Alithya Group Inc. (NASDAQ:ALYA) Q2 2024 Earnings Call Transcript

Alithya Group Inc. (NASDAQ:ALYA) Q2 2024 Earnings Call Transcript November 14, 2023

Paul Raymond: Thank you, Benjamin. Good morning, everyone, and thank you for joining us for the review of our second quarter fiscal 2024 financial results. Despite our lower revenues this past quarter, we are particularly optimistic in respect to progress in key areas that I would like to discuss. I would first like to highlight three notable areas of achievement from our second quarter, and then we can dig deeper into how they impact our results and influence our confidence for the future. First off, we are pleased with our continued progress in terms of gross margin as a percentage of revenues. We continued our favorable progression both sequentially and year-over-year, largely due to greater project efficiencies, improved utilization, a reduction of some contractors and continued focus on growing our higher-margin segments.

Second, during a historically slow summer quarter and despite lower year-over-year revenues, we continue to make progress in reducing our SG&A spending. Along with other ongoing initiatives, that trajectory better positions us to increase our profitability faster once the world returns to a healthier economic context. Thirdly, we continue to feed our strong pipeline of bookings for the future, both in terms of newly proposed projects with existing clients and through the addition of 36 new clients in the quarter, which is a good achievement for a company our size. I would note that this latest accomplishment reflects Alithya’s growing reputation for not only offering robust solutions for leading technology partners, but also for our ability to provide professionals with the end-to-end expertise required to ensure successful outcomes for our clients.

No now let’s dig a little deeper into those highlights, including the factors driving them. Gross margins are a source of pride in our Q2 results, both as a percentage of revenues and in terms of making progress in our offering of higher-margin products and services to our clients. Despite persistent industry factors beyond our control that our CFO, Claude will further explain later, we are back above our minimum gross margin threshold of 30%, again, in a declining top line quarter. This is the result of ongoing initiatives in several areas. One of those areas is our reduction of subcontractors and Q2 saw our ratio decreased by 5 percentage points, while simultaneously maintained our utilization rates. Additionally, we’re able to maintain sequential stability in terms of the number of professionals we employ in our higher margins, smart shoring jurisdictions, and we remain focused on increasing our size and reach in that realm.

In terms of SG&A spending, despite the inflationary pressure that we have been feeling for a couple of years now, we were able to exercise strong control over our spending and to flatten our expenses. In fact, sequentially, we experienced a decrease in spending of $2.6 million and a year-over-year reduction of 1.6%. At times, that process requires some difficult decision as part of a push for greater efficiency, and you will see this in the restructuring cost taken in Q2. As a result, considering the slower conditions that we’re seeing in certain areas of the information technology services sector, we are doing well, and we have taken great strides to operate with greater efficiency as things start to improve. Those cost reduction and efficiency efforts are not completed as we will discuss further in the presentation.

Our Q2 revenue amounted to $118.5 million, down year-over-year primarily due to a cyclical decrease in IT spending in the Canadian financial services sector. Additionally, cautious spending decisions by some of our clients also had adverse effects on our U.S. training and digital adoption services. However, to counter some of those headwinds, we continue to show up our offering of AI-enabled solutions targeting greater efficiency. Another client-centric trend is causing a slower start to some projects as well. Investments that typically require a CIO sign-off are now being circulate more broadly within organizations with increased scrutiny to ensure sustainable ROI. In response, Alithya is diligently working to present clients with the facts that they need to order to move forward.

However, Q2 saw some projects start delays in line with that trend. Additionally, as Alithya’s reputation grows, we continue to close on bigger contracts, particularly in our leading U.S. verticals of health care and manufacturing. And as we sign larger deals more frequently, they often require final approvals at the board level, which takes more time. In the U.S., our Microsoft business delivered growth on a year-over-year basis, while our Oracle business also experienced a strong quarter. Both lines of business generate higher margins, and we are excited about the future given the forecast for growth in some of the key sectors that we service and especially the U.S. health care sector. In Canada, the financial services market remains tight but steady.

Despite an important reduction in volume experienced from a few of our big financial services sector clients, our market share are not decreasing. And the projects and spending remain on track for the long term. We also continue to make progress in the public sector, which accounts for a significant portion of our business in Canada. That progress is largely due to our ability to adapt to emerging trends in that segment. For instance, government agencies are increasingly breaking up their large-scale projects into smaller segments, dividing phases between multiple suppliers in order to manage risk. Looking ahead, we’re inspired by strong bookings of $110 million and a book-to-bill ratio of 1.08 when excluding the impacts of the two long-term contracts signed in April 2021.

