[IVR/AVR] Good day, ladies and gentlemen, and welcome to today's Calian's First Quarter Results Conference Call. As a reminder, today's call is being recorded. At this time, I'd like to turn the conference over to your host for today, Mr. Kevin Ford, Chief Executive Officer. Mr. Ford, please go ahead.
Thank you, Sarah. Good afternoon, ladies and gentlemen. With me today is Jacqueline Gauthier, our CFO. We'd like to welcome you to Calian's first quarter 2019 conference call. Despite mixed results this quarter, we've achieved several positive metrics with our largest quarterly revenues in the company history, as well as 20% growth in the profitability of our VTS division. SED division continues to be very busy in all segments, with a focus on current projects and new technology innovation. In support of our customer retention pillar, we're very happy to report this quarter the re-win of our Canadian Army Simulation Centre contract with an initial value of CAD 93 million, and with options factored in, an aggregate contract value for the full nine-year period of approximately CAD 170 million.
With a duration of up to nine years, this win has helped grow our contracted backlog to CAD 1.3 billion, which is a very strong foundation to support our growth agenda. Factoring in the CAC contract, our contract signings exceeded over CAD 200 million this quarter. Again, another strong sign that our sales efforts are working. I will now ask Jacqueline to review the quarterly numbers. Over to you, Jacqueline.
Thank you, Kevin. As Jacqueline mentioned, results for this first quarter are mixed. Our VTS division saw continued improvements in revenues and EBITDA from strong performance and demand in all of its market segments. The SED division reported a slower quarter than the prior year, driven by a few projects moving to the right and a slightly less favorable revenue mix in the quarter. However, these results do not change our outlook for the year, as we continue to expect strong performance from both divisions. We also expect contributions from our most recent acquisitions, IntraGrain and SecureTech, to increase in the remaining quarters due to seasonality of their business, where the first quarter activity is typically minimal.
Net profit for the quarter was CAD 0.43 per share compared to CAD 0.54 in the prior year, impacted by SED results, the negative impact of seasonality of IntraGrain and SecureTech acquisition, the amortization of intangibles, and the accretion of interest expense related to these two acquisitions. If we were to exclude the negative impact of IntraGrain and SecureTech in this first quarter, net earnings per share would have been CAD 0.50. For the first quarter of 2019, revenues were up 5% from the prior year. The general business environment in 2019 is strong in both divisions. The company's healthy backlog and its recent acquisitions should provide for a solid year. SED revenues were down 16% this quarter. Although the division continues to work with a solid backlog of work, some ground system contracts are still ramping up.
Product sales continue to provide solid recurring revenues. Interest continues to grow with some of our newer products with new customers entering the mix. SED's other business units continue to be busy in a range of activities. IntraGrain activities did not play a major role in revenues this quarter, as its business is seasonal and most of its activities will be reflected in the third and fourth quarters. VTS revenues increased 13% this quarter. The acquisition accounts for only 4% of the growth, with the remainder achieved through organic means. All service lines showed solid increase in demand for their services with existing customers and saw the benefit of various new wins. Gross margin continues to show an overall positive trend and was up again this quarter. Gross margin in SED, although less than in the same quarter the previous year, was still respectable.
This reflects solid execution across all business units impacted by customer-driven development projects that, until fully developed, result in lower margins. In addition, the influx of new resources to fulfill project requirements continues to have an impact as these resources continue to be trained and ramped up. Gross margin in VTS continues to show improvements, with most of the uplift being attributed to solid execution on existing contracts, with new acquisition only accounting for approximately 22% of the increase. Operating expenses have gone up. The costs have increased over the prior year due to the inclusion of the acquisition, SecureTech, Priority One, and IntraGrain, as well as continued focus on selling and marketing efforts and service line evolution, improvements and expansion in our facilities, the expensing of share-based compensation, in addition to certain one-time costs. We will continue to challenge discretionary spending.
