CGI Inc (GIB) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the CGI quarterly results conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Lorne Gorber, Vice President, Investor Relations. Please go ahead, Mr. Gorber.

Thank you, Amy, and good morning. With me to discuss the second quarter of fiscal 2006 are Michael Roach, our President and CEO, as well as CGI's founders, Serge Godin, Executive Chairman, and Andre Imbeau, Executive Vice President and CFO.

This call is being broadcast on cgi.com. Supplemental slides, as well as the press release we issued last evening are also available for download. Additionally, our Q2 MD&A is posted on our website and is being filed with both SEDAR and Edgar.

Please note that some statements made on the call may be forward looking. Actual events or results may differ materially from those expressed or implied and 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 such as adjusted EBIT and cash net earnings, among others, which should be considered as supplemental in nature. See the MD&A for definitions of each non-GAAP financial performance indicator used in our reporting.

All figures expressed on this call are in Canadian dollars unless otherwise noted.

Now I'll turn the call over to Andre, who will review the financial highlights of the second quarter. Mike will then comment on the operations and make some concluding remarks. We'll try and leave as much time as possible for Q&A, at which time Serge, Mike and Andre will all be available to answer your questions. Andre?

Thank you, Lorne, and good morning. Yesterday after the close of the market we reported Q2 revenue of C$866.8 million. Compared to the same quarter of 2005, our business is stable when you exclude the C$24 million in lower revenue from BCE and the C$27 million currency impact.

As part of the program we announced to strengthen our competitive position, a pretax provision of C$31.3 million was taken in the second quarter for severance. We expect to incur approximately C$60 million in remaining provision over the course of this calendar year, which is in line with the total program cost announced in March 29.

Q2 cash net earnings, before the restructuring costs related to the specific items, were C$56 million or 6.5% of revenue. This was C$0.16 on a per share basis compared with C$0.17 in Q2 2005. While not a GAAP measure, we believe cash net earnings provides better visibility of our ability to generate cash from our assets.

Cash provided by continuing operating activities in the second quarter increased to C$82 million compared with C$66.8 million in the year-ago period. Cash and cash equivalents at the end of the quarter were C$188 million.

Our long-term debt increased in Q2 to C$962.2 million due to the previously announced purchase and cancellation of C$100 million CGI Class C shares from BCE. We utilized our credit facility and used C$127 million in cash to fund the buy-back. In addition, we made a C$29.5 million debt payment in the quarter.

So at the end of the quarter we are pleased with our cash management and have more than ample flexibility to support the corporation growth.

At this point, I would like to turn the call over to Mike to make some remarks in discussion to the operating highlights.

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Thank you, Andre, and good morning, everyone. The second quarter was one of repositioning our company for the next wave of profitable growth. As outlined in our March 29th announcement, the catalyst for restructuring was a sharper-than-expected sequential drop in work from our largest customer, BCE, some C$34 million lower than last quarter and, as Andre mentioned, C$24 million below quarter two 2005. In fact, both the sequential and year-over-year deltas on revenue are explained by the drop in BCE revenues and currency fluctuations.

We are working hard to aggressively implement the restructuring plan which has three overarching goals -- first, to offset the impact of reduced BCE work volumes; second, to accelerate and expand our global delivery model and capabilities; and third, to improve our competitive position and our margins over time.

Relative to implementing the plan, here's where we stand. The first round of severances went ahead as planned at the end of March. We appointed the same Senior Vice President who successfully oversaw the integration of AMS to drive the timely implementation of our plan and the full realization of its goals.

We've already vacated some office space included in the program such as 4 King Street in Toronto and work continues on consolidating real estate.

We have also accelerated initiatives with respect to moving more work into our global delivery centers. The rollout of these centers is moving ahead with the establishment of two centers, Southwest Virginia and PEI, as well as the expansion of our Indian presence with a new site in Bangalore.

As we said last month, to successfully execute the plan we expect to invest C$90 million in calendar 2006 with the first third provision in the second quarter. The expected result will be C$90 million in annualized synergies by calendar year end or a one year payback.

Now beyond the activity relating to this restructuring program, let me spend a few minutes highlighting certain aspects of our operations in quarter two. We booked C$1.75 billion of new business during the quarter, including the previously announced BCE contract extensions.

