CGI Inc (GIB) 2015 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the CGI second-quarter 2015 conference call. I will now turn the meeting over to Mr. Lorne Gorber, Senior Vice President, Global Communications and Investor Relations.

Thank you Oliver and good morning. With me to discuss CGI's second quarter of FY15 are Michael Roach, our President and CEO; and Francois Boulanger, Executive Vice President and CFO. This call is being broadcast on CGI.com and recorded live at 9:00 AM on Wednesday, April 29, 2015. Supporting slides as well as the press release, financial statements and MD&A issued earlier this morning are available on CGI.com in addition to being filed with both SEDAR and EDGAR.

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. The complete Safe Harbor statement is available on CGI.com and included in this morning's disclosures. We encourage our investors to read it in its entirety.

We are reporting our financial result in accordance with the International Financial Reporting Standards or IFRS. However, we will also discuss non-GAAP performance measures which should be viewed as supplemental. The MD&A contains definitions of each one used in our reporting. All of the figures expressed on this call are in Canadian dollars unless otherwise noted.

This morning in an effort to get more of you into the Q&A our prepared remarks will be very brief. We are trying this shorter format based on your feedback, asking for more Q&A time. I will turn it over to Francois as usual to review our Q2 financial performance and then Mike will make a few comments on the six-month results before going right into your questions. With that, Francois.

Thank you Lorne and good morning everyone. I am pleased to share our results for Q2 FY15.

Revenue was CAD2.6 billion compared with CAD2.7 billion in the year ago period. Three primary factors account for the year-over-year delta. The completion of projects in North America last year make up approximately two-thirds or CAD60 million. The biggest portion relates to the wind down of government health care projects in the US, volume reduction from the Nordic region, some of which ties back to plan integration related contract run-offs, and finally a net headwind from currency with a stronger US dollar being more than offset by the euro and Swedish krona.

Bookings for the quarter we're impacted by the traditional second quarter seasonality compounded by ongoing sector-wide delays in the US federal business and more recently the UK election contract freeze. Over the last 12 months, bookings are running 107% of revenue. We remain optimistic by the European market's positive response for our solutions and offerings as all segments are surpassing 100% book-to-bill.

Adjusted EBIT was CAD363 million in the quarter, while our EBIT margins increased by 140 basis points to 14%. Excluding last year's nonrecurring items, namely the provision reversals related to the Logica purchase price allocation, the operations expanded EBIT margins by 230 basis points. Net earnings were up CAD20 million to our record CAD251 million up 9% from last year and 6% from last quarter's.

As a result, net earnings margin reach 9.7%, the second consecutive quarter above 9% and an indication that we are running -- returning to pre acquisition levels of profitability. EPS was CAD0.78 per diluted share compared with CAD0.73 last year representing an improvement of 7%. In the quarter there was a CAD6.6 million FX loss largely due to the timing of payments which impacted EPS by CAD0.01.

Our operations generated CAD285 million in cash with DSO improving to 41 days, but offset by an increase in income tax payments, CAD73 million more than Q1 and CAD43 million more than Q2 last year explained by the timing of these payments between quarters and the ongoing improvement in US profitability along with CAD30 million in integration payments, excluding the CAD30 million. [CACS unrated] was CAD315 million. This leaves CAD53 million to be disbursed mostly in the back half of the year. Over the last 12 months, the operations have generated CAD1.5 billion or CAD4.64 per diluted share when excluding integration disbursement of CAD106 million.

Turning to the balance sheet. We repaid CAD462 million of debt during the quarter leaving total debt at CAD2.1 billion. We have CAD250 million remaining on the CAD1 billion term loan due in May 2016. At the end of March, net debt was CAD1.9 billion or CAD800 million less than last year. As a result, the net debt-to-capitalization ratio improved from 36% to 24% with a fully available revolving credit facility and CAD224 million in cash, we have more than CAD1.7 billion in readily available liquidity and access to more as needed.

Now I'll turn the call over to Mike.

Thank you Francois and good morning everyone. Our second quarter and year-to-date results were both strong and continue to track to our 2015 business plan.

After six months, revenue is CAD5.1 billion and trending towards incremental improvement. Adjusted EBIT is up 10% exceeding CAD700 million. EBIT margin is 13.8% up 180 basis points with all operating entities above 10% excluding intangibles.

Net earnings are up 16% to CAD487 million or 9.5% of revenue. EPS of CAD1.52 is an improvement of 15% and continues expanding. Cash from operations is up 50% to CAD2.10 per share. And our bookings are up 16% in the first half to CAD6.6 billion or 128% of revenue. The operational and financial benefits of implementing our model continue to yield significant benefits to our shareholders.