Additionally, our cross-selling strategy continues to bear fruit, and we are looking forward to engaging in new projects with existing clients as they explore the benefits of Alithya’s broader offering of products and services. Simultaneously, we have 36 new clients to explore those same possibilities, including a growing portfolio of proprietary products outside of our traditional Microsoft and Oracle offerings. Once again thank you for joining us this morning. And I will now turn the floor over to Claude Thibault, our Chief Financial Officer. Claude?

Claude Thibault: Hey Mr. Paul, good morning. As Paul mentioned, revenues for the quarter amounted to $118.5 million, a decrease of 8.1% compared to revenues of $128.9 million for the second quarter of last year. Of note, Alithya had one less billable day in Q2 been in the same quarter last year, which in itself accounts for a reduction of just under 2%. In Canada, revenues decreased by 9.5% to $68 million due mainly to a reduction in IT investments in the banking services sector. However, we are seeing good progress and revenue increases in other areas of our Canadian business. Looking at our U.S. business, revenues decreased by 6% to $45.7 million. This decrease was primarily due to weaker demand for our digital skilling and change enablement services and some slower project starts, as mentioned earlier by Paul.

Decreased U.S. revenues were partially offset by a favorable U.S. dollar exchange rate impact of $1.3 million between Q2 of this year and last year. As for our international operations, they also reported a softer revenue quarter, decreasing 8.3%, mainly due to reduced activities in Australia, but partially offset by a favorable foreign exchange rate impact of $500,000 year-over-year. Now let’s look at our Q2 gross margin dollars, which overall decreased by $2 million or 8% to $34.8 million. However, as a percentage of revenues, our second quarter consolidated gross margin increased to 29.4%, up from 29.3% for the same period last year. On a sequential basis, gross margin as a percentage of revenues also increased despite a sequential decrease in revenues that naturally puts pressure on gross margin performance.

The increase in gross margin percentage is derived from better individual project and general utilization management, increased revenues from higher-margin offerings and finally, fewer subcontractors. Let me take a moment to further comment on our Q2 gross margin percentage. In the second quarter, Alithya recorded a $1.1 million provision adjustment on tax credits receivable from previous periods, reflecting certain changes in estimates and assumptions with a notable portion relating to the activities of our previously acquired business. While this provision impacts our Q2 numbers, it is not related to the second quarter performance per se. And as such, if we exclude it, gross margin as a percentage of revenues would have increased by 1% to 30.3% compared to the same quarter last year.

It is not only a notable increase in itself, but it also brings us back above our minimum threshold of 30%. And this during the quarter with decline in revenues. Again, it is very challenging to be increasing gross margin performance during a soft revenue quarter, including as it relates to utilization rates. And as such, all the factors and initiatives, leading to this overall improvement in Q2 bode very well for when our revenues resume a more typical organic growth matter. Now let’s look at SG&A, which also represent a notable second quarter improvement. Total gross SG&A expenses in the second quarter totaled $29.9 million a decrease of $500,000 or 1.6% compared to $30.4 million in the same quarter last year and despite a negative U.S. currency impact of $0.4 billion.

Therefore, this represents our year-over-year quarterly reduction of almost $1 million. This decrease comes mainly from remuneration and recruiting expenses, partially offset by increased business development and travel expenses and higher internal improvement project costs. On a sequential basis, SG&A also decreased by $2.6 million from $32.5 million in the first quarter. This $2.6 million reduction reflects a nonrecurring impairment charge of $1.4 million in Q1. But even when excluding that amount, there is a sequential quarterly reduction of $1.2 million, coming mainly from remuneration elements. We are pleased to see our efforts on that front starting to show actual net reductions in dollars. We look to maintaining the same continued discipline on SG&A spend going forward, and we are actually working towards achieving additional savings in the current context.

Overall, as a result of decreased revenues in gross margin dollars, including the $1.1 million provision I mentioned, partially offset by decreased SG&A expenses, our second quarter adjusted EBITDA amounted to $6.5 million, representing a decrease of $2.9 million compared to an adjusted EBITDA of $9.4 million during the same quarter last year. Now looking at our adjusted net loss. Our Q2 adjusted net loss amounted to $0.2 million, representing a reduction of $3.6 million from a positive $3.4 million of adjusted net earnings for the same period last year. This marginally negative number is a result of the reduction in adjusted EBITDA and the notional effect of income taxes relating to adjustments as can be seen on Page 22 of our Q2 MD&A without which adjusted net earnings would be positive.

