CGI Inc. (NYSE:GIB) Q2 2024 Earnings Call Transcript

CGI Inc. (NYSE:GIB) Q2 2024 Earnings Call Transcript May 1, 2024

CGI Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen. Welcome to CGI’s Second Quarter Fiscal 2024 Conference Call. I would now like to turn the meeting over to Mr. Kevin Linder SVP of Investor Relations. Please go ahead Mr. Linder.

Kevin Linder: Thank you, Joelle and good morning. With me to discuss CGI’s second quarter fiscal 2024 results are George Schindler, our President and CEO; and Steve Perron, Executive Vice President and CFO. This call is being broadcast on cgi.com and recorded live at 9:00 a.m. Eastern Time on Wednesday May 1 2024. Supplemental slides, as well as the press release we issued earlier this morning are available for download along with our Q2 MD&A, financial statements and accompanying notes, all of which have been filed with both SEDAR plus 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.

The complete Safe Harbor statement is available in both our MD&A and press release as well as on cgi.com. We recommend our investors read it in its entirety. We are reporting our financial results in accordance with International Financial Reporting Standards or IFRS. As always, 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 dollar figures expressed on this call are Canadian, unless otherwise noted. I’ll now turn it over to Steve to review our Q2 financials and then George will comment on our business and market outlook. Steve?

Steve Perron: Thank you, Kevin, and good morning, everyone. I’m pleased to share with you the results of our second quarter of fiscal 2024. In Q2, we delivered CAD3.7 billion of revenue, up 0.7% year-over-year or stable when excluding the impact of foreign exchange. The strongest CGI segments were UK and Australia at 5.1% constant currency growth. Asia Pacific at 5%, Northwest and Central East Europe with 4.2% and US commercial and state government at 4.1%. From an industry perspective, we had the highest growth in government with 5.7% constant currency growth while we continue to experience softness in industries more sensitive to interest rates, particularly in the banking subsectors. In addition, the majority of our geographies were negatively impacted by one less billable day in the quarter.

IP as a percentage of total revenue was 22% in the quarter. Our IP continues to resonate with clients with vast majority contracted as longer-term recurring engagements with over 60% delivered as Software as a Service. Our overall bookings in the quarter were CAD3.8 billion for a book-to-bill ratio of 100% and 113% on a trailing 12-month basis. Booking ratios for the quarter were led by Finland, Poland and Baltics at 127%, Western and Southern Europe at 115% and UK and Australia at 109%. Global backlog reached CAD 26.8 billion or 1.9 times revenue helping to support our overall business resilience. Turning to profitability. We continue to manage with discipline, despite the current macro environment, delivering solid year-over-year improvements.

Earnings before income taxes were CAD577 million for a margin of 15.4%, up 20 basis points year-over-year. Adjusted EBIT in the quarter was CAD628 million, up $28 million year-over-year. This represents a margin of 16.8%, up 60 basis points year-over-year. Mainly as a result of a larger proportion of IP-based revenues and benefits being realized from our previously announced cost optimization program. This program, which was primarily focused on SG&A has now concluded as planned. We delivered strong margin geographically as follows: Asia Pacific at 31%, North America at 17% and Europe at 14%. Our effective tax rate in the quarter was 26.1% and we expect our tax rate for future quarters to be in the range of 25% to 26.5%. Net earnings were $427 million for a margin of 11.4%, up 10 basis points year-over-year.

Diluted EPS was $1.83 representing an increase of 4% year-over-year when compared to $1.76 in Q2 last year. When excluding specific items, net earnings improved to $459 million, up $24 million when compared to Q2 last year or a margin of 12.3% up 60 basis points. Specific items for the quarter were mainly expenses associated with the cost optimization program. On the same basis, diluted EPS was $1.97 an accretion of 8.2% when compared to Q2 last year. In the quarter, cash provided by operating activities was $502 million, up 7% year-over-year representing 13.4% of total revenue. On a trailing 12-month basis, cash provided by operating activities was $2.1 billion also up 7% year-over-year representing 14.6% of total revenue. DSO was 40 days in the quarter, five days better than our target, mainly due to quality delivery and our mix of business.

As a reminder, Q2 generally produces the lowest DSO each year due to a higher volume of IP maintenance payments from clients. In Q2, we used our cash to invest $103 million into our business including NII and invest $260 million to buy back our stock. In the quarter, we continued to deliver a strong return on invested capital at 15.9%, up 30 basis points year-over-year demonstrating our proficiency and discipline on deployment of capital. Looking ahead, with $2.8 billion of cash readily available and access to more if needed, our capital allocation priorities are: First investing in our business; second pursuing and closing accretive acquisitions by leveraging CGI’s strong balance sheet evidenced by a leverage ratio of 1.1x and a net debt to capitalization ratio of 16.4%.

