUCTIONS). Mike Abramsky, RBC Capital Markets.

Thank you, operator. Mike, congratulations and Serge, best of luck in your new role.

I just wanted to discuss organic growth a little bit. In your MDA, it says it's down negative 3%, 3.1%. Where do you see the trend going on organic growth? Do you consider, as some of the steps that you are putting in place to address those, you just went through a number of things and which are perhaps the most significant to improving organic growth?

Well, thank you, Michael. Yes, I think one of the things we're running into constantly is the impact of currency, so I think that number is before you adjust for currency. You know, we've had currency fluctuations on the U.S. side; now we are seeing it on the euro. I guess it's kind of what comes with being an international company, so the organic growth was off about 1.3% year-over-year when adjusted for currency.

Having said that, you know, we still seeing some strong opportunities out there. I tried to give you a bit of flavor by the two largest geographies. In Canada, as I say, we get some good visibility to virtually any opportunity that comes out. Royal Sun Alliance is a recent example; it takes more time to close these deals. A lot of these deals are now international, where you are dealing with not only the Canadian office but you're dealing with the UK or the U.S. in terms of processes and approvals. Nonetheless, in that example, we did compete against two very large global competitors, and one -- in the U.S., as I mentioned, I'm very pleased with the activity down there of the wins; closing the Commonwealth was a great accomplishment. We really believe that now that we are the partner in that area, we will get much more visibility into other opportunities beyond what we announced with the initial contract. So yes, we believe that the opportunities are out there, the reorganization. The adjustment that Serge announced this morning we think will also help in terms of us focusing our attention on not only the day-to-day operations of the Company but on those strategic initiatives that Serge spoke of in his comments. (multiple speakers)

In supporting Mike's comment here, so this is the exact rationale of the organizational adjustment. So, as the Company is much more visible than it used to be in the past, has a footprint in the both U.S. and Europe, it's much bigger. So we are invited more and more on much larger opportunities, namely on the outsourcing front. So, in a sense, we're talking about a large initiative here. It is much more demanding I mean from the business-development point of view, which is why we have proceeded with this adjustment in order to allow me to spend more time with those highly strategic clients, you know, which could -- you know, we're talking about what we have experienced in the Company over the last few years and when we signed deals which were very significant for the development of the Company. This is the idea behind that -- this is the rationale behind that.

So, your pipeline was about I think 7 billion at Q4. What is the size, now, and mix of the short-term -- say, less than one year -- and long-term opportunities in your pipeline, given that it sounds like the exposure to the long-term opportunities could have these longer sales cycles associated with them?

Well, again, I guess a general comment there -- a company of our size with the opportunities, the pipeline stays roughly the same size. We haven't seen anything there that would cause us to materially move it up. The challenge is the one that we commented on, is the speed at which we can move these through the various stages, so it is the speed at which we can try to get the deals across the line. As I mentioned and Serge said in his comments, we are finding it's taking longer now than it did in the past. Again, some of this I am convinced is not only the size but the complexity -- we are dealing with more multinational firms now that have other checkpoints that need to be made before we can get them signed and closed off.

Okay, I have other questions but I will -- (multiple speakers) -- for others.

Paul Steep, Scotia Capital.

Serge and Michael, maybe you could talk a little bit about what you see the top three growth opportunities being for the Company that would drive you in the MD&A to make the statement that while you saw the market only growing 4 to 5 points annually, you think growth is going to be stronger than that. Where do you guys see that you are going to step above the market?

I think there's two or three areas that I would comment. One is outsourcing in general. We continue to see that that piece of the business will grow faster than the generic 4 to 5% that the analysts talk about on the systems integration consulting side.

I think the second area is around our solution set. You know, we are -- we continue to market solutions like Advantage and Momentum. We are also continuing to expand the offerings that we give those clients, and what I mean by that -- AMS primarily was selling licenses in those spaces; we've been working to convert some of those into managed services, so we would have a longer revenue stream associated with those solutions. I think our timing is very good there. I mean, we bring that capability of the clients; a lot of governments are finding that their employees are aging with the demographics, so they are also looking for other alternatives. Third, they are all looking for cost reductions and we bring all three to the table. So I think, around the solution set, the portfolio we have, we expect to see more growth there.

Then as far as a market goes, you know, the government side and the financial vertical seems to be very robust. This is an area where we have very good market coverage and a good calling card, including, as I mentioned, the work in Virginia has really accelerated the awareness in the U.S. generally but also in the government vertical. So those would be the three areas, Paul.

Great. Then just second one would be if you can update us on the strategic review undertaken of BPS with the appointment of Michael Denham.