Despite the impact of a longer selling cycle associated with large outsourcing, we did book several strategic wins across our lines of business. At the end of March our backlog stood at C$13.7 billion with an average remaining term of 7.3 years.

We continue to gain visibility with a growing number of business opportunities across all five verticals in each of our geographies. In Canada we recently announced a 10-year, C$130 million full IT outsourcing contract with the internationally acclaimed entertainment company Cirque du Soleil. This is a key strategic win for us, not only in terms of dollar amounts but in terms of brand awareness as Cirque is one of the most recognized brands globally.

I'd like to focus the balance of my comments this morning on U.S. operations. In the U.S. public sector, in particular, we are experiencing increased strength in the state and local government sector, as well as increasing activity in the federal space.

As part of our U.S. strategy, we are focusing on two areas with respect to the public service. First, to grow and expand our suite of business solutions, specifically Advantage and Momentum, to existing clients through upgrades and to new clients as part of the CGI offering. Second, to transform what was once primarily licensing revenue into recurring, long-term managed services revenue.

On both counts we continue to make progress. Recent evidence can be seen with the New York Advantage expansion and with Wake County, North Carolina, a new Advantage client. We are seeing further client acceptance of an IT managed service offering with respect to these business solutions and expect more success in the coming quarters with both Advantage and Momentum.

Building on what I told you last quarter, our business process services division has seen a lot of activity year to date. In the first quarter we announced HUD contracts and healthcare wins totaling C$100 million. In quarter two we were successful in growing our BPS insurance practice with recent signings in Florida with Universal for an amount of US$75 million over seven years and in Massachusetts with OneBeacon.

As a result of these wins and our own market outlook, we are actively recruiting 500 new employees across the U.S. operations. These employees will be targeted to the public service opportunities and wins that we've mentioned above.

In closing, I want to reiterate a few key points. Our company is financially strong. We continue to generate solid cash flows and have close to C$200 million in cash at the end of quarter two. With respect to the restructuring program, we expect to begin to see the benefits gradually materialize this quarter and through the balance of the year, steadily improving both the top and bottom line.

Finally, we are confident in our growth strategy. The new leadership structure we've been working under for the last couple months is producing results as our pipeline-- as activity continues to grow. We are pursuing a number of very interesting opportunities across all pillars of growth.

Let's go into the questions.

Just before going to your questions, a reminder that a replay of the call will be available, either via our website our by dialing 1-800-408-3053 and using the passcode 3182696 until May 10th.

Amy, if we could poll for questions from the investment community? And a reminder to the media on the call, we'll be pleased to take your questions afterwards. Feel free to give us a call.

Thank you. [OPERATOR INSTRUCTIONS] The first question is from Scott Penner from TD Newcrest. Please go ahead.

Oh, thanks. Guys, I'd just like to start by talking about the EBIT margins, 7.2 this quarter and 8.8 last quarter. There are obviously some one-time impacts such as the BCE effects and what looks like various significant investment programs that you have at the same time. To the extent that you can, could you sort of run through what you would consider the one-time or non-recurring impacts on EBIT and talk about any kind of-- any kind of targets for margin recovery that are in your business plan? Thanks.

Thanks very much, Scott. Clearly, as you pointed out, the impact of BCE was significant impact on the EBIT. Having said that, though, the restructuring initiative and the first wave of severances were specifically targeted, for the most point, to actually restore our utilization rates on that account. So what we're expecting now is that we will have restored our margins relative to the BCE account for the most part, although, obviously, on a lower revenue base.

The restructuring plan itself is targeted with gradually improving those EBIT margins back to and hopefully above our traditional rates that we've run, say, in the same period last year.

And I think on the expense line we have been-- related to that we have been impacted because we had to go through that process of reduction on the revenue side and we have to support more availability on the-- on our delivery team. So it's one time I will say it does impact things, I can say, okay, the EBIT, okay, for this quarter.

Operator, if we can go to the next question.

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

Okay, great. It was really relating to the margins again. Michael, maybe you could go back to where the margins were. You mentioned that you thought you'd bring the BCE margins back up on a certain basis and then you sort of moved on. Is that like two quarters, the end of the year or is it into next year before we see those margins hit on that account, I guess, is the first part of the question?