Finally, as appropriate, cash will be used to repurchase our stock and/or paying down our debt. Now, I will turn the call over to George to further discuss the insights on the quarter and outlook for our business and markets. George?

George Schindler: Thank you, Steve, and good morning, everyone. In the second quarter, our team again embodied CGI’s discipline and agility by prioritizing actions for delivering shareholder value and partnering with clients to position CGI for profitable growth opportunities. With continued strong profitability and cash generation, our financial strength reflects CGI’s resilience and capacity to invest in our Build and Buy growth strategy. Our team’s disciplined management practices contributed to our strong balance sheet even as macroeconomic uncertainty continued to impact some of the industries where our clients operate. Margin improved as we grew the mix of recurring revenue with IP revenue up 6.5% in constant currency and managed services revenue up 2.1% on the same basis.

As planned actions completed through the cost optimization program also contributed to margin expansion. Utilization was up year-over-year, as we continue to align talent to those industries that are growing, such as government transportation and utilities. Delivery quality remained high and client satisfaction again increased across every dimension we measure. Clients continue to partner with us to address their most complex enterprise and ecosystem-wide digitization initiatives. This operational excellence also led to deeper employee engagement as a proportion of employees who are shareholders rose to 87% further expanding our culture of ownership, which is a differentiator for client partnerships and CGI talent attraction and retention. In Q2, the diversity of new client awards affirmed CGI’s positioning as the go-to partner for driving outcomes.

Large project awards contributed to the higher proportion of SI&C bookings in the quarter. We also saw increasing demand for our emblematic business and strategic IT consulting offerings, including CGI’s framework for responsible use of AI as well as change management and CIO advisory services. Client demand for managed services remains robust in line with the buying trends we have seen over the past year. Importantly, on a trailing 12-month basis, the managed services bookings were up $1.6 billion compared to the same period a year ago for a 21% increase. We do see clients continue to exercise caution in their spending on IT services, which is most acute in the banking and manufacturing sub-sectors. However, this cautionary approach is not diminishing clients’ interest across every industry to explore with CGI the opportunities for cost efficiencies through managed services and for ROI-led system integration project.

We also see an industry-wide trend related to timing of decisions notably in delays for large engagements with enterprise clients. We remain well positioned as the partner of choice to help clients achieve the tangible and trusted business outcomes they seek. Example awards in the quarter included LocalTapiola, one of the largest insurance and financial services companies in Finland, extended their strategic managed services partnership with CGI for five years in an agreement valued at $284 million. CGI will apply new technologies, including AI and automation to help drive operational efficiencies across their enterprise. The digital department of the U.K. government cabinet office, appointed CGI as a strategic digital transformation delivery partner in an agreement valued at $162 million.

As part of this new partnership, CGI will provide a range of consulting, data and digital services to help the government innovate and drive value from digitization. The U.S. Department of State’s Bureau of Consular Affairs renewed its 10-year agreement for CGI to deliver visa services across nine countries in the Asia Pacific region. Under the $75 million award, we will continue to leverage CGI Atlas360, our AI-powered customer relationship management and business process IP to help the bureau efficiently facilitate visa applications. And the city of New York expanded its partnership with CGI in a five-year base plus two option year agreement to maintain the city’s parking violation system, which runs on CGI’s Advantage Collections IP platform.

Under this contract, CGI will partner with the city’s Department of Finance to administer the adjudication, payment and collection processes for summons violations issued by the city. Through the use of the CGI platform, the city expects to collect nearly $1 billion in annual revenue. Looking ahead now to the demand environment. Client budgets indicate continued investments in digitization over the next year, according to CGI’s most recent proprietary research. When we ask clients about their budget plans, more than 70% indicated they intend to sustain or increase their IT budgets. CGI’s pipeline over the next year validates this finding as the value of new opportunities grew by nearly 30% on a year-over-year basis. This overarching finding as part of the preliminary insights we have identified based on more than 1,800 discussions with current and prospective clients.

More than 80% of our discussions were with C-level business and IT executives and organizations located in every geography in which we operate. These annual Voice of Our Clients discussions were initiated during the second quarter as part of our strategic planning process and concluded just a few weeks ago. There are three preliminary findings that we see shaping client demand over the next 12 months. These findings underscore the tight alignment between CGI’s current investment priorities and those of our clients. First, clients across industries have indicated their intent to rebalance their business priorities, from primarily cost savings to a renewed focus and also driving revenue growth. Second, executives noted that the alignment gap between business and IT within their organizations has largely been eliminated.