Looking ahead, we're well positioned for the remainder of the year with the financial and operational ability to continue to execute our build-and-buy profitable growth strategy. Thank you for your continued interest and support. Let's go to questions now Lorne.

Thank you, Mike. Just a reminder that there will be a replay of the call available either via our website or by dialing 1-800-408-3053 and using the pass code 1214143 until May 8. As well, a podcast of the call will be available for download within a few hours.

Follow-up questions should be directed to me at 514-841-3355. Oliver, if we could poll for questions, please.

(Operator Instructions) Thank you. We will now take questions from the telephone lines.

(Operator Instructions)

There will be a brief pause while the participants register. Thank you for your patience.

The first question is from Richard Tse from Cormark Securities. Please go ahead.

Mike, you and the team have done honestly a great job at driving profitability here. I was looking at a higher level. Over the next 12 months, what would you rank as your top one or two strategic priorities for the Company?

Thank you, Richard, and yes, I'm very pleased with how the teams around the world, frankly, have stepped up and implemented our model. As I said many times before in the services business, if you focus on operational excellence there's still opportunities to improve margins.

I think if you look at the -- we're over 9 net margin now for the second quarter in a row. We're back to where we were before Logica integration, yet we don't have the same mix yet in Europe and in those acquired entities, so we still have opportunities there to increase margins.

But I think if you look at the priorities, I think the first and foremost, again, we want to return to profitable organic growth. We want to ensure it's quality revenue. We'd like to have more of it as recurring revenue.

I think as well, we want to start to see the mix, and I'll comment on that a little more of where we are on IP, but continue to evolve the mix so that we're not only working hard, but we're working smart with our customers to help them succeed in their business. I think on the other side, you know, on the buy-and-build strategy, we're clearly in a position to acquire if we see the right asset.

And over the next number of periods, if we see something we'll move on it, but it could range from, as I said many times, a niche acquisition of fill in versus something more transformational. And the last point, which could probably just as well be the first one, is to continue to be very close to our customers in terms of understanding where they're going and how we can help them get there.

So we're just rolling up the input to our annual strategic plan update, which we'll be releasing probably the findings sometime in July, but we'll have talked to pretty close to a thousand customers in the C-suite around the world touching all our verticals. And that information is used to help us validate the path we're on and also where we should accelerate and make additional benefits -- investments, sorry.

Thanks on that. With respect to the government in the US, I think you said in the earlier comments that they're still seeing some headwind on the federal side.

Would you view this as a big sort of structural change in the market that's going to persist over time, or is this going to pass over the next 12 months? Just maybe give us an update on that.

Yes. There's no doubt about it, the whole industry continues to see bookings push to the right. We're no exception. I think we have about CAD1.2 billion still awaiting approval.

Meanwhile, we continue to have a high portion of renewals and extensions and add-ons, which, again are reducing in some degree the cost of sales in there and enabling us to continue to maintain or strengthen our margins. But when I step back on it, it's still a huge market.

So I think that in our case, we're split roughly 50 civilian, 50 defense side. I would say the civilian side is catching up. I'd say the defense side is still pushing to the right.

But as you may know, there's quite a discussion underway in the US about defense spending and whether there will be an increase there. That could well be a trigger to break the back of the situation that we find ourselves in with other companies.

But again, just to reiterate because again, I follow this pretty close. I'm actually on the Federal board. And it's an CAD80 billion business.

Our pipeline alone is about CAD23 billion in that market. So this is an area where obviously we're in for the long haul and continue to look for ways to expand our reach and capability in that big market, so very important market.

There's no doubt about it. It's pulling down bookings. It's putting pressure on the top line, and as I said, given the mix of how the work is being awarded with extensions and the discipline that the team is showing there, we continue to maintain our margins in that sector.

Okay and just one last question. It strikes me that there's a potential big opportunity in the US with respect to commercial. Is the only way you can make a material move in that market via an acquisition or do you have plans here to grow that business out organically?

Well, you're quite right. I mean, if I look at the growth in our commercial business, it's approaching double digits, so it's extremely strong. It's visible really at two levels.

Our existing customers are ramping up investments as the economy returns. Our account teams are staying very close there. We're working to getting share in those accounts.

And then there are more opportunities for us to work with companies who are headquartered in Europe, but have businesses in the US. So Michelin is a good example where we've won business both in France and in the US. So that's a second opportunity -- and other banks, Richard, you can imagine they're global banks.

It will be a longer road doing it organically. So obviously if we did find the right company with the type of commercial business that we're looking for, because we're not interested in the low-end commoditized business.

We believe that would not be accretive to our long-term strategy and frankly, wouldn't add a lot of value to our commercial clients. So we would certainly pull the trigger if we find the right company at the right price.

