Alithya Group Inc. (ALYA) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Alithya to acquire R3D and sign $600 million in commercial agreements. I would now like to turn the meeting over to Rachel Andrews, Vice President, Communications and Marketing. Please go ahead, Ms. Andrews.

Thank you. Good morning, everyone, and thank you so much for joining us this morning. Alithya's press release announcing that a definitive agreement has been reached for the acquisition of R3D Conseil was issued earlier today. The webcast presentation can be found on our website in the Investors section. On the call with me this morning are Paul Raymond, Alithya's President and Chief Executive Officer; and Claude Thibault, Chief Financial Officer. After remarks from Paul Raymond, we will open the call for questions. Before we begin, I would like to specify that this conference call is intended for the financial community. Also, please be advised that this call contains statements that are forward looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. Please refer to the cautionary statement on the slide of our presentation available on our website for more detail. Let me remind you that all figures expressed on today's call are in Canadian dollars, unless otherwise stated, and be aware that we will refer to certain indicators that are non-IFRS measures. Please refer to the cautionary statement on the second slide of our presentation for more details. Now I would like to turn the call over to Paul Raymond.

Thank you, Rachel, and good morning, everyone. [Foreign Language] It is with great pleasure that we announced earlier today the execution of a definitive agreement to acquire R3D Conseil, a private Quebec-based company specializing in digital solutions as well as the signature of 2 transformative commercial agreements. This strategic transaction remains subject to customary closing conditions, including the approval of the TSX, but we expect the closing to take place quickly during the first quarter of our financial year ending March 31, 2022. Also, for those who are familiar with R3D, I must also point out that their international division, focused mainly on servicing clients in the automotive industry, is not part of this transaction, having been recently sold as part of a management buyout with employees. So this morning's announcement is twofold. First, we are very excited by the numerous synergies that this acquisition will bring about after the closing. This acquisition will contribute to the consolidation of Alithya's leadership position in key verticals, such as the insurance and telecommunications industry as well as the public sector. Second, driven by long-term commercial agreements and commitments from 2 of R3D's principal shareholders and clients: telecom leader, Québecor; and insurance leader Beneva, this transaction will generate long-term recurring value for Alithya, our customers, our people and our shareholders. Both 10-year renewable agreements in effect until 2031 will generate approximately $600 million in combined revenue over the term, during which Alithya will provide value-added services in support of the digital transformation projects of both companies. Thanks to these 10-year agreements with Alithya and the acquisition of R3D, Québecor, Beneva and all of the clients of R3D will have access to our more than 3,000 experts to support them in their operations and technological evolution. These agreements and R3D's acquisition will significantly contribute to the achievement of our plan of doubling the size of our company in the current strategic cycle. In the short term, the transaction will make an immediate contribution to Alithya's profitability, notably due to the annual minimum volume commitments and value-added projects resulting from the new commercial agreements. As for R3D's net revenues, they were approximately $63 million and growing for the past 12 months ending on December 31, 2020, which is a very good performance in the context of COVID and attests to the quality of its loyal customer base. We're expecting these 2 agreements to add another $36 million of annual revenues from higher-value offerings once fully ramped up. As a result, we expect this to be an important benefit to our Canadian operations. The transaction is also expected to be immediately accretive to margins. Now more about R3D and the strong operational alignment with Alithya. This acquisition strengthens Alithya's position as a leader in digital transformation across numerous essential sectors of the economy, including insurance, telecommunications, banking and public sector vertical markets. We are particularly excited by the prospect of this strategic transaction as a complement to Alithya's offerings in the insurance sector. Insurers partner with a company like Alithya to digitally enable various aspects of their operations to keep up with the demand of their end clients. The digital transformation of insurance, powered by cloud-based enterprise solutions, digital applications, artificial intelligence, predictive analytics, mobile services, live chat, et cetera, is enabling insurers to do just that. And we intend on being a change agent for this industry for years to come. The commercial agreement with Beneva and R3D's acquisition will enable us to accelerate our plan to expand our presence in that global market through the combined strength of the 2 companies. This is why we are also announcing our plan to create a Quebec City-based global digital center of excellence for the insurance industry that has a significant presence in this city. Acquiring R3D strengthens the foundation of Alithya's future growth, paving another stretch of road to advance our unrelenting quest to become a North American leader in digital transformation. By leveraging R3D's proficiency in business technology processes, this transaction helps solidify Alithya's expertise in key areas. In addition to acquiring proven expertise in strategy and governance and digital solutions development, the acquisition infuses additional technical expertise in 2 areas where Alithya is already very active, thus enhancing our service delivery, web and mobile application development, cloud computing and big data offerings. As demand for digital transformation services continue to soar across all sectors, the acquisition of R3D bolsters Alithya's growing pool of experts with the addition of 600 billable Quebec-based seasoned professionals. The added commitments will also enable us to create 350 new positions for exciting high-value digital transformation projects. I would also add that because of the similarity, complementarity and proximity of our respective activities, we believe we'll be able to successfully integrate our operations fairly quickly, bringing positive operational synergies and benefits over the short and midterm. This transaction is another example of our disciplined and creative approach to value creation for our clients, our people and our shareholders. It is very exciting as our new scale will immediately enhance our ability to qualify for and win much larger deals in the upcoming quarters. From an investment perspective, the acquisition also adds the presence of Québecor and Beneva as minority shareholders and business partners, while slightly increasing Investissement Québec's position vis-à-vis Alithya as it continues to support us in our growth strategy. We wish to thank them very much for their trust and support and believe they, along with our existing Alithya shareholders, will benefit from the great value created with today's announcement. In closing, we will begin our fiscal 2022 on a very positive note, from a position of strength with additional strategic customers and increased critical mass and an outstanding backlog. This transaction epitomizes Alithya's long-term plan to profitably grow the company through a balanced blend of acquisitions and organic growth. Claude and I will now be pleased to answer any questions that you may have. Casey?