On the-- on the BCE account, don't forget, there was two-- two issues we are addressing there. The first one was the volume dropped very rapidly, which obviously left us with people that weren't fully utilized. So what we did at the end of March was to try and bring those utilization rates back up to address that issue.

The second thing we're doing with BCE is we're moving work from Toronto, Montreal to Atlantic Canada throughout the balance of this year. So there will be transition costs and shadowing of employees to make that happen. But the biggest impact was the lower utilizations driven by the drop in revenue. The corrections that we did in the end of March has addressed the bulk of that.

So what I'm saying is the margins in the BCE account in quarter three will be much stronger than they were in quarter two and that over the balance of the year they will-- they will return to the more normal levels but on, obviously, a lower volume of revenue than we had, say, last year.

The same thing we're expecting to see with the restructuring program. Because if you can see in the severances we took this quarter we also took some costs down in corporate, as an example, so that will ripple through for the balance of the year and, in fact, compound as we go on.

So the program was designed to address immediately the drop in the BCE revenues and then, as well, to gradually help us improve the bottom line and the top line over the balance of the year up to the end of calendar 2006.

Okay, great. So if we step back on that, then, actually for a second,that was the next question, which is the scope and the scale of, I guess, the program or the project to restructure. How fixed is that? I guess my question really relates to in the past I know you've done a number of divestiture programs. Clearly there are a lot of businesses that make up the bulk of CGI. How much latitude does the-- I guess, the partner that you've got in charge of this initiative have to go after other potential margin gain that we might get through maybe divesting or looking to divest some business?

Well, again, I think the mandate we've given him is to execute the program as we announced and make sure we get the goals and the outcomes within the timeframes that we've identified here.

In terms of divestitures, that would be beyond his scope. That's something that we would look at from a management perspective and, again, I would say on that front we're constantly looking at acquisitions. We're constantly looking at how to improve shareholder value. We have done divestitures in the past when it made sense.

I could tell you at this point we do not see anything material on the divesting side. I think the thing you have to realize that all our business units and our lines of business are profitable in this company. What we're really talking about here is taking an action to improve our profitability and our market positioning on a go-forward basis here.

Okay and then I guess the final one that actually relates to shareholder value, as well, if we looked at your debt side and, obviously, there's a large chunk of BCE stock that becomes unlocked May 12th, what are the thoughts there in terms of how you would think about that in terms of a further shareholder value initiative? Is there room in terms of the current debt covenants to do something additionally on that front?

Well, I think, though-- I think to be clear, we have no intention or interest in buying back that remaining block. I think we have bought back with BCE what we intended to do. The other 28 million shares, as you say, become unlocked on the 12th of May and, frankly, if it went back into the market, probably it would increase liquidity, which I think would probably be a good thing for us.

Okay.

But we're not restricted. We don't have any restrictions in terms of covenants. It's more focused on not a desire to buy.

What we want to do is to keep-- to support the growth, okay? We target to continue to grow and use our cash flow on the development of the corporation at this point or to reimburse the debt, okay, as an orderly manner. We want to do that to reduce our debt as a level that we used to have in the past. At this point, it's still comparable to the rest of the players, okay, in the market but it's part of the objective we have.

But mainly support the growth. We see, as Mike said, a lot of potential, okay, in the market, mainly related to outsourcing and BPS, plus some acquisitions, potential acquisitions.

Okay. Thanks, guys.

Maybe-- Serge here as a supplement. That C$28 million-- the 28 million shares, instead, in the end of BCE since that date in May 12th, so the-- I don't know if you followed that, but because of the warrants in the case of Desjardins that they exercise their warrants and mean-- what it means that they acquired more shares. And the agreement we have with BCE that if they are to divest they are going to do it with an orderly-- with an orderly manner just to be sure that you're going to keep a good value of their investment.

Okay. Thanks, guys.

Thanks, Paul.

Thank you, Paul.

Thank you. The following question is from David Shore from Desjardins Securities.

Thanks. Maybe I'll turn Paul's question around. What level of debt are you comfortable carrying and how aggressively do you want to repay the debt to get there?

As we said in the past we were working with a ratio between-- between 20% and 30% of the-- as debt compared to the-- the debt ratio, okay, itself, to work around that. At this point we are at 31% net of the cash, so it's-- as we said, supporting the growth, use-- if there is no growth, okay, in the one quarter we'll reimburse the debt. But at this point we are comfortable with the level of debt. My expression is not to say we are not comfortable, because we are already comparable to the other peers and the other-- the peers in the market.