Great. Thanks Mike.

Thanks Richard.

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

Great, thanks. Mike, I got a two-part question. The bookings, and in Europe, especially the Nordics, does that change your thinking around organic growth in Europe in the second half?

And then your margins is well above comps in Europe. Is there a scenario where you invest some of the margin gains to fund some organic growth, how do you balance the two? Thanks.

Well, again, my sense is that it's not really a tradeoff between margin and growth. I think a lot of people, even some that might work here, believe that's the tradeoff, and I really don't think it is.

I mean there may be certain times, Steven, where you look at it more holistic, but we've always believed there's no such a thing as a loss leader. I think there have been companies in our space before who have believed that they could lose money for a couple years on a ten-year deal and get it back. As it turns out, you don't get it back.

So the margins that we're generating, we do invest that back in the business. In some cases, Nordics is a good example. We are pulling the levers as that we believe do help us in the long haul, so more work going to our global delivery centers.

And of course in the short haul you've got the expense in there of training the people and moving the work and also dealing with any force mismatches you might have. But you know if I look at the broader question, we continue to trend towards a growth situation here.

I think in the first quarter, if you look at the Company, we were down 6% year-over-year. This quarter we're down 3.5%.

The third quarter, we have a bit of an additional pressure in the US in that if you look at the health care business, the third quarter last year. It ramped up again on a revenue standpoint when the remaining states we were working on, we had reached an accommodation with them in terms of us getting paid for the work that we were doing and also more clarity around what was our responsibility versus those states.

So you see a bit of a ramp up in the revenue coming from that health care sector in the US, but it starts to run off a little more at the tail end. But it's really a profile issue across the US, a good part of FY15. Calendar 2015, obviously we started into a better spot.

But when I look at the units, we're seeing some good stabilization in France, the UK, Canada's trending in the right direction, so is the broader groups in the Nordics and those areas. We were down 5.5% year-over-year in the first quarter. Now we're down 3.9%.

So I like the macro trend. The guys are heading in the right direction here. So we clearly haven't given up on our goal. We realize that we need to drive EPS through continuing operational excellence, but also profitably growing the business.

Thanks. It sounds like organic growth is more likely in Q4, fiscal Q4.

Well, we'll see. Yes, I think clearly [three] we're still looking to improve the trend line, but, we're clearly focused on -- and as I say, we continue to drive earnings per share growth of 15%.

So even though we're working through various things we continue to focus on delivering that EPS to our shareholders and in doing so create value. But we do understand that getting a larger contribution from organic revenue is really key to continuing that type of growth on the EPS.

Okay. Great. Thanks Mike.

Thank you, Steven.

You're welcome, Steven.

Thank you. The next question is from Kris Thompson from National Bank Financial. Please go ahead.

Great. Thanks. Mike, on the bookings they look very interesting.

The new business was the highest in five quarters. Your systems integration and consulting was the highest in eight.

Health care was 15% versus 2% last quarter, so I thought you might be a little bit more bullish on your organic revenue outlook in the back half of this year. Is there maybe some contracts that are winding down that we're not thinking about that we should be aware of?

No, I don't know what you read in my tone that I'm not a bullish guy, Kris. I'm probably just a cautious guy.

But no, I think, first off, those are good trend lines. I think again, if you look at the new business, those are the businesses I mentioned that we're bringing on that has the better margin, so that's contributing to our overall plan here.

But, as far as pushing ahead, as I say, I just flagged that kind of rolling impact in 2014 in the US that we're trying to work through here. But no, I would say that, I'm still clearly focused on returning the Company to a profitable, organic growth path.

Okay and in Canada in the MD&A you mentioned some contracts that are running off. Is RioCan one of those? Did you renew that?

And are there any other ones we need to think about? And maybe just, Mike, an update in Canada on your efforts to build the financial services business in Toronto and the energy team out west.

Yes. So I think on the roll offs, as I've mentioned on before, one of the things about Canada -- we've got a very good position in Canada, good people on the ground. When you have as much outsourcing as we do, what happens is that as the individual customers depending on the industries they're in, Kris, they end up either finishing off various transformational projects that they started a couple years ago and/or start to cut back on volumes because of perhaps some of their own pressures in the sector that they operate in.

So we ride that curve up and down. The second thing is in Canada we continue to put more IP into the business, so we've just finished an installation of Collection 360 in a financial institution. And this continues to be an area of opportunity for us in Canada.

I'm not concerned on the long haul here on the margins in Canada. I think, clearly when we look at our situation in Canada that when I look at who's going to invest an increasing amount of dollars in IT, it's clearly the financial institutions.