[Operator Instructions] And your first question here comes from the line of Amr Ezzat from Echelon Partners.

Congrats on the transaction.

Thank you.

Can you give us a sense of R3D's services and products? Like what is their strong suit? And how does it sort of contrast to your Oracle and Microsoft practices?

Yes. Sure. Great question, Amr. So they have 2 very distinct parts of their businesses. One part of their business is what they would call their digital studio, where they actually do many digital transformation and digital solutions for customers. This group is based in Montreal. The other group, which is based in Quebec City, is very close to what we do. They have a very large strategic consulting team, so very senior consultants working on strategy, change management, architecture type stuff, and also another group that is more on the consulting side, similar to what we do where they do projects with the government and the insurance industry, telecom, as I mentioned earlier.

Okay. So can you -- I'm not sure if you guys are willing to give like a sense of like profitability levels. You mentioned that it's immediately accretive to margins, I think, is the language that was used. Is that like gross margins, EBITDA? How do we think about profitability?

Sure. I'll let Claude give you some color on that, Amr.

So if you look at the press release, based on yesterday's stock price, the value -- the enterprise value of the transaction is roughly $84 million. Those of you who've been following us in recent years, our past acquisitions, we've always paid between 6 and 7x EBITDA. So without providing specifics and too many details, we can tell you that we stuck within our historical range of 6 to 7x EBITDA, which would translate into $12 million to $14 million of EBITDA for this transaction, for the target. That, however -- just a word of caution, this includes the ongoing profitability, trailing profitability. It includes the profitability from the commercial agreement. And it includes some synergies that will be implemented going forward. So the trick here is in the phase-in of these, both the commercial agreement and the synergies. We cannot say it's going to be immediate. It's going to take a while to fully materialize. But in terms of the big picture, that's what we can tell you.

Okay. That's very helpful. Because I think it answers like my next question, which was a housekeeping question. You did say it's $63 million in LTM revenues, then the 2 agreements added an additional $36 million in revenues. Is that correct? So that's additive?

Correct.

Okay. Maybe one last one. On the cost side, like you obviously have a pretty good footprint in Quebec in terms of offices and personnel. How should we think about potential synergies, cost synergies?

Well, that's a good question, Amr. The offices is an obvious one. As you can imagine, especially since the beginning of COVID, the need for physical space has significantly reduced. So one of the obvious places we're going to be getting some synergies are in the infrastructure and back office. On the sales side, it's actually the opposite. We -- as part of this, we're going to be creating 350 new billable jobs. So we're going to be ramping up pretty fast on the hiring side to meet the numbers.

Your next question comes from the line of Deepak Kaushal from Stifel GMP.

Just really quickly, Claude, just to confirm some things from Amr's question. So on the revenue side, it's going to be a pro forma revenue of roughly $99 million, is that correct?

Yes.

So $63 million plus $34 million. Excellent. And then when you said $12 million to $14 million of EBITDA, I assume that was on the $63 million base. So are we looking at a 21% EBITDA margin after synergies or before synergies?