But we as a corporation like to be between 20% and 30%, okay, on the equity side-- on the debt side ratio.

Okay. The second question is on the stock comp expense brought by the--?

Which one?

On stock compensation expenses, the stock option expenses--

Yes, okay.

--dropped by about-- almost half from first quarter. Do you expect that level going forward or will it be more like C$4 million or so a quarter going forward?

Based on the role and the-- we have made the adjustment, okay, on the cut of the stock-- the stock options to put that in line, okay, with what do we expect to be exercised or to be in-- as an expense, okay, for the full year. Now if we're looking at the year to date, okay, as a number, you will have what we do plan, okay, as a cut, okay, for the corporation for the full year.

Okay. Thank you.

Thanks, David.

David, as a supplement, our stock option plan it is performance-based. There is no time-based stock option in our company. Everything is based on performance. So every quarter the cost of those-- of the options are always adjusted according to the results.

Okay, thanks a lot.

And the plans. Okay?

Yes.

Thank you. The following question is from Wojtek Nowak from Blackmont Capital. Please go ahead.

Thanks. Good morning. First question is on the restructuring. You've incurred one third of the planned restructuring cost so far. Will that result in one third of the planned savings? In other words, can you help us gauge the impact of what you've already done?

No, it wouldn't be a one-to-one on the first-- tranche, but, as I say, I think you have-- all I can do is reinforce, as we've said, that it's a one year payback and that by calendar year end we would be at the run rate of the savings. So no, they're going to be staggered over the course of the next nine months.

Okay. Can you give us some color on maybe the profile? Is it going to be more impactful in this quarter versus the coming quarters?

No, it'll build.

Okay.

It'll build as the year goes on.

Sounds good. And can you provide us on an update on-- in terms of the BCE business? How is that trending in Q3 and what is your outlook for that?

Yes, I think relative to BCE our outlook right now would be that quarter three would be stronger than quarter two. As far as how much stronger, it's very early in the quarter, but it could range anywhere from 5% to 15% stronger, depending on what happens in their work program.

And I think I mentioned before that we are expecting work to come from some of the restructuring that BCE is doing relative to setting up their income trusts. As you know, they have appointed a leader now and as they start to work through that they will identify information technology work relative to setting up those entities and that should help us on a go-forward basis.

Excellent. Thanks for that. Lastly here, can you give us an expected timeline for some of your larger contracts? When will those come on stream into revenues, specifically the Cirque du Soleil, Royal Sun Alliance, the Universal contract? When do you expect those to start being recognized?

Yes, that's a good question because it's one of the-- as I mentioned before, it's one of the challenges that we're having here relative to seeing the revenue associated with the bookings. Some of the contracts we've announced this year, as I mentioned before, were in the infrastructure piece, Manualife Hancock, the Royal Sun Alliance and, therefore, the-- there's much more time required to move those data center operations to ours so that the revenue visibility takes longer. We are actually making good progress on those and we do expect to see some of that revenue, obviously, appear in quarter three, quarter four.

Actually with the Cirque, because it's a full outsourcing opportunity or win it's got more than data center. It's got the people piece. So that revenue stream started effective with the announcement.

Okay, excellent. Thank you. And just lastly, if I could, the deferred revenue balance went up sequentially. Can you perhaps comment on that?

It's related to the payment we received, okay, from clients, okay-- on our outsourcing contract. It's mainly that and it's a matter of timing, okay, related to that.

Okay. That's it for me.

Thank you.

Thanks, Wojtek.

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

Thank you very much. Good morning.

Hi, David.

I guess just a question about your organic growth rate and perhaps there's not much you can do about it, but are you satisfied with the current organic growth rate? If you take your business-- take out the currency fluctuations and take out the BCE issue, the non-- the rest of the business doesn't seem like it's growing that fast. So should we be frustrated with just the fact that the market's not growing that fast or should we be looking for more growth out of CGI.

Well, I think to answer your question head on, no, we're not satisfied with the growth that we're seeing. I think secondly I would validate your analysis, David. When you back out the BCE revenue and the currency impact, there is organic growth, but it's not-- not at the level that we have delivered in the past and what we would expect.