And I think that you clearly understand the kind of business dynamics that they're operating in, so when we saw that our decision was to set up a second dedicated business unit in Toronto, and we clearly have costs of doing that. We have to split SG&A out.

We made some very strategic investments in some high-end people that have maybe more senior relationships in these banks. And, as a result, we've got a bit of a button hook there to work through.

But, I'm personally involved with a number of these discussions, and I'm convinced we made the right decision here. It will take a little while for it to hit, but I think we're much better positioned and our positioning in the financial institutions continue to strengthen in Toronto.

So that also helps our mix in Canada, because I think we were clearly under represented in that segment in Toronto. The flip side of it as well, we have, the second business unit now is more focused on the other sectors including manufacturing, government, health care, telecom.

So I think, it will take a little time, but I think we certainly are better positioned us to get in a better place in Canada. But it will take a little time.

Okay, that's great Mike. Just one last one from me.

Are you able to disclose your revenues segmented by a fixed price contract versus time and material? I know they used to talk about that a couple years ago.

We could take a look at that. I mean, what happens obviously after you do a transaction like Logica, there's a lot of SI and C business in there, especially in a place, Kris, like France, which is a big SI and C-type market, but I don't have that at the ready. We'll take a look at that and maybe Lorne can get back to you.

Okay. Great. Thanks a lot.

Thank you. The following question is from Paul Treiber from RBC Capital Markets. Please go ahead.

Thanks very much. I just wanted to turn to your M&A strategy to determine as the search for Dan is put out, that comment about doubling the size of the company in every five-to-seven years.

And it has been three years since you announced Logica. Does the time frame for that goal, does it have an influence on your decision-making in regards to doing an acquisition?

Well, first, the five-to-seven doesn't start from the purchase of Logica. It was actually linked to post integration of Logica. So if you look at our Company, we've doubled every four years for 20 years. And we've put that out there because I think it does a number of things, Paul. It tells companies who may want to consolidate with -- sell, that we're interested. Also telegraphs to our customers and potential employees that we're here for the long term, and there's opportunities here and value in working with a partner who we could shake hands with is going to be around for ten years.

And that kind of a calling card is getting more validation today given all the mergers that are happening. So we stretched it out to five-to-seven years because of the size of the magnitude here. We're probably -- we're talking CAD10 billion. But, again, our strategy for planning purposes -- and that's an aspiration. It's not a firm comp-driven goal. Because we don't drive to acquisitions for the sake of an acquisition. We do it because we can create value for our customers and our shareholders.

So, no, it doesn't change how we think about acquisitions, but it does achieve the goals that I said. It does tell players who are looking to strategic alternatives that we're in the market and we are always interested to talk if it's within our strategic goals. Generally for planning purposes as well Paul, what we do, we look at generating half that growth organically and half by acquisition.

So just to give you some relief, we're not necessarily hunting for a CAD10 billion company. We look to do both. And again, the buy-and-build strategies are very linked, because it depends which way you come at it. We need to build a company organically so we have the cash to actually invest in the buy side.

On the other hand, the buy side also enables us to get in a better position to get the organic growth because it builds out a platform, a global platform in this case that allows us now to approach more customers. So they're very linked. I think what the chairman was talking about is an aspiration in line with our 20-year history, but just a little higher than the average of four years given the size of the goal.

Okay. That's a good perspective.

Just focused a little bit in terms of the near term. We've seen a number of transactions in the IT services space.

Now how do you think about valuations in this current environment, and then how does the availability of historically cheap financing. How does that influence what you're willing to pay for an acquisition?

Well, I think on the cheap financing, obviously, when you run an accretion model, it's very helpful when you see the cost of capital. And I think, as you know, we've been proactive in locking down long-term debt with repayment crunches going out I think as late as 2012 (multiple speakers). Yes, 20.

So we've locked in some very good financing terms going ahead, which then allows us over that period of time -- and back to the earlier question in terms of looking at the five- to seven-year period, we've already locked in at very good rates some debt. But it's not the primary driver here. It's one of the number factors. The same as currency is not a primary driver. Folks say well, given the delta between the Canadian and US dollars, is that an inhibitor, it's not really an inhibitor. It's just another factor in terms of the modeling, and the structure of how we would pay for a transaction.

You know, first and foremost we're looking to see if it meets the criteria that it's going to enable us to better serve our customers and put us in a position of profitable grow and reinforce the various verticals we're in. So on the valuations, I don't want to comment on specific transactions as you can appreciate, but clearly some of these valuations -- we've seen it before where they swing.

These are not the type of valuations that we would pay for a services company. In my mind they get closer to an IP-based operation. We're in it for the long haul. We know what we're looking for. But, we're not about to pay two times revenue. The kind of multiples that we've seen in a number of these transactions. We don't believe it's accretive and in the long-term interests of our shareholders.