Of note, as adjusted EBITDA is lower and as the amounts deducted to calculate the adjusted net earnings do not materially change from quarter-to-quarter, it is to be expected that the adjusted net earnings amount decreases proportionately more than the adjusted EBITDA amount. This is also true in the opposite direction and any future improvement in adjusted EBITDA will translate into a proportionately higher adjusted net earnings amount, everything else being equal. Moreover, despite our reduced adjusted EBITDA and adjusted net earnings, it should be noted that Alithya is still generating positive operational cash flow during the quarter even after considering CapEx, lease liabilities payments and interest and even after considering our nonrecurring business acquisition, integration and reorganization dispersed.

Despite our decline in revenues and gross margin dollars, we see well on Page 7, our rebounding gross margin percentage, which again would be even higher than 29% when ignoring the previous period impacts. As for our long-term adjusted EBITDA trend, because of our disciplined SG&A performance and the scale which we have now reached, the decrease in adjusted EBITDA is relatively smaller. Indeed, while our gross margin dollars are $6 million lower than our high watermark in Q4 of last year, our adjusted EBITDA is only $4 million lower. The difference indeed coming from overall SG&A reductions. Again, this points to potentially enhance EBITDA performance going forward just as soon as revenues return to a sequential growth pattern. Now turning to liquidity and financial position on Page 9.

Net cash used in operating activities were $17.3 million, representing an increase of $16.7 million. This amount resulted primarily from $20.9 million and unfavorable changes in noncash working capital items. Those changes in noncash working capital items consisted primarily of a $12.2 million decrease in accounts payable and accrued liabilities, a $6.2 million increase in accounts receivable and a $3.1 million increase in unbilled revenues. The accounts payable and accrued liabilities reduction comes from both a reduced number of employees and subcontractors and a reduced number of accrued days at the end of the quarter. The increase in accounts receivable mainly comes from delays on certain large customer balances, most of which do not pose any credit risk and have notably receded as of today.

Finally, the increase in unbilled revenue mainly comes from our project type mix as well as a few specific billing particularities at the end of the second quarter. As such, while this $20.9 million working capital usage is a high amount, it is largely a timing and mix issue. And among others, we already know that the reduction in number of days of accrued salaries will be reversing at the end of Q3. Now back to you, Paul.

Paul Raymond: Thank you, Claude. So before we go to questions, let’s recap on the three notable areas of achievement of our second quarter. So one, it’s very challenging to be increasing gross margin performance during a soft revenue quarter and as such, all the factors and initiatives leading to this overall improvement bode well for when our revenues will resume a more typical organic growth pattern. Two, we continue to make progress in reducing our SG&A spending, and we look to continue to improve this measure going forward. And finally, our continued strong bookings and our growing sales funnels are also very encouraging. So we will now take questions. Joel?

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Q&A Session

Operator: [Operator Instruction] Your first question comes from Jerome Dubreuil with Desjardins.

Jerome Desjardins: First one is on the utilization rate and margins. Is it fair to say that — in the past, you would always keep a relatively high level of headcount to be ready for a bounce back and now you might be a bit more nimble on that front and maybe more adjusting to the situation you’re seeing? Is it going to say that then is what major changes were done to TSX?

Paul Raymond: In the services industry and our model, most of our costs are tied to headcount, so we have the ability to adjust up or down based on demand and the market conditions. During COVID, as you all know, we had incredible growth and to be able to keep up with that growth, we couldn’t hire fast enough. So we actually use a lot of subcontractors where we could find people and if we grew extremely fast. Of course, when things slow down or when clients start reducing less strategic stuff, the first place that we cut is the subcontractor. So we’ve reduced our subcontractors significantly in the quarter. Those usually have a much lower margin which is why we like having full-time employees that we can invest in. And the other one is utilization.

Of course, we take a much closer look at that and in tighter markets when the work is delayed or people are working on less projects. We want to make sure that the utilization is at maximum. Instead of keeping a very large pool of available people, you have more flexibility in terms of how you use those. So yes, utilization and margins are two things that we can tweak in our type of business.

Jerome Desjardins: Second question for me. maybe not easy to answer because maybe budgeting period isn’t fully over with your clients, but what would you consider as a normal state of spending for your financial services vertical? Is it maybe a year ago when there was higher spending or is now the normal spending? Are we a bit of a terra-pocket because of what was done in the past [indiscernible] Covid-19?