Having said that there are a lot of things that are impacting that, depending if you-- if you compare it year-over-year or quarter-to-quarter, but the-- the way we look at this thing is that we're in a very good line of business. I mean outsourcing is here to stay. It's growing. We have a good offering. We have a global delivery model.

We've got a solid management team. We're strong financially. We're still, as I mentioned, sitting on C$200 million of cash. Our debt levels are reasonable. We still have flexibility to grow.

We are somewhat frustrated with the time it's taking to move some of these opportunities through the funnels. The funnels themselves are still very healthy, both on the systems integration and consulting side and on the outsourcing side, but the speed at which they're moving through the funnel is not up to what we would like to see.

Hence, to address that kind of thing with the organization announcement we made with Serge assuming a bigger focus on-- on business development and actually trying to help move some of those opportunities through the funnels faster, we do-- we do believe that this will, over time, and, as I mentioned, over the balance of the year, that we will gradually see improvements in both the bottom and top line.

Now that's notwithstanding what we can assume on currency because, again, the Canadian dollar, as you know, continues to strengthen and that certainly has an impact on our top line when you look at the revenue that we're getting internationally.

Right. Okay. Flipping it around a little bit, the manufacturing sub-sector did well. It was the one area that you did see organic growth. What is going right in that area?

Well, again, I think-- I think it's--

Is that predominantly Canadian business?

It's--

It's a small sector by the way.

Yes.

Yes.

So, no, I don't think there's any permanency in the trend there. I mean, I think the sectors that we continue to look, David, for growth are in the government sector and in the financial sector, I think are clearly the two largest opportunities that we're seeing here for kind of more steady growth over the next period of time.

Okay, thanks. And in your press release, I guess, you mention about acquisitions and you happen to hint at selected metro markets, which is a slightly different spin than what I have been thinking about because I thought that business process outsourcing was more of the focus, which, to me, doesn't think about metro markets. So is there a statement you're making there that maybe in the near term you see more opportunities by these selected regional opportunities or am I reading too much into it?

Yes, I think you're reading too much into it, David. No. We-- we're obviously continuing to look at all opportunities, including BPS, and, again, as you know we have a two-level type of program. We have a local program where the guys in the local metro markets would identify targets below C$50 million and then we have our corporate-wide acquisition program that would look at larger opportunities, greater than C$50 million, that would, in fact, cross these metro centers. Both of them are still active.

Okay, great. Thanks. And just a clarification on-- you have cash earnings of C$56 million and I was just wondering how you get there from the kind of net earnings, excluding restructuring charges? Was it the recovery of some previous restructuring charges related to Cognicase or what's the differential there? From C$34 million, excluding restructuring, and then you have C$56 million, the delta.

Yes. You have the impact of the taxes on the-- It's net of tax. The C$31 million is before taxes. That's-- and other restructuring costs-- the C$31 million is pretax, so after tax, because the cash net earnings is after tax.

Okay.

Are you okay there, David?

Did that make sense?

Well, I just assumed-- Like you have net earnings from continuing operations of just C$35 million and then you're saying that the only difference between that and C$56 million is the tax?

Amortization of the intangible.

Okay.

Okay?

Okay. Thanks very much.

I'll follow up with you.

Yes, thanks, Lorne.

Okay.

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

Hi, guys. Just a quick question here. In your MD&A you talk about one other reason for a decline in revenue is say ramping down and termination of isolated contracts not meeting profitability standards. So I guess year to date what's the value of contracts that have been eliminated and how does that compare to last year? And finally, what do you expect that to be going forward here?

There is one contract that has been stopped last year that does have an impact this year. It's the Fireman's Fund that has been announced last May, 2005. So that one has an impact, of course. That's why we do talk about the-- of that type of contract.

And also there is some other contract that we are seeing them ramping down, okay, mainly related to their profit level impact-- their profit level does not achieve our own target. But it's not a significant part of the changes, it's the main changes as we told you it's related to the exchange rate and also related to the BCE situation at this point.

Okay, great. Thank you.

Thanks, Richard.

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

Thank you. Just a couple questions. Firstly, I found it interesting your hiring comments in your press release about U.S. hiring comments and I was just trying to reconcile that with some of your earlier comments last quarter or the quarter before about ramping up more in India and, indeed, around the restructuring. We'll just start there.