However, continued prudent investments are required to support the evolution of the company's service lines. Our net cash position is now at CAD 8 million following the acquisition of IntraGrain. Cash position in the near term will be impacted by additional working capital requirements at SED and the remaining payments due on our acquisition. Finally, please note that certain information discussed today is forward-looking and subject to important risks and uncertainties. The results predicted in these statements may be materially different from actual results. I'll now turn the call back over to Kevin.
Thank you, Jacqueline. I really believe that Calian is at a pivot point in the company's history as we continue to invest in R&D and headcount to drive long-term growth for the company. Our innovation agenda is focused on new product development, developing tools to support our professional services in areas such as emergency management training, and also entering new customer segments. This quarter, we invested another CAD 650,000 in new product development and continue to increase our government market resources to ensure that we have capacity required to support our growth. Our M&A agenda also continues to be a focus, with current priorities being the integration of IntraGrain, Priority One, and Secure Technologies that we completed last fiscal year. We continue to proactively search for companies to support our growth objectives as we look to diversify our customer base as well as evolve our services.
I'm also happy to report that our health service line with our business partner, Bayshore HealthCare, has successfully completed the startup phase of the healthcare provider requirement contract with Department of National Defence, launching the in-service phase of this contract with DND, RCMP, and Veterans Affairs Canada. At now 69 consecutive profitable quarters, strong cash flows, continued focus on our innovation agenda, and our dedicated employee base, I'm confident that we'll continue to make progress against all elements of our four-pillar strategic growth framework. I'd also like to acknowledge that this will be Jacqueline's last conference call as Calian CFO. On behalf of our board of directors, our shareholders, and our staff, we want to thank Jacqueline for her dedication and years of service at Calian. Anyone who knows Jacqueline respects her work ethic, her passion for growth, and her outstanding ability to manage a complex financial publicly traded organization.
She can be proud of her work here and the legacy she will leave with the company. I'm happy that she has agreed to stay on for a period of time to facilitate transition to Patrick Houston and as well support elements of our growth strategy. I would also like to formally welcome Patrick to the Calian team. Patrick is a seasoned CFO, and I'm confident will bring an excellent toolkit in the CFO role to support Calian's profitable growth strategy. In closing, traditional markets in which Calian operates are stable, and management expects organic revenue and earnings growth in most or all of its service lines through the successful execution of our growth strategy. However, we must caution that revenues realized are ultimately dependent on the extent and timing of future contracts as well as customer utilization of existing contract vehicles.
Based on currently available information and our assessment of the marketplace, we expect revenues for fiscal 2019 to be in the range of CAD 330 million-CAD 360 million, earnings per share in the range of CAD 3.60-CAD 3.90, and net profit in the range of CAD 2.10-CAD 2.40 per share. With that, I'd like to now open the call to questions. Sarah, can you please open the lines for questions?
Absolutely. For the audience, if you have a question or comment today, please press star then one on your touchtone phone. For those of you joining us today via speakerphone, please make sure your mute function is turned off to allow your signal through to our equipment. Once again, to the audience, please press star then one if you have a question or comment today. We'll go first to Deepak Kaushal of GMP Securities.
Hi, guys. Good morning. Thanks for taking my questions. Kevin or Jacqueline, I just had a quick question on the slowdown in SED. Is that related to the record satellite contract that you guys announced previously? Is there any changes, if so, any changes to the 36-month ramp-up period for that and the expectation for 66% of that to come in 2020?
Deepak, it's Kevin. From my viewpoint, slowdown not necessarily with regard to SED. I think it's just the reality of what we're dealing with from a project schedule. As we look at the phasing of that program, which we announced last year, the largest ground system contract, as you're referring to, for SED. It's really just a schedule timing issue right now from my perspective. There is a lot of work going on with new technologies there that, frankly, is quite exciting. We're monitoring that project very closely. I wouldn't categorize it as a slowdown. I think it's just basically the reality of the mix of projects, where we're ramping projects up, ramping other projects down. The division right now is extremely busy across all segments, I don't really think it's a slowdown. I think we're just dealing more with a timing issue.