Paul Raymond: So spending increased significantly during Covid, everywhere, every industry, as you can imagine and as we’ve seen, and put a lot of pressure on salaries and hiring people moving all over the place and turnover was high everywhere and everybody was scrambling for people. I think the banking industry was the first of our industries to be hit by the current situation. And It’s a simple math. It’s the rapid change in interest rates have pushed a lot of banks to cut costs, and we see this everywhere, not just in Canada, but everywhere. You’re seeing the layoffs that the banks are doing, which we haven’t seen in a few years, significant layoffs. While they’re trying to adjust to the position they’re in of having mortgages with lower rates than what they’re paying for.

So as that cycle fixes itself within the next year or so, we think it’s going to level out and based on the conversations we’re having with our clients in the financial services sector, they all expect to be resuming higher spending in about a year. So they’re really going with the bare bones right now. If it’s strategic, if it’s important, if it cut costs and everything else has been put on hold. So we’ve seen some significant and a tactical reductions in our financial services clients in Canada, where we have more exposure to that. The other thing, though, that we’re seeing in talking to them is they all want to do more with AI in the coming year. We do have a lot of conversations with these clients about getting ready for projects in the new calendar year to do with data and AI and automation.

So that’s very encouraging as that’s where we’re investing the most right now in terms of new offerings.

Operator: Your next question comes from Vincent Colicchio with Barrington Research.

Vincent Colicchio: Follow up on the last comment. Are you currently working with a number of AI pilots with clients?

Paul Raymond: We actually have projects, not just pilots, but we actually have pilots — if you’ll remember we did an acquisition just over a year ago about Data & Solutions, which is all 100% of what data did was data and AI-driven solutions. So we actually have IT that we rolled out at some of our clients to automate some of their back-office processes, modernizing legacy systems. So that part of the business is doing extremely well. And we have other areas, we’re also doing pilots, not in terms of piloting what we do, but sometimes it’s the first time a client actually does a significant AI initiative. And of course, the biggest challenge there is the data. So we actually have data services where we can help the clients clean up the data or figure out what it is that they want to do before they launch into these automation projects. So yes, we’re very active in that area.

Vincent Colicchio: And are you seeing increased demand for offshore services? And if so, are you looking to accelerate that side of your business?

Paul Raymond: Yes. That’s an area, Vincent, good catch where I don’t feel we’re moving fast enough on that one. And we are making changes there to accelerate that. It’s a big upside for us. You folks know the numbers and you know the difference in cost. We have the business. We have the large contracts. It’s our job to move faster on that. And as you see pressure in the industry today where companies trying to get more competitive, to me, that’s an easy area where we can improve our margins and become more competitive at the same time. So yes, that’s definitely an area you’re going to be hearing more about in the coming quarters.

Vincent Colicchio: One last question. Where is your subcontractor ratio at today? And where do you expect to be by year-end?

Paul Raymond: We haven’t disclosed the number. It’s at the lowest that it’s been in two years and over two years. Vincent, our plan is to keep reducing it.

Operator: Your next question comes from Gavin Fairweather with Cormac Securities.

Gavin Fairweather: This is Graham Smith on for Gavin Fairweather. So just my first question is back on the financials. I was just hoping if you guys can maybe quantify the impact on this quarter? And then you talked about some of the Canadian revenue streams verticals are picking up as well, it’s great if you could call out which ones maybe those are? That would be great.

Paul Raymond: Mostly banking, Graham. We have a handful of clients that represent most of the decrease in Canada.

Gavin Fairweather: And just on the ones that you said maybe are picking up as well.

Paul Raymond: Well, it’s interesting because when we exclude those large clients, we’re seeing some really positive stuff throughout the business. The Microsoft business is growing. The Oracle business is growing. We have 36 new clients. The size of the projects that we’re bidding on keep increasing because of the reputation that we’re building and the scale of the Company now, and of course, the larger the projects, the longer it takes to close them because of the approval levels within the organizations, but we have $20 million projects that we’re bidding on now that two years ago, we weren’t even invited to those projects. So there’s a lot of positive stuff that we’re seeing. So that’s why we’re confident for the future and why it’s so important for us to keep focusing on getting our costs down and our margins improve because as the revenue starts picking up, it’s going to have a greater impact in the bottom line. Our focus is really on that right now.