Peter, in the United States where we operate in federal, state and local, there are very few of those jurisdictions that would have their work done in India. So these jobs are targeted to those wins that I mentioned on Advantage and other wins we're having in the U.S. government sector. Those jobs cannot be moved to India.

In terms of--

And, as well, Peter, the other ones were the business process jobs in Florida relative to the Universal contract that we mentioned.

In terms of employee utilization rates and revenue per head, et cetera, is there more cost or more people that maybe can be shifted from other geographies to meet that demand in the U.S.?

There may be possible and we're looking at that at moving some people from Canada into there. As you know, there are visa requirements in moving foreign workers into the U.S.-- but they don't apply to the same level to Canadian workers as a result of the free trade agreement. So we are, in fact, looking at can we move Canadians down there to do some of this work.

And then the last question, I mean, on some metrics the BCE restructuring and what they're doing, indeed, they were talking about the fact that they want to cut IT expenses more and they seem to be telegraphing to the market that they have an ability or are going to cut C$100 million plus of revenues with you folks and I just find that tough to reconcile. It seems to me that that's the run rate when you look at the shortfall this quarter. Can you help us understand that?

Well, I don't want to-- I can't comment on what BCE has told you. I think on our March announcement we were very transparent with our agreement relative to BCE from a contractual standpoint. From a working standpoint I can tell you the relationships is very good and very strong and they-- they have many avenues to cut costs. I guess IT is one of them, but any company of that size needs to continue to invest in information technology. Having worked there myself for 25 years I can assure that most of their activity and services are IT-based so that there's very little goes on in a telephone company that isn't highly dependent on information technology.

So I think relative to BCE this year we've worked with them. We've made the changes. We've reached an agreement on moving some of the work and, as I say, I think some of the changes they're making to their own organization, while it may have slowed down a little bit of the work program now that ultimately, as those changes go into effect, at this point we're expecting to get some additional work there from the levels that we've seen in-- in the past quarter.

Sorry, if I could squeeze two more. I mean, you're one of their biggest customers in terms of wholesale. Is there any leverage to renegotiate and get a better deal, given the level that they've been doing, or is that--?

We, obviously, do that on an ongoing basis and, again, we don't normally publicly announce that kind of thing, but we're-- as part of this program, I can assure you we're looking at all the costs including cost inputs to our model, which would include telecom, we mentioned real estate, all levels of procurement. We've in fact-- are utilizing the services of Silver Oak, which was the procurement expert company that we acquired in the U.S. We've put that program in our company and they are identifying savings that we would harvest throughout the balance of this year and into next year.

And last question, I promise, in terms of your free cash flow and EBITDA, I mean, on a number of metrics you're trading like something on 7 times to EBITDA and some ridiculously low multiple on free cash flow. It's got to be frustrating for your folks. Certainly I've had an earful from a few people. How do you surface value over the next 12 months? Thanks.

Well, again, I think you surface value by doing things right and doing the right thing. We are absolutely convinced that we're in a very strong market. We're a very strong competitor in there.

In fact, some of the things that are happening with our competitors, we believe, are surfacing opportunities for us. There's some uncertainty out there relative to a number of our competitors, frankly, putting themselves up for sale. I can assure you in the outsourcing business clients like to be associated with firms that are stable, that have a stable management team, that are in it for the long haul and that are financially strong and that is absolutely the description of CGI.

As well, the new structure that we've announced between Serge and I is also very much focused on really surfacing that value. We believe the value is there. That's why we bought back the 100 million shares. We believe CGI is a great investment at this level and we believe in the future of the company.

So while it might be frustrating, I think, again, we've found that over 30 years you need to look at the long term here and those are the type of investors, we believe, that are attracted to CGI.

Thank you.

Thank you.

Thanks, Peter.

Thank you. The following question is from Ranjit Narayanan from RBC Capital Markets. Please go ahead.

Thank you. Your BPS business was down year-over-year and there was a recent study by a large IT consulting firm that BPO was one of the largest and growing segments of the IT services space. Could you just comment on your outlook for the BPS business and are there any strategic referenceable deals in the pipeline?

Yes. I guess BPS-- and I did comment on it in the previous quarter and I updated it, as well, I think when you look at our BPS numbers we did some divestitures there. It's also-- there's a currency impact that's hitting our BPS operations.