And digital leaders in every industry have significantly widened the gap with their peers in realizing the benefits of digitization. Relating to the first finding, business executives globally cited driving revenue growth as their top priority for the next year. This is closely followed by the need to drive innovation and introduce new products and services. Both of these priorities are new and top 5 this year. While these top business priorities are growth-oriented, business and IT executives maintain their focus on modernization, optimization, cost control, each of which ranked within the top five priorities across most industry sectors. This resurgence in growth as a client priority along with continued focus on efficiencies is well aligned to CGI’s end-to-end services and solutions portfolio.

We expect this dual-focused client agenda to drive an expansion of new opportunities for both SI&C and holistic managed services over the coming year. Moving to the second preliminary finding of our client interviews. Business and IT are now tightly aligned as client executives noted that the alignment gap has effectively been eliminated. Over the past six years of research, this is the first time there’s been such a steep increase in the alignment ratings, indicating a new shared agenda between business and IT teams. We believe the primary driver for this finding is the combination of business efficiency focus and the promising potential of digital technologies, including AI and cloud. For CGI, this alignment is expected to generate larger value engagements as business and IT address enterprise transformations to integrate technology and operations.

We see early signs of larger value opportunities within our pipeline as the average deal size increased significantly for enterprise clients as compared to this time last year. And lastly, digital leaders are increasingly realizing the benefits of digitization and widening the gap compared to those organizations in the earlier stages. This enables digital leaders to accelerate investments in driving revenue growth. Our findings show these digital leaders are more successful in expanding their data strategies, modernizing legacy systems and applications, driving agility into their business models through a higher reliance on managed services, and implementing advanced technologies including generative AI. For digital leaders, this will drive increasing demand for all CGI services as they reinvest savings garnered from their modernization and optimization initiatives into new capital spending to drive future growth.

And for those organizations in their earlier stages of their digitization, the expanding gap and producing ROI will continue to generate new demand for CGI’s end-to-end services, with a stronger emphasis on transformative managed services and the full suite of our IP business solutions. These three preliminary findings are connected by the continuing critical role of technology and digital acceleration. Again this year, nearly three-quarters of our clients cited digital acceleration as the most impactful macro trend for their organization with CEOs rating the impact the highest. Not surprisingly, the rise in client interest for AI and GenAI solutions amplifies the importance of digitization across all aspects of society. CGI continues to progress our AI investments focusing first on talent development and hiring, which is already enabling us to enhance our end-to-end service offerings and strengthen our operations.

For example, we are improving the quality and speed of service delivery and software development for our clients through the use of GenAI, embedding AI across our IP portfolio and leveraging GenAI for more efficient development and maintenance of our 150-plus business solutions; leveraging GenAI to enhance our bid and proposal capacity, and experimenting and applying GenAI to optimize internal processes and transactions, including in our procurement, risk and HR functions. In Q2, our bookings at integrated AI technologies were again over $200 million, including wins with a large US financial and mortgage institution to create a cohesive GenAI strategy to drive portfolio-wide technical capabilities. A global car manufacturer to design and create data and AI platforms and products.

Multiple European space industry clients to leverage real-time AI to improve data transmission rates in lunar and deep space missions. And a multinational telecommunications company to deliver AI-powered solutions for cost savings and improve customer satisfaction. Notably bookings in the quarter utilizing our global alliance partnerships are up double digit on a year-over-year basis. Our client interview findings highlight the overall implementation of GenAI remains in the early and experimental stages, but it is ubiquitous with nearly 80% of clients stating that they are actively exploring AI technologies. In line with this demand, CGI’s active engagements that incorporate AI continue to increase across all lines of service. Turning to the buy side of a profitable growth strategy.

We continue to prioritize investments in M&A to deepen our resilience and serve as a catalyst for future organic growth. We are in active dialogue with merger targets at each stage of our pipeline. We remain committed to merging with like minded companies that are complementary to our geographic footprint, client base and end-to-end portfolio capabilities. Our strategy remains focused on a range of merger opportunities for metro market to transformational. As always, we will be disciplined to make sure that all mergers create value for each stakeholder. Our operational strength, stability and financial capacity will enable us to move quickly with discipline on the right opportunities. In closing, now more than ever CGI’s culture, capabilities and commitment to deliver tangible and trusted business outcomes are highly valued by clients as they navigate the current market environment.

We are well-positioned to remain a partner and expert of choice for clients and empowering environment for our consultants and professionals and engaged ethical and responsible corporate citizen and investment of choice for our share. Given our operational strength, resilient model, talented team and the alignment of our priorities with those of our clients, we remain committed to driving shareholder value through the disciplined execution of our strategy. Thank you for your interest and support. Let’s go to the questions now Kevin?

Kevin Linder: Thanks George. Joelle, we can now poll for questions.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Richard Tse with National Bank Financial. Your line is now open.