Okay. And then just one last one from me. In your prepared remarks you mentioned the acquisitions could include smaller niche ones. It does seem that as the companies become larger that the size of acquisitions has definitely increased. So in regards to the smaller ones, does that represent a shift in the strategy? And then should we think about smaller ones as being more, probably, IP or software based?

Well, it could be. No, when you look at our buy and builds as I say, 50% organic, 50% through acquisition, and then on the acquisition side we have two funnels there.

We have the larger funnel, which is associated with more transformational deals and, frankly, those are the ones where we identify and work them through at a corporate level. The second funnel going into that buy strategy is actually generated by the local businesses unit.

So a leader in Germany could say I see something here that fits to adding my capability with an existing customer, entering a new vertical that we follow corporately, but he may not be in, you know, retail or manufacturing in there. So, it comes up that way. So it could be something that actually strengthens us with an existing customer, strengthening us in an existing vertical or allowing a country who is not in one of our six verticals to actually enter into that vertical. And then of course within that there's IP.

So in some cases what we're looking for is we have an existing suite of IP and we're looking at add-on IP. Something that would allow us to actually bring more services to our existing base of customers who have our IP. So to give you just an example, the whole field of analytics and data mining is becoming much more relevant and prevalent with our customers. So a number of cases we have IP: clearly that's very significant, but we in some cases want to add analytical capabilities so that we can mine that data more productively for our clients.

So we would in some cases build that, and in other cases if we use that as an example we would look to acquire it. So there's areas like that which I'm talking about is really in that separate bucket coming from the line operations in the various countries around the world linked to the buy strategy versus what we would generate here at corporate in terms of investment bankers or other large players in our field who would contact us or we'd contact them to talk about what their long-term strategic plan is.

And again, I would reinforce, you see the benefit of us putting out our aspiration of five-to-seven years, it's pretty clear to anybody in our industry where we intend to be in five-to-seven years.

Okay. That's great (inaudible). I'll pass it on.

Thanks Paul.

Thank you. The next question is are from Thanos Moschopoulos from BMO Capital Markets. Please go ahead.

Hi, good morning. Mike, maybe just to clarify a point, would revenues in the US have been flat to up in constant currency adjusting for the health care impact year-over-year?

Yes.

Okay. That's good to hear.

And you mentioned the streams you're seeing on the commercial business in the US. Can you provide us with an update on the state and local side?

Yes, state and local side is actually growing organically as well, which is very encouraging. As you know, in the US the states have to have a balanced budget on the government side, so they continue to use a lot of technology here to enable them to provide more digitization transformation in their businesses, also to control their costs.

And again, I remind you that we have, a lot of IP at the state and local business. A lot of that IP is actually focused on exactly what the states are doing which is modernization.

If I look in my state and local business, our bookings were exceptionally strong in the quarter. In fact, as you know, we announced in the quarter a deal with the State of California pension system. It's the largest education-only pension fund in the world.

And again, that's typical of the type of contracts that we're seeing. So in this case, and again links back to the bookings. That was announced because the customer -- it was a public process, so it was out there, but we did not take that booking in the quarter. So that's a booking that will show up in the third quarter here. So good business.

We're well positioned, and this is an area where when I look at the commercial growing, the state and local growing, I'm left with the industry-wide challenges in the federal business.

But, again, there, I think it's really now starting to isolate a little bit more on the defense side than the civilian side. So I think we're headed in the right direction.

Great, and then finally on capital allocation. It seems that in recent quarters you've prioritized debt repayment over buybacks. Given your current capital structure and as you run your accretion models, how should we think about those two relative to each other going forward?

That's a good question. I think, as you know, we had the CAD1 billion term loan that was due on May 16. We've paid off CAD750 million.

We've got CAD215 million remaining. I think when I look at the accretion model, the repurchase of shares looks much more interesting, given where I am now on the debt. So I think our intent would be to in the back half of the year be more active on the share repurchase.

Great. Thanks Mike. I'll pass the line.

You're welcome.

Thank you. The next question is from Jason Kupferberg from Jefferies. Please go ahead.

Hell. This is Ahmed for Jason. Just wanted to quickly speak about your cash flow up to this point in the year. The free cash flow of course has been great, but one other thing that I noted is your DSOs have come down to around 41 now, and I believe at the end of last year they were around 47.

I just wanted to see, how you are thinking about cash flow for the rest of the year? Are you expecting the DSOs to move back to your target around 45, which could impact cash flows in general?

And also, when you're talking about that, just CapEx in this particular quarter was low, so what is your expectation going forward? If you could comment on that. Thank you.