Okay. Great. Can you maybe perhaps discuss beyond the contract, particularly related to the satellite industry, what are you seeing in that environment of late compared to this time last year?
We're still seeing lots of opportunity, frankly, based on two factors, frankly. Number one is that our legacy customer base continues to come back to the SED division, whether it's for upgrades to current systems or for new mandates. Our current base is continuing to be very loyal, and I think that's just been deserved by the fact of the excellent delivery we've had over the years. Secondly, when you look at the innovation agenda at SED, I think a lot of people continue to look at SED as primarily a satellite segment, which I understand because historically it's been that. Just a reminder, the other segments we serve right now, the aerospace and Defence is again growing very strong. With the acquisition of IntraGrain now and the ag tech piece, we believe we're just at the start of that journey and very excited.
That market, by our market research, is growing 12%, 13% a year, we're just starting to enter into that segment. We believe there's huge opportunities there as well for the company. Even within our core satellite business, it's good. Our aerospace business is good. Now with the ag tech piece, you know, we're pretty excited by where that could go for SED. The last point I'm going to make is just on the research and development we're doing at SED. There's other segments we're looking at beyond those three. I'm still very positive on where we are with SED, across its broad spectrum now of customer bases as we move to non just a satellite core. Hopefully that answers your question.
Yeah, it does. Thank you. Just going back to timing. I think Jacqueline mentioned seasonality at IntraGrain. Sorry, excuse me. IntraGrain. I think in your press release, you also mentioned seasonality in SecureTech. I'm just kind of curious, is there seasonality impacting the revenue portion for that acquisition? Maybe you can give a more personal take there.
Yes. They sell quite a bit to the government, they tend to have a very high Q2. They do a significant portion of their annual revenues in Q2. Both IntraGrain and Secure Technologies had a negative impact in Q1, but we are very confident that they are going to pick back up in the next quarters. SecureTech in Q2 and IntraGrain in Q3, Q4.
Okay. In terms of SecureTech, is that something that is standalone versus DWP that you've acquired in the past, or are you guys able to integrate and get some synergies around the cybersecurity acquisitions you've made in the past few years?
Yes. We actually purposely integrated SecureTech immediately with Calian. They're part of our cyber team, and both Calian, SecureTech, and the DWP portion are all working together to attack new markets, to get into new markets.
Okay. Excellent. Then, Jacqueline, just on the capital side, you mentioned some increasing working capital requirements in SED. I'm just kind of looking over the past few years, EBITDA to cash from ops conversion. It bounces around quite a bit on an annual basis, largely due to working capital requirements. What should we expect over the next two years in terms of, if we're taking round numbers and you're doing about CAD 30 million in EBITDA, how much can we expect that to convert to cash from ops, and rebuild your balance sheet?
Basically, the main element of our working capital is that large contract at SED that's going to be running for the next 30, 36 months or so. We're expecting working capital requirements between CAD 10 million- CAD 15 million at its peak. That's going to show up in the next few quarters for sure. Then once we get past the middle point of that contract, things should start reversing. We're expecting that in the last 12 months, we should be working capital positive on that project.
Okay. When you think about capital structure, I know perhaps maybe this is a question for tomorrow's investor day, and Mr. Houston. How do you think about debt to EBITDA and that kind of ratio in terms of turns? What are you guys comfortable with? Can you remind us?
We've always said one to two times, I think that's going to stay for a while. It's something we discuss at the board on a regular basis, I think we will just evolve as we continue to do acquisition and acquire additional cash. For now, this is what we're targeting.
Okay. Well, thanks so much for taking my questions. I look forward to seeing you tomorrow.
Great. Thanks, Deepak. Appreciate the questions.