Having said that, as I mentioned, I think, in quarter one we announced over C$100 million in deals. We announced a number of new deals this quarter and we are seeing the activity there. We have a leader that's focused on BPS. So we would share the optimism that there is continued growth in the BPS business and we're determined to capture a fair share of that on a go-forward basis.

Okay?

Yes, thank you.

Thanks. The following question is from Paul Bradley from Fraser Mackenzie. Please go ahead.

Good morning. A couple of quick questions here. You commented on the debt-- target debt to equity ratio. I just wondered, in terms of the covenants, what are the key variables that your lenders are looking at there?

The key variables?

Yes.

For sure the-- I think if-- it's a normal covenants ratio that they are looking related to the EBITDA and also related to the coverage of interest.

Interest coverage, okay.

I think it's-- but most of these items are related to the EBITDA level and the-- as of now our coverage is very good. We can justify all of the-- when we did that transaction with BCE we did look at our bank level and the debt level and all of the coverage looking forward, also, and we are very confident, okay, on that part.

Okay. And if I were just to apply sort of industry norm multiples on that, I'd understand where you are with respect to those.

Yes. I would say it's the same kind of coverage that you can see, okay, as a standard, okay, in the market.

Okay. No, I was just trying to understand--

We have-- we have very good flexibility in there.

Fine. That's--

Because of the cash flow-- because of the cash flow capability or ability we have, there is no-- we have a lot of flexibility.

Right. No, that's just what I'm trying to understand in terms of anything you might want to do in future.

Yes.

Just flipping back to BCE for a moment, I know it's been subject to a number of questions. Roughly what proportion of your overall business does BCE represent now, sort of given the current status?

As we said, their largest client, which is BCE, is 10.6%.

10.6%? Okay.

The full business with the client.

Okay.

Because there's a lot of corporations within the BCE--

Well, yes. So that's grouping all of those people together.

And the major one is-- it's lower than 10%.

That's in the quarter.

It's within the quarter.

Oh, right. That's within the quarter, okay. And-- but that would presumably hold roughly on an annualized basis, 10%, 11%?

Yes, around that.

Okay. Jumping back to, I think, something that was asked earlier in terms of BCE and what it's doing, it clearly has a plan in place to significantly cut its costs. It's looking at all sorts of different ways of doing that, internal process changes and putting pressure on suppliers which, clearly, you're one.

Now I guess there's two ways in which they can do that. One is just simply buy less. The other one is make you supply that at lower cost. To what extent is moving people out to Atlantic Canada putting pressure on your margins? They may cost less, but presumably you're having to bill them into BCE at lower cost, as well.

No, actually, moving the work out there really achieves the objectives of both the client and ourselves.

Right.

On one hand, the client is getting the services at a lower price after we move the work--

Okay.

--and in our case we're lowering our costs and protecting our margins.

Okay. Protecting but not expanding or protecting and not seeing too much downward pressure.

No, I use protecting to say it's-- we're not taking a-- any kind of an erosion there that would be material.

Right.

I mean, it-- when you move work to a center like that you get a benefit-- we get benefits not only in the sense of relative to that account, but we get future embedded benefits of having the center and being able, now, to leverage it to other clients. So that's why I'm hesitating a little bit, because I look at it not only on the account, but I look at it from a total CGI perspective.

Right.

The fact that I have more capability out there, a marquee account is out there, it helps us sell other large clients to move their work to our centers of excellence.

Okay. Now just to pursue that, just to understand the impact on pricing, now clearly in the case in BCE they understand what you're doing there. I mean, they're asking to have services at lower cost; you can achieve that by moving people there. So in their case, that doesn't really give you any effective control over pricing to them.

But for other accounts, are you able to charge the same rates as if you have those people in, I don't know, a higher cost center or is there, necessarily, a bit of a ceiling now on the rates you can charge for those employees?

No. You have to watch-- obviously, if you were doing your IT work in New York City, the reason, the market reason, the value creation opportunities to convince that client to move his work from New York City to Southwest Virginia, he's going to get a lower cost or if he moves it to Atlantic Canada or to Montreal he'd get a lower cost, again. And he moves to India-- so it's kind of a menu here of value creation. From our standpoint, though, obviously, if it's a new customer we're going to gain top line and bottom line. If it's an existing customer, depending on what the pricing arrangements are, we could end up with less revenue and the same margin or if the price is fixed and we move the work we could end up with the same revenue at better margin.