I'll turn it over to Francois, but I don't want to miss an opportunity to actually call out the hard work that the teams have done on DSO, especially some of the groups in Europe that came through the integration. They've worked exceedingly hard to get that DSO down.

Some of them have dropped 20 days from their high spots, very focused on it. When we actually -- you may recall when we acquired Logica, most of their cash was coming in one quarter. So, over the period of time I think we've been working closely as a team to highlight the importance of DSO. And so I'm very pleased obviously with 41 DSO, and maybe Francois you can talk about the capital.

And just to finish on DSO, 41 days is fantastic. And always committed to the bill out of 45 days, can be naturally lumped in depending on new contract coming in and milestone billing and milestone payment, but we're pretty convinced that we're capable in the long run to still be better than the 45 days target that we have.

As for the capital side, now this quarter we were -- we did a little bit more capital lease that we did in the past, so that's why we were -- they are presented as non-cash in the cash flow statement. And so that's why you saw some reduction in the cash flow statement. But if you're looking at the asset and the balance sheet, you'll see that we had some increases on the capital side, and it's really because we used a little bit more off capital lease at this quarter.

All right. Perfect, and just quickly on -- talking on margins.

I mean, of course, you know pruning off a lot of contracts is visibly helping margins. But talk a little bit about are you also actually moving more of your work force in lower cost regions such as India, and if that's so, is there a target that you have in mind of percent of work force to be there?

Well, we're clearly using all the levers that we have to increase our margins, not only in absolute terms, but over time we hope to have them on more consistent performance. And that's why I'm pleased that net margins for the second quarter have grown over 9. I think we're back to industry-leading net margins here.

I don't set targets for a couple of reasons on that. Ultimately it's the customer who decides what the mix of work ought to be.

And again, I'm trying to drive the right behavior here and protect our operating model, which is a proximity-based model to make sure that we have a relationship that goes with the work that we're doing. That's why I think, if you end up having very low end work with lots of people in India doing it, but there's no link to the business side from the top down in terms of the business analyst, systems analysts, the architects, this is not where we want to be.

We believe that one of the reasons we produce the kind of results we have is because we're the local team with global capabilities. We're not the global team with no local capabilities.

So what we normally do is we look at things that we're doing internally, could be on SG&A. It could be on IP where we control where that work goes, and we start moving it to lower cost centers, which obviously reduces the amount of cash that we have to disburse.

It does help margins, and it does help our competitive position as we go to the market and price that IP. So that's important. And then in the various bids, of course we do introduce not only global delivery but near shore delivery.

With the currency swings, we have a lot of local centers that are in low cost areas of North America and Europe that are very price competitive and the Indian currency, as you know, is rising. And with that, if you add on the wage inflation, I think our balanced, global model is extremely competitive and does give a lot of customers a choice at where this work goes. So that's kind of how we look at it.

Perfect. Thank you.

Thank you. Our next question is from Rob Peters from Credit Suisse. Please go ahead.

Hi. Thanks very much for taking my question. Mike, you touched on the trends you're seeing in the US, specifically on the fact that in the third quarter you are going to have the ramp up of the health care exchanges or in 2014 to comp against.

I was just wondering, when you look to European trends, how do you see the organic growth going in the back half of the year in Europe? Is it going to be more of a Q4 thing as well, or do you think that will improve more in the third quarter?

There is two things there, Rob. We want to get back to organic growth there and we also want to have some consistency. So what we see in Europe now, we're seeing various businesses turn the corner in a quarter and then have something in the next quarter that pushes them back under, and so it takes some quarters to get the balance there.

And one of the reasons it can swing like that is the mix of the systems integration consulting business, where in North America we have much more recurring revenue, so we don't have the same exposure to a swing. So if you take Canada where we have maybe 60% or in the US 50% of recurring revenue, if a project gets stopped of some magnitude, it doesn't impact us as much as it would in a country like France or Netherlands where the amount of recurring revenue is very, very low.

And in a lot of cases, the backlog in some of these countries when we acquired them were under 60 days, 90 days, which was not unlike what we found, by the way, in 2004 with AMS. So until we continue to change the mix there, you will get more swings in the growth profile of these various entities.

But what I like is the UK has crossed that line. They've had a setback this quarter year-over-year. France though is also moving in the right direction. So some of our big geographies over there are going in the right area.

The other thing, which I can just give you an idea, because we -- focusing on getting our IP more into Europe and I just had a little update on that. And our backlog continues to grow on the IP, because we started now to qualify customers in the various areas. So we've got a pipeline, sorry a pipeline, not a backlog. A pipeline of about CAD10.5 billion in IP, and about 35% to 40% of that is Europe, and in Portugal we have won our first Collection 360 deal with a financial institution.