Well, again, I think that's probably a longer conversation that we can cover on the analyst call, but I think suffice to say that Michael has helped bring clarity around those areas of BPS that we will focus on. You notice we did divest a piece this quarter. I think, for the most part now, we have good clarity around those areas, and we are concentrating now on bringing the pillars of growth to there. The organic piece you saw; we had a couple of good organic sales that were in that space; they were also U.S.-based. The claims piece seems to be picking up a bit; people are claiming again now when they have accidents, which is good news, I guess, at one level. So, what we're doing now is essentially continuing to focus on the organic growth and looking for appropriate targets, acquisition targets that would fit into the lines of business.

Great. Thanks.

Scott Penner, T.D. Newcrest.

I just want to pick up on the organic growth, if I may. I mean, the bookings for CGI have been very strong now for several quarters. I'd appreciate any comments regarding I guess the changes in the lag from booking to the beginning of revenue, or changes in the ramp up of revenue that would just cause the organic growth just to continue to fall behind what would seem to be the number implied by bookings.

Yes. No, that's a good question, Scott and it gives us a good opportunity to address it, because you are right; the bookings are strong and we are very proud of the work that's been done there. I think there's probably two or three things that need to be looked at. One is some of the bookings on the outsourcing side have been what we refer to as Tier 1 or infrastructure deals, and in an infrastructure deal, there is a longer lag between winning the deal and actually seeing the revenue, because on an area like development or maintenance, it's people so that you can announce the contract and you can start to scale up and see a revenue stream earlier. On the infrastructure piece, in many cases, in all cases, the client is already with another supplier or they are doing it themselves, and there is a much longer period to actually technically move those facilities from their data centers or a competitor to ours, plus given the size of some of these companies and their dependents, obviously, on their data centers, you have to pick certain windows; you need a three-day weekend like Presidents' Day in the U.S., you know. One would do a cut-over then because you have a three-day weekend. So, you will see a lag on some of the bookings to the wins, especially when it comes to the infrastructure piece. That could be anywhere to 6 to 9 months, depending on the size of the deal.

I think the second thing is, as you know, probably as a percent, we have a higher percent of our revenue that comes from outsourcing deals than a lot of our competitors. So, relative to systems integration consulting. So under these long-term contracts, on an annual basis, there are price adjustments, there are benchmarking clauses which actually -- and there are ongoing pressures from the clients to continue to do things a different way to drive more value for them. Therefore, what you find is, while we are growing our revenue organically, it can be offset by the triggering of benchmarking clauses or individual pressures that might be in a specific client or a specific sector. So, that also has the temporary effect of masking the impact of some of the bookings that you talked about. So those are kind of two factors that I would say that you're seeing when you look up the relationship between bookings and revenue.

I appreciate it; that's very helpful. Just Andre, if I could ask you quickly to run through a couple of the impacts to EBIT that you mentioned.

Yes. I think, on the EBIT side, that we had mentioned was you know, there's the merge of some contracts, some (inaudible) clients which did have some impact, okay, on our EBIT side. Also, positively we had the impact also of the selling of the switching business\ that will bring to us $[89] million of positive (indiscernible) on that part. Also, we had to invest, okay, in our business solution related to the brokerage business, you know, when we had to support that. You know, it's spending; we do not capitalize that spending, but we have to invest on our solution, okay, as an expense; (indiscernible) been expenses completely, okay, during the quarter. So, it's what did impact us, okay, on that part.

Richard Tse, National Bank Financial.

Just a quick question here for Serge -- you know, there's no secret that private equity has been looking at this sector and the States in particular, and given that you are short of moving to sort of work on strategic initiatives, would you ever consider the possibility of kind of talking to a private equity guy in terms of taking a stake or maybe a larger position in CGI here?

There's a lot of activities happening, as you know, so we have seen what is the -- I don't want to comment on rumors, you know, happening on the other players, but we have been no secret there. We have been visited by also all of those VC firms. In our case, we were identified by some of the VCs as being the best, from an execution standpoint, as one of the best-managed companies from an execution point of view, in our space. So we're going to continue to monitor those situations very closely. I will be looking at all of these opportunities. Nothing, though, so far which is of interest to date for us as we speak. (multiple speakers) -- but there is a lot of activities on that front in our space.

The reason for that, that's because namely the outsourcers, they are looked at by those large firms, those VC as being a good performer in terms of cash, production of cash and cash flow, and this is why, you know, it is of interest for all those investment companies.

So this is something that you would consider?

I said that we will look at all situations.

All right, okay. Great. Thanks a lot.

David Wright, BMO Nesbitt Burns.

Congratulations, Michael, on your new responsibility and kudos to you, Serge.

Andre, you just mentioned that you were investing in your brokerage business there. What was the R&D spending in the quarter?