Well, it's about $100 million in net revenues indeed, and it's $12 million to $14 million of EBITDA. That would be post synergies, with a conservative number for that. So we have -- we always have ambitions to achieve a lot. But certainly, we price this transaction on a conservative number. So yes, it would include synergies.

Got it. And then in the time frame to get to that full kind of margin run rate, are we talking a quarter, 2 quarters, 3 quarters? It sounds like it's pretty quick to integrate.

Well, the challenge is on the commercial agreement. We really want to do this right. So honestly, right now, we're looking at 12 to 24 months.

Okay. Okay. That's helpful. And just going back to the acquisition, Paul, maybe you can kind of discuss how it came about, why R3D is selling the business, why they chose Alithya. Was it a competitive process? Any kind of background on the deal? And then I've got one follow-up after that.

Sure. That's a good question. Thank you, Deepak. We've known R3D for a very long time. We've competed with them, we've partnered with them. We know the management team there. They went through a restructuring process 2 years ago where they were acquired by Québecor and La Capitale, the insurance company, as well as Investissement Québec. As you know, Investissement Québec is also an investor in our organization. After we saw that announcement, we obviously were paying attention. We have some customers in common. The conversation started up very naturally. They were -- they had similar ambitions of accelerating growth and doing acquisitions and so on and so forth. And after talking with them, we came to the conclusion that it would be a lot faster for everybody if we did it together instead of doing it separately. We had very similar visions, I'd say, similar values, so there was a cultural fit for the 2 companies to join. The conversations, even though it's a very complex and creative transaction, the conversations with all of the stakeholders have always been very fluid and very positive. This deal is actually one of the few transactions, I'd say, that are a win-win for everybody. The customers of R3D win because they now have access to a much larger pool of expertise. The investors win. As everybody can see, they basically joined a growing company. They found a way to make their investment -- the short-term investment converted into a very positive longer term investment. So they saw -- they liked our plan. They saw a lot of similarities between -- within the plans. And for them, this was kind of a no-brainer. I think one of the things that people probably don't realize, if you think about the value of this transaction, is that many deals of this type in the past have been for cost savings, like people would outsource to save on costs. This is not the case. This -- these 2 agreements are for new digital transformation projects. Beneva is going through a very large consolidation of their own, between La Capitale and SSQ, so there's significant consolidation projects there that we're helping with. Québecor is in the heart of the 5G revolution, which is going to be generating a lot of new application-type opportunities, and they're going to need to help with that. So this is really -- it's new business, new project, which is the type of stuff that we -- that gets us up in the morning and the type of projects that are very good for attracting and hiring new people. So we're very excited. This is not a cost play. This is really a value play.

Excellent. Well, it sounds like this is very much along the lines of your heritage as you built on the TSX, so it's nice to see. The only last question I had, and I don't mean to hog the line here, is I know that they have a specialization in insurance and telecom. Any particular IP you can note that you can use to transfer to your existing customer base?

Not in the current stage of what we have, but I'm sure we'll be developing some of that with the new agreements that we have with Beneva and Québecor.

[Operator Instructions] Your next question here comes from the line of Gavin Fairweather from Cormark.

Congrats on the deal.

Thank you, Gavin.

It sounds like, correct me if I'm wrong, but it sounds like this is largely a custom development shop and a strategy shop, so it's one of the big kind of opportunities to bring in your Microsoft and Oracle expertise into this client base?

Absolutely. So they are -- they have a great reputation on the custom development side through their digital studio here in Montreal. And they also have a very good reputation as strong strategic consultants in Quebec City, government and private sector. So I mean on the strategic side, it opens up many opportunities for our delivery teams. And on the digital side, it actually opens up new opportunities of things that we can add to existing customers and leverage our existing practices with their customers. So yes, 2 very -- there are several very exciting opportunities coming out of this.

That's great. And then on the client base kind of outside of Beneva, Québecor, can you just kind of speak to that a little bit? Just from bouncing around on the website, it looks like they have some clients kind of outside of Canada. Can you just speak to that base, how diversified it is and kind of their success in kind of moving outside of their region as well?