So we continue to push on those levers that once they're in there, the mix changes. The cash flow is more consistent. The earnings are more consistent, and we're much better shape in terms of avoiding these swings.

But this is a journey, but I like the path we're on. I think the folks have embraced the levers that we talk about, the global delivery model, the IP mix, the outsourcing approach, the recurring revenue.

And you see that in some of the DSOs because I could tell you on the IP side, the DSOs are a lot lower than 41 days. So that makes it a great business to be in.

Perfect. Thank you very much. Maybe if I can just follow up to that.

You mentioned on the UK, I think you highlighted that there was an election freeze impacting bookings in the quarter. Just wondering when that wraps up, I believe it should conclude around May.

Would you expect to see some of those pent-up bookings then to go through? Or how should we look at that over the remainder of the year?

Yes, Rob, thanks for that. Actually what happens over there, which is a very civilized way to look at the world is, the government there continues to work with suppliers like ours, but within a certain period before the election, there's a gentleman's agreement that these things will be put on hold and not signed until the new government is in.

And the reason for that is of course they don't want to commit the new government to things that were committed by the previous government. So what we have there is, you end up with some bookings that are clocked in that area, and then you run a two-sided risk.

You could end up where if current government is reelected, then the tap comes on and just continues to flow. I would suspect as we've seen in other countries where there's a change in government, sometimes there's a pause while they sort out what are their priorities versus the previous regime. So, I think in the UK case, we would expect our booking number to pick back up when we see what the outcome of the election is.

(Multiple speakers)

We have a very good pipeline in the UK. I think the other thing that's happening in the UK is that a lot of those deals that were signed with the big jurisdictions ten years ago by VT or Capita on the government side are actually coming up for renewal. And obviously at that time, we were much smaller and couldn't really play at that level.

But we're clearly in a different spot now and some of those are very significant and transformational deals. So I like the pipeline there. We have good visibility on some great opportunities.

Great. Thank you very much.

Thanks Robert.

The next question is from Michael Urlocker from GMP Securities. Please go ahead.

Thank you. Michael, you mentioned that I think you said you've done or in process of doing survey work with hundreds of customers.

I wonder if -- perhaps it's foolish to ask for generalities, but the way I look at your business, especially tied to the economic cycle, often when times are tough companies are looking for companies like CGI to help save money. And then when times are good customers are looking to CGI to help grow and expand their business. Maybe if you could describe what you're seeing on those parameters in the commercial markets in Europe versus the US, or any other highlights you'd observe from what the customers are telling you.

Yes, Michael that's a good question, a good observation. In fact, you really have a number of situations there. You have companies who, frankly, need to increase their investment because they're facing heavy competition from new entrants, technology companies.

Silicon Valley, as you know are entering a lot of traditional businesses, which is going to cause or is causing a discontinuity in the thinking of some of the incumbents and of course information technology is what Silicon Valley uses here as the sharp end of their spear to grow their business. So we're clearly seeing customers who are much more interested in how do we allocate our IT investment to the right things?

And of course our value proposition is we can significantly reduce your current operating expenses and therefore free up investments that otherwise would have been allocated to just operating the existing technology infrastructure. You can now reallocate that to new initiatives that will help you meet your goals.

And of course we can do that through a number of ways: one clearly through our classic end-to-end managed services business, including leveraging labor arbitrage, also a lot of work we're doing in improving productivity in the various functions. But as well, given that we're in the IP suite as well, what we can also offer them is a shared services model to say: why don't you just take your trade business and put it on our global platform and turn a fixed cost into a variable cost?

So the more letters of credit that you issue, your expense rises and the inverse is also true. So we have a lot of levers that we can help companies work through that. That's kind of how we see it.

We don't have the results yet, but again, normally the outcome of what we do in the strategic plan is to identify the top 10 areas of priority on the technology side and then the top 10 on the business side. And without seeing it, I can imagine cyber security is on there.

I think more value for investment is also there, and probably flexibility of their IT infrastructure. The ability to move quicker to react to markets. So we'll have those results as I say and we'll make those known.

And I think you'll find that they are clearly drivers for information technology. I think the last time I looked last year of the 10 business priorities, at least eight of them were linked directly to information technology. So most of the things that folks would want to do in the business side, they now need information technology.

Thank you. I appreciate that and I wonder, because my sense was that cyber security would be a high priority. Would you say that business of yours is getting sufficient traction today or is it still in the early stages?

You know, we're growing very rapidly there, double digit. The bigger issue there, Michael, is to get the proper skills. So you're looking for somebody who doesn't not only have a good understanding of technology, but you're also want to make sure they have the appropriate security clearances and that they really understand the customers' business, as well as our side of it.