The full R&D spending -- you know what? The R&D that we do present as an R&D spending is mainly related to the one that gets qualified on the taxation side, okay? So, we do provide you with $6.8 million on R&D, and we have also -- we did spend close to $15 million, okay, on the development, okay, on our solutions. (multiple speakers) -- and it's -- the spending we did, okay, on the other business, okay, is outside that numbers I just give you, okay. We consider that within our expense.

So is that $15 million, so that's expensed in the quarter. How would that have compared to either Q4 or Q1 a year ago?

You know, just be sure we do understand each other, we are talking around $22 million of total spending. Close to $7 million is qualified R&D; the rest would be qualified as development cost, okay? As I told you, the one that I do refer in my text is over and above that. Okay, the $15 million, it's -- part of it is capitalized, right?

Okay, so that part is capitalized. I guess what I noticed was that your gross margin, depending on the assumptions on R&D in that -- but your gross margin seems to be slightly lower than what we've seen for quite some time. So I'm trying to figure out, is it extra spending that you've done in the quarter or is it because of slower growth in the industry and therefore competitive pressures on margins? Perhaps you could discuss the margin issue and your spendings.

It is Mike here. Just to (indiscernible). One of the things that happens there, if you look at Virginia Royal Sun, we had expenses in the quarter to close those deals, especially a Commonwealth is kind of a long process. So, we would have had kind of a few additional expenses in the quarter associated with working our large outsourcing funnel -- (technical difficulty) -- as an example.

Now are those expenses, though, are they part of amortization of goodwill and long-term expenses?

No.

So that's actually up in the gross expense line?

Yes, yes.

And so, is your comment that -- like with many industries when you get slower growth, you get pressure on margins, either from customers or more aggressive competitors. So what's your comment on competitors? Are they being more aggressive in their pricing and are customers expecting more?

Yes, again, I think, you know, certainly I would think, if you talked to our competitors, they would probably see us as one of the aggressive competitors. You know, it is an aggressive market out there right now, but again, we have a very flexible cost structure and we manage our costs, as you know, extremely tight. What you will see, though, is the comment I made earlier to Scott is that as -- on an annual basis, you do see the outsourcing benchmarking clauses and these type of things start to kick in over the first couple of quarters, normally depending on when the deals were signed, and see some temporary hits there and then as we adjust and change how we do the business, we earn back those margins as we past the costs onto the (inaudible).

So I've been expecting that, with the completion of the AMS acquisition and others, that your margins should be improving this year, but I guess, in the slower-growth environment and with extra work to sign contracts, is that an assumption that might be questionable?

Well, I think, again, since the AMS acquisition, our margins have been going up quarter-over-quarter, so we have wrung out the kind of operational synergies that we look at. What you're seeing now is more expenses going to the seller and we are now -- the first thing in a large acquisition, you've got to -- you have to get the costs out rapidly to make it accretive. So we've done that piece, and you've seen that on the margins. Now, we are reinvesting more on the marketing and sales side to grow the Company, so you're seeing a bit of that. Again, I think the good news there is I'm happy with what I'm seeing in the U.S.; we've had some good wins there and we have more in the pipeline.

Great. Thanks very much for your comment.

(OPERATOR INSTRUCTIONS). Wojtek Nowak, Blackmont.

Good morning. Mike, can you perhaps talk about the systems integration and consulting business? I would have expected that to jump back a little bit after the September summer seasonality. What are the dynamics going on there, and what do you see going forward?

Well, actually, on the systems integration side, it's kind of a strange situation because the way Christmas fell this year, frankly, we had a lot of vacation periods not only in December but it came into January, especially in Canada here because, as you know, the teachers and the kids never went back to school until the 7 of January, so it was a very quiet period, not only our traditional period at the end of December but it spilled into January as well.

Again, we're seeing most of the activity, as I mentioned, in government. It's slower procurement in government, obviously, but the activity is good there. The opportunities we see in the U.S., I would think that the systems integration piece will be a little stronger there, so there is certainly a seasonality piece. Companies also have run their budgets out to year end and a lot of them are on the calendar, fiscal calendar, so they will start back up in the first and second quarter. But I'm not seeing anything different out there one way or the other.

Sure. Would you expect a sequential uptick in 2Q?

Yes, throughout the year. Again, some clients and some of our outsourcing clients are, again, on the calendar year, so their ramp up -- you know, they've got to write the specs for the projects and the time they turn it over to us; it could be out a quarter or two into more of the summer period.

Okay, thanks very much.

Thank You There are no further questions registered at this time. I'd like to turn the meeting back over to Ms. Dore.

Thank you very much! So, again, I'd like to take this opportunity to wish you a happy new year and we see you, I hope, at 11 o'clock for our AGM. Thank you very much.

Have a good day. Goodbye.

The conference is now ended. Please disconnect your lines at this time. Thank you for your participation and have a nice day.