Okay. So there is a degree of variability there?

Yes.

Okay. A couple of other questions. If I look at the breakdown of geographical revenues, Europe and Asia-Pacific looks to be down, I think it was, 20-something percent in the three months, maybe 20% over the first six months. I'm assuming that's not all accounted for by currency. I just wonder what else was there?

Well, if I look at it year-over-year, it's down, I think, C$16 million. C$9 million of it is currency.

Okay.

And the other-- the other material piece there or piece of interest is we had a-- we have a contract with BT on Suffolk on e-government. The first phase of the e-government project went in as planned and was very successful. In fact, has helped us now to partner with BT and we're now short-listed on another e-government transformation in Somerset, which is another jurisdiction over there. The phase-- what you're seeing here is the phase two hasn't ramped up yet.

Okay.

So we've got a kind of a pause between phase one and phase two there and that's where you're seeing some of the revenue decrease.

Okay. Okay. Although in context-- And just last question was the-- I think you spoke earlier that you see growth in the government and financial services sectors as being the opportunities for you and I guess you've talked on a number of occasions about the size of the pipeline and the types of opportunities. Is it inherent that in both government and financial services it simply takes longer to negotiate the kind of contracts you're interested in?

Yes, I would say it certainly-- the answer is yes, more so than government, obviously, than in financial services.

Right.

But, again, we deal with very large financial services groups and, therefore, it does take quite a while to move it through the organization. But I guess the message I was saying is both those areas are active and when compared to manufacturing they certainly offer much more opportunity in terms of growth for our company.

Okay, but no-- but as a result of that, presumably no reason to expect the pace at which you can sign up those deals to accelerate in the near future?

No. I don't think so. I mean, governments move at their own pace.

Clearly. Okay. Many thanks.

Thanks, Paul.

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

Andre, there's a statement in the MD&A that just says one of the EBIT impacts is from the impact of changes in project-related estimations. I've seen that term before, but can you just run through that again?

Yes, it's some project that we had to review the degree of achievement or the degree of completion and we had made, okay, during the quarter adjustments related to that project.

Okay. And then just-- last quarter you mentioned one of the impacts on EBIT was benchmarking of clients against competitors. I'm just curious, any comments of whether that continues to be an intense impact on EBIT or whether you see that lessening over time?

It's Mike. Firstly, it's a normal course of business in our industry and in some of our contracts -- we don't have benchmarking clauses in all our contracts. We do have them in a number. They're primarily in the infrastructure piece and-- but, no, we haven't seen anything out of the usual there. The only thing that we would say is that sometimes just because the clients are on calendar years you see some of those impacts hitting you in the first quarter of the calendar year because a lot of our clients are on calendar years so that they've tried to time any benchmarking or price adjustments to the first quarter of their fiscal year.

Great. That's helpful. Thank you.

Thank you, Scott. Amy, I guess we have time for one or two more questions.

Thank you. The last question is from Steven Li from Raymond James. Please go ahead.

Thank you. Mike, can you update us on the size of your pipeline and whether you're seeing contracts getting bigger in scope?

The pipeline-- the number we've used in the past and we validated it before-- before the end of the quarter is, on a discounted basis, we still see a very healthy pipeline in outsourcing of about C$7 billion.

The size of the deals-- I would say the ones that are moving through the funnel -- and it's kind of an interesting thing, because if you can imagine, the speed at which one moves through the funnel is kind of, in some regards, tied to a number of factors, one of which is size. So if you have a deal that's C$50 million a year you can get that one through the funnel in some basis faster than a C$500 million deal. Another factor would be whether it's an international company, as I mentioned before, because in some cases you need a number of levels of approval.

I would say that some of the deals that we're working on at the lower end of the funnel are-- range in the C$100 to C$300 million range, total contract value. So they're probably more in the mid-size, medium-size in terms of revenue stream. Okay?

Okay, Steven?

Thank you. I would now like to turn the meeting back over to you, Mr. Gorber.

Thank you, Amy. And thank you all for being here. Just a reminder. Our third quarter conference call will be on July 26. So we'll hope to see you all then. Thank you.

Thank you.

'Bye-bye.

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