Once again to the audience, it is now the time for questions. We'll go next to Benoit Poirier of Desjardins Capital Markets. Excuse me. Please go ahead.
Yep. Thank you very much. Good morning, Jacqueline. Good morning, Kevin. Just to come back on the large satellite ground system contract, just want to make sure that there was basically minimal contribution in Q1. Is the ramp up still expected in Q2 mostly with the bulk reported or recorded in fiscal 2020 next year??
Yeah. We haven't changed the profile of that contract. It remains the same as what we provided last time. It's on track. I think it's just that there's quite a few players that are ramping up. We have a lot of suppliers that require to do some set up and getting ready for this contract. I think right now everybody is in that phase of getting ready for the first milestone. There's no indication that things are going to significantly slide to the right on that contract.
Okay. Looking specifically for SED, Jacqueline, revenue or EBIT, how should we look at the ramp up over the next few quarters? The biggest increase will be done in Q3, Q4, or are we going to see even a good improvement in Q2 for SED specifically?
We don't provide guidance on a quarterly basis. I'd hesitate to give any details there other than we feel very strongly that SED is going to have a good year. We have to cut off on the last day of a quarter end, and sometimes things are done and sometimes they're just not quite done. It's very difficult to assess a quarterly number, but we feel confident about the year.
Just a reminder, Benoit. From my viewpoint too, Benoit, I know the large ground system contract will take a lot of focus over the next period of time as we deliver that and push that project through with delivery. I'm also very positive on things happening outside the large contract, the research and development and our product developments in certain areas, whether it's in applied Oxus or even [inaudible] in some of the areas, and then IntraGrain as well. Appreciate the, as I say, the size of that program. I think for SED for the year, it's going to be a combination of clearly that program as well as I think the other projects that are running right now that are really, frankly, quite exciting in the innovation they're going to be bringing to market.
With respect to the working capital ramp-up that you talk about, the CAD 10 million, CAD 15 million at the peak, where would you be at right now, or what remains to be done in terms of ramp-up in terms of working capital, Jacqueline?
I think we'll be ramping up to that, let's say, CAD 12.5 million by next quarter or beginning of the following quarter. We're getting into that phase now.
Okay. Basically, you haven't ramped up the working cap yet, there's another CAD 12.5 million, let's say, increase in the coming quarter or two.
No, we've started ramping up, we'll be at our peak in the next quarter.
Okay.
We'll stay there for probably a year.
Okay, perfect. For the guidance, obviously there's intangible, the accretion interest expense. Just want to make sure that the CAD 210-CAD 240 basically take into account the amortization and intangible and accretion interest expense. Am I right here?
Yes. That includes everything.
Okay. Accretion interest expense, is it something that we should see in the coming quarter, or it's basically just a one-time item?
It gets accrued over a period of two years. It relates to the earn-outs. When we set up our earn-out liability, we need to discount it, and then we need to bring it back up to the full amount at the time that it needs to be paid out. So whenever we have earn-outs, it's going to be consistent with the timing of the earn-out. You will see this on IntraGrain for the next two years.
Okay. Basically, should we expect kind of a similar amount to be recurring in the coming quarter?
Yeah. We acquired IntraGrain November 1st, we have two months in this quarter, we'll have three months in the following quarters.
I see. That would be stable over a two-year period. Okay.
Correct.
Okay, perfect. Any impact from the IFRS 15 in terms of revenue recognition? Is there any impact at Calian?
Yes. The main impact is on warranty. If you've looked at the financial statement, you'll see that we restated last year, over the course of the full year, fiscal 2018, we will be recording an extra CAD 0.05 of earnings per share. It relates to having to record cost and revenue associated with warranties sooner than we did under the old rule. That's the main impact.
Okay. Is there an impact for fiscal 2019, though, Jacqueline?