And again, if you look at cyber, the human element is still probably the biggest exposure. There's a lot of work to be done internally in a lot of businesses to see what can be done here. How can technology help address that?

But what other stuff do you have to do from an insider's threat perspective? What do those programs look like? And I think this is an area that we're focusing on, but we continue to add to our portfolio there in terms of qualified people.

Excellent. Thank you.

Okay.

I appreciate that.

Thank you. Next question is from James Schneider from Goldman Sachs. Please go ahead.

Hi, this is (unidentified participant) for James. Mike, just a question on M&A.

You've already talked about it, but just in terms of thinking about interest in US assets, what kind of assets are you looking at? Is it more for consolidation or still focus on IP?

Also if you could share some of the key financial thresholds you would use to evaluate a potential deal. Is it going to be based on IRR, earnings accretion or something else?

Well, we happen to have our head of M&A here close. So, Claude, why don't you kind of share how we -- kind of modeling we do and valuation process that we use on an M&A transaction?

Thank you Michael. As Mike mentioned, we are looking on a multi-criteria basis. Essentially, we want to have something that is accretive to our current operation.

We want to consolidate some of our key verticals. As you know, in the financial institutions in the [elgaramansfacturing] the R&O sector, and basically we're looking for something that will improve our operation, will expand our operation. But at the same time it will be done in such a way that it allow us to continue improving our profitability and return to our shareholders.

Some of the indicators I think he was asking that we use on valuations, Claude.

Oh, the typical stuff that you financial analysts are used to seeing. Obviously, the IRR are a key to analysis, but these days cost of capital is not always different than it was 10 years ago, so it tends to be relatively easy to justify an acquisition only on financial terms.

But we're looking at really key operating questions and how we can turn this operation around and apply our magical recipe to these operation. So it's really a multi-factor basis. That's how we look at it.

Thanks Claude.

Oliver, we're going to have time for one last question.

Excellent, thank you. The next question is from Ralph Garcea from Cantor Fitzgerald. Please go ahead.

Thank you for taking my questions. Just two quick ones here. Can you comment on utilization rates by geography, and whether you need -- the need to hire in some regions where the utilization rates have gone to the max levels?

I think again it does track, as you can imagine Ralph, pretty close to the growth projection. So US obviously is picking up.

So I think if you see there is hiring reqs out there. And again, if I look at Europe. France for example, will bring on hundreds of university grads in a cycle over there that also drives a lot of demand on that SI and C business.

So I think you look at our larger geographies. You'll see it's probably France, the UK, United States and India we continue to hire.

And also, we're looking a lot harder at our other offshore sites like Philippines on the BPS IT side. Philippines is a very competitive area in terms of offering customers great value here, especially on the BPS side. So we'd be hiring in all of those areas.

In the other countries where we continue to hire, obviously back to the comment I made on some of those leading edge services like cyber. So, again, you'll see hiring, frankly, probably across all the geographies, but in some it's more driven in terms of filling or adding more capability to where the customer demand is very hot. In other areas it's hiring to fill out various projects that have a beginning and an end.

And just on the IP, I mean, you've got some great IP obviously, across supply chain and procurement, the trade and collections for finance and then I mean you're billing stuff in the smart grid. I mean where do you see the biggest leverage across your five verticals on the IP? And are these sort of CAD100 million plus opportunities as you go in and harvest the customer base and try to sell this?

Yes, so I think two quick answers. Clearly the financial vertical continues to be a very interesting vertical when it comes to the IP for the reasons I said earlier.

You know, looking to turn fixed costs into variable costs, much more open now to be on a quasi-shared services in terms of not having to bear the capital costs or the operating costs alone in terms of getting access to the information that they need. So I would say that is the main area of opportunity.

The other areas, again, we have segregated our IP. We know which ones will travel globally and we're stepping it up. As I say, the funnel there now is over CAD10 billion.

The duration also is very interesting, Ralph, because in some of these deals, they're -- very seldom, they're less than 10 years. And in a lot of cases depending on the area within the company, they can go out to 15 years and beyond. Because in certain areas, when the customer looks at the last time they changed out a payment system or a collection platform or a trade platform, it has been 15 years.

So we're able to have that discussion and also bring more value to the customer when they go along, and of course more value for us in terms of backlog, recurring revenue and certainty of cash. So good discussions in that area. I like the discussions.

I mean I don't have a lot of people saying I'd like to try and do something in a two-year period or three-year contract. We're talking right in our sweet spot.

Thank you very much.

Alright. Thank you, Ralph, and thank you everyone for joining us and we'll see you back here late July for our Q3 results. And again, follow up with me directly 514-841-3355.

Thank you. This conference has now ended. Please disconnect your lines at this time, and thank you for your participation.