Richard Tse: Yes, thank you. George I was just wondering, if you could maybe talk about the extent of expectations for a second half pick up that are predicated on rates coming down across the board. You did a great setup in terms of the opportunity down the road. I’m just curious to see shorter term what’s really driving that pickup here?

George Schindler: Yeah. No, it’s a great question. I don’t have necessarily the clarity that I’d like to have on that. The green shoots are increasing in most industries and geographies for new project work. But they’re just not uniform or consistent right now. So the short-term, it really is still overall managed services and IP demand is what’s generating the opportunities. But as I mentioned, it’s still offset by some cautionary spending in SI&C and overall slow procurement decision making, so and even project start-ups. So it’s just not — it’s not uniform yet and we don’t have that clarity and visibility.

Richard Tse: Okay. Fair enough. You’ve done obviously a very good job at taking margins up over the course of the past few years. And has your business changed in the way the mix of service delivery, meaning on a geographic basis or more customers willing to offshore to get more attractive pricing like, or is it pretty much the same as it was a year or two years ago?

George Schindler: No, I would say that we’ve seen an ongoing trend to moving more our work. What I would still say is the global delivery model. So it’s not just offshore but certainly offshore and you’ve seen that consistently grow faster than the rest of our business, again in this quarter showing that growth. But also the near-shore centers, which continue to pick up specifically in Eastern Europe, Southern Europe and even in Latin America. So it really is a combination of factors. So we always had a global delivery, but I think it’s even more powerful now and the way we deliver our solutions. And of course automation continues to play a role and will continue to evolve as we drive more technologies into the delivery that we do for our clients.

Richard Tse: Okay. And just one quick last one for me. Can you talk about sort of staffing levels here as we look ahead to next year and maybe the degree of wage inflation how it may have moderated here recently?

George Schindler: Yes. Well I mean wage inflation has certainly moderated in most countries in which we operate. And we have a couple of different levers that we use. One is what we just discussed around global delivery and rotating some of our work and then rotating our people to the higher end work that we can get the additional wage rates in various locations. We also have our intellectual property that we can leverage. And so that allows us not to be so linear to people and salaries. And so we’ve got a couple of ways to manage that as we continue to build out the company. So it’s — that doesn’t factor in in a big way as I look at the next year.

Richard Tse: That’s great. Thank you.

Operator: Your next question comes from Daniel Chan with TD Cowen. Your line is now open.

Daniel Chan: Hi. Good morning. George, the US Federal bookings came in a little bit weaker again I think for the second quarter rolling out. I think the expectation was that for it to accelerate as we get closer to the elections. Any color on that?

George Schindler: Yes. Here’s what I would say. I went back I looked at this and cyclically a light booking quarter for us just due to the federal government procurement cycle in the US. There are many more RFPs in this quarter and we have a large number of outstanding RFPs out there and then the award in the second half. Maybe they shift that to more awards in Q3. That’s certainly something that we’re looking at. But I’ll just remind you our trailing 12-month book-to-bill in US Federal is at 136%. So yes, it was 72% in the quarter. But I think our average in this quarter is usually between 70% and 80% and we’re right in that place. So, yes, the election isn’t necessarily having the effect that I thought it might have. It will have an effect as we move through the year and get closer.

And one of the phenomenon that we’re seeing is that there are a lot more bridges for longer periods of time just given the concern about how that election cycle and the stability might occur. So a lot of our outstanding RFPs right now are were less sole source bridge awards. They just haven’t happened yet. So that we’ll look for that in the second half of the year.

Daniel Chan: Thanks for all the details. That make sense.

George Schindler: Sure.

Daniel Chan: Maybe a question on the margin side of things. Obviously the margin strength you mentioned from a higher mix of IP. Just wondering if there’s anything else to call out there and whether you think the margin profile this is the run rate going forward or if there’s more to go?

George Schindler: Yes. So here’s what I’d say. It’s a combination of the improved IP business mix, but also the cost optimization. That’s what’s driving some of this margin. Some of that will stick because of the cost optimization and certainly has that payback. But some of that’s going to be offset by continued investments in AI business development and the growing mix of SI&C. So as we move as things pick up, you’re going to see that change a little bit. We’re still committed to the incremental margin expansion, but we had a nice uptick in this current quarter just given what’s going on. So some of that’s sustainable and then we’ll continue to expand. But some of that we’re going to give up for the right reasons on investing in AI business development and what we believe will be a return of the SI&C here. And you heard that some of that Voice of the Client insights I shared.

Daniel Chan: One more if I may. You mentioned that the sales cycles remain a little bit longer than expected. Just wonder if you can reconcile that with one of the findings in your recent client survey saying that there’s good alignment between business and IT. You would assume that when there’s good alignment you would get these projects approved faster. What do you think is causing that slight disconnect.