Well, looking forward, it's hard to assess the impact because we'd have to do it the old way and the new way to see exactly what the impact is. Basically, we're using the new rules now. In theory, if you take that further, we continue to recognize cost and revenue sooner on those warranty projects. In terms of timing difference, there shouldn't be any other than the mix of projects we have at any given time.
Okay. It's not like it's providing a big boost on the EPS for fiscal 2019, let's say.
No.
Okay, perfect. Last question for me. If we talk about the health services contract, would you be able to quantify what is the run rate and any color about further ramp-up that could be done with the other departments?
Yeah. Right now, that contract on any given year, and again, it goes up and down, but generally we're seeing the run rate in that CAD 75 million- CAD 80 million range. The new customers that have come in through the new contract with RCMP and Veterans Affairs are ramping up. I think we've seen more uptake initially on Veterans Affairs, and RCMP is not far behind. The primary customer account still is National Defence, and as Veterans and RCMP want to grow aware of the contract, number two, understand how to use it nationally, we continue to see increased demand on those segments as well.
Okay, perfect. CAD 75 million-CAD 80 million in terms of run rate, Veterans Affairs is more advanced than RCMP in terms of ramp-up, right?
Yeah. Again, it's a smaller piece of that. The major customer is Defence for sure, Veterans Affairs and RCMP, as I said, they're just now looking at a national governance around the contract. We'll see. I expect that to ramp over the next couple of quarters, but I wouldn't put it in any significant way at this point..
Okay. Thank you very much.
Thanks, Benoit.
Just as a final reminder to our audience today, it is star then one if you have a question or comment. From Acumen Capital, Brian Howe.
Good morning, everybody.
Morning, Brian.
Jacq, I just wanted to clarify again, you indicated that the seasonality relating to IntraGrain would've impacted net income by about sort of CAD 0.07. Is that what I understood from your comment?
Yes.
Okay. Is it really just in their Q1 that they're, I say, in a loss position, then they ramp up for the balance of the year and be profitable?
IntraGrain will tend to be in a loss position for Q1 and Q2. Then most of the revenues are in Q3, Q4. For Secure Technologies, they tend to be in a negative position, let's say Q4, Q1, and they do most of their revenue in Q2 and the early part of Q3.
Okay. Do you expect that to change at any time in the future, or will that always be the case?
Based on the existing business, I would say similar. Obviously we're trying to expand in different areas, that should be lessened in the future in terms of the impact.
That's good. All right. Just switching to, again, the working capital. Again, on that SED contract, it sort of peaks at CAD 10 million-CAD 15 million and sort of sits there. Again, that's sort of like a work in progress. Is that the best way to think about it?
Correct. On that project, we have to deliver approximately 20 units. We always tend to be a few units behind in terms of getting the payment for the work that's been done. Initially we ramp up, then we continue to do work, then we're paid on the previous units, that's why it stays at the CAD 12 million, CAD 15 million for a year.
Okay. Again, just further on the working capital, can you give us a little bit more insight on sort of the remaining payments on the acquisition, sort of what you expect, this year and next year?
If you look at the balance sheet, we've got contingent earn-outs of about CAD 8 million. I would say that more than half of that will be paid in the next year, and then the remainder the following year.
Okay, great.
Probably 60% this year.
Okay, thank you. All right, look forward to seeing you tomorrow. Hopefully, the flights will allow us to get into Toronto. Enjoy your travel today.
Thanks, Brian. We're getting pinged here all over the place from people trying to get into Toronto. If anyone's traveling today, I suggest you get to the airport or jump to a train for those that have that option. Any other questions, Sarah?
It appears we have no further questions at this time.
That's great. Thank you everyone for attending the call today. I appreciate the questions. I guess next call will actually be Patrick and I sitting here, talking about the next quarter results. Look forward to that discussion and I'll talk to you then. Sarah, with that, we can close the call.
Thank you. Again, ladies and gentlemen, that does conclude today's conference. Thank you all for joining.