Sure. So Beneva, as you know, is the merger of La Capitale and SSQ in Quebec City, so they're now across Canada in terms of the business that they go after. Quebec City is a very particular market in that they have 10 insurance companies based out of Quebec City. They've always been very active. They have several insurance-focused groups over there. One is called [indiscernible] which is basically a collection of the insurance companies that look at things they can do together and try to drive the market to everything from technology choices to influencing curriculum and local university. So for us, leveraging that and the fact that we also have other insurance customers in Canada and the U.S., we saw it as a great opportunity to set up a -- an insurance COE, a center of excellence, for digital solutions and insurance in Quebec City. So that is something we'll be able to leverage across all of our markets because, as you know, insurance companies use the same systems, whether they're in Canada, the U.S. or Europe. The -- some of the terminology changes and the currencies, they change, but the systems are very similar. And the needs are very similar. The needs of the customers are very similar. And that is an industry that, I believe, has -- still has a ways to go on the digital transformation side. So we see a lot of opportunity there, not just for locally, but market-wide. On the telecom side, we also have other telecom customers today. So again, that's an industry that's going through tremendous change. 5G is going to be generating, again, incredible change for the years to come. 5G is also going to bring in a new age of application development and new applications to leverage the throughput of the new technology. So that's an area that, we believe, is going to have significant growth for us. And the beauty of the 2 agreements that we have, I mean, it's guaranteed recurring revenue, and it's not a cost-plus type thing. It's really based on the value. It's market-driven value where we're going to be doing projects that add value to the customer and not projects to basically outsource people and cut costs. These are really to take them to the next level, so we're very excited about those.

That's very helpful. And then just lastly for me, when I think about kind of the revenue, it sounds like you're getting roughly a 50% bump as these new agreements kind of kick in, and you're growing the workforce by about 50%. So would it be fair to say that their utilization kind of before this was quite high?

Yes. So they were actually growing, doing very well. To Claude's point, the $60 million, the agreements, $24 million of that is already in place. So it's just $36 million additional revenue, so we'll have to hire for that. There's nobody -- nobody is sitting around and waiting for that. And we're going to be hiring in the -- again, in the digital transformation type work. So this is new technologies, new projects, so we think that's going to be very positive as part of our hiring messages.

Congrats on the deal.

Thank you, Gavin.

Your next question here comes from the line of Kevin Krishnaratne from Desjardins Capital.

Congrats on the acquisition. Just maybe one for me. I'm wondering...

Thank you, Kevin.

Yes. I just wanted to understand, I -- sorry, I jumped in a little bit late. But I'm wondering, does -- are there any specializations or strong vendor relationships that you might want to call out that the acquisition might bring? I know you're obviously strong in Microsoft and Oracle, among other vendors, but I'm wondering if there's anything of note that they specialize in that can help you drive any sort of cross-selling opportunities with your existing client base.

Yes. Great. Thank you, Kevin, for joining us. The -- on the -- they have something, they call it the studio, which is a digital solutions center where they actually develop and build custom digital type projects, which is something again that we can cross-sell across our business. They have some industry-specific skills, so insurance. Again, they've developed apps in insurance and telecom in the public sector and banking, so these are things that we'll be able to leverage. And they also have -- they're very well-known for their senior strategic consulting services, so these are senior advisers to the C-suite, change management, which we see a lot in the type of projects that we do, architecture -- technological architecture-type work and also modernization work. So they actually will take legacy systems and bring them to the latest and greatest cloud-based technologies. So those are all things that we know we can leverage. Some are industry-specific, and they're lined up in the same industries as we are. So again, we see a lot of growth synergies there that we're looking forward to.

Okay. Great. And then I know you provided some guidance or thoughts on EBITDA. Can you tell us what the gross margin profile looks like? Is it similar to yours? And then as much as you've got contracted revenue, I understand that, or backlog revenue, as you've got great visibility there, but is there a way to think about any sort of like recurring revenue, things that might -- beyond the backlog, if you've got multiyear software licensing deals? Is there any sort of level of recurring revenue that you can point to longer term for the business?

So yes, so that's a good question, Kevin, but I think that we need to be very clear on the message here is that this is basically $60 million of recurring revenue for the next 10 years with high-value-type projects. So in terms of gross margin profile, it's in line with where we want to go as a business. So if you look at how our Canadian gross margins have been growing in the past few years, this is in line with that trajectory.

Well, congrats, gentlemen.

I'll turn the call back over to Alithya's CEO for closing comments.

Thank you, Casey. Thank you, everybody, for your presence this morning. Take care. Stay safe. And if you have any additional questions, just reach out to Claude, and we'll make sure we can address it. Thank you.

And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.