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CGI Group (NYSE:GIB)

Q2 2014 Earnings Call

April 30, 2014 9:00 am ET

Executives

Lorne Gorber - Senior Vice President of Global Communications & Investor Relations

David R. Anderson - Chief Financial Officer and Executive Vice President

Michael E. Roach - Chief Executive Officer, President and Director

Analysts

Jason Kupferberg - Jefferies LLC, Research Division

Maher Yaghi - Desjardins Securities Inc., Research Division

Richard Tse - Cormark Securities Inc., Research Division

Justin Kew - Cantor Fitzgerald Canada Corporation, Research Division

Scott Penner - TD Securities Equity Research

Paul Treiber - RBC Capital Markets, LLC, Research Division

Thanos Moschopoulos - BMO Capital Markets Canada

Michael Urlocker - GMP Securities L.P., Research Division

Operator

Good morning, ladies and gentlemen. Welcome to the CGI Second Quarter 2014 Results Conference Call. I would now like to turn the meeting over to Mr. Lorne Gorber, Senior Vice President, Global Communications and Investor Relations. Please go ahead, Mr. Gorber.

Lorne Gorber

Think you, Melanie, and good morning. With me to discuss CGI's second quarter fiscal 2014 results are Michael Roach, our President and CEO; and David Anderson, Executive Vice President and CFO.

This call is being broadcast on cgi.com and recorded live at 9 a.m. on Wednesday, April 30, 2014. 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 are being filed with both SEDAR and EDGAR.

Please note that some statements on the call may be forward-looking. Actual events or results may differ materially from those expressed or implied, and CGI disclaims any intent or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The complete Safe Harbor statement is available on both our MD&A and press release, as well as on cgi.com. We do encourage our investors to read it in its entirety.

We are reporting our financial results in accordance with International Financial Reporting Standards, or IFRS. As before, 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.

David will first review our Q2 financials, and then Mike will comment on our strategic and operational highlights. So with that, David?

David R. Anderson

Thank you, Lorne, and good morning. I'm pleased to share the financial details of another good quarter.

Second quarter revenue was $2.7 billion, up 7% compared with $2.5 billion in the year-ago period. Foreign exchange fluctuations favorably impacted revenue by $236 million or 9% compared with the same period last year. Adjusted EBIT was $341 million, up 31% versus last year, while our EBIT margin of 12.6% increased by 220 basis points.

Net earnings were $231 million or $0.73 per diluted share compared with $114 million or $0.36 in diluted EPS in the year-ago period. Similar to previous quarters, we have specifically itemized the impact of the integration-related expenses and any onetime tax adjustments on our net earnings as the amounts were not related to operating activities.

In Q2, the integration-related expenses were $26 million, and we had a benefit resulting from the settlement of a tax claim for $11.9 million. Subsequent to the finalization of the Logica purchase price allocation and according to GAAP, the adjustments to the acquisition-related provisions must flow through the statement of earnings.

During the quarter, we had realized such benefit in the amount of $11.7 million. To provide a better basis for better intra-period comparability, we have specifically disclosed this impact.

Excluding specific items, namely the integration-related expenses, the onetime tax benefit and the adjustments to the acquisition-related provisions, net earnings were $230 million, or $0.72 per diluted share. This compares with $176 million or $0.56 in the year-ago period, representing an earnings improvement of approximately 31%.

Let me now take a minute to walk through where we stood at the end of the March quarter relative to the $525 million Logica integration budget. $497 million or 95% of the budget has been expensed to date, and $418 million in cash payments or 80% of the budget has been disbursed, including $50 million in Q2. All remaining integration expenses will be incurred and the majority of the cash disbursed by the end of this fiscal year. More details can be found in the MD&A.

Cash generated by operating activities was $351 million in the second quarter. This sequential improvement in cash was largely driven by the completion and collection related to some large building milestones. This drove a reduction in our DSO from 55 days to 47 days, back in line with our 45-day target. When you add the $50 million of integration-related payment I just described, we reached $400 million in cash generated from the operations for this quarter. A detailed bridging schedule showing the impact of all the moving pieces on our cash from operations can be found in the MD&A, as well as the slide deck we posted earlier this morning.

As we have said many times, given normal fluctuations in the working capital elements from quarter-to-quarter, we suggest that investors analyze cash generation on a trailing 12-month basis. With that in mind, excluding the integration-related cash disbursements, our trailing 12-month cash from operations is $949 million, or $2.98 per diluted share.

Turning to the balance sheet. Net debt stood at $2.7 billion at the end of March, representing a net debt-to-capitalization ratio of 35.6%, down from 39% sequentially and 43% year-over-year. At the end of the quarter, we had approximately $1.5 billion of liquidity available to continue profitably growing our business.

Now I'll turn the call over to Mike.

Michael E. Roach

Thank you, David, and good morning, everyone. We delivered very solid performance in the quarter, as we continued to execute our business model on a global basis for the benefit of our clients and shareholders.

As European comparisons become meaningful with each quarter, the significant positive impact of our integration plan is now more visible at the operating level. In other words, the expected benefits continue to materialize.

During the quarter, the company booked $2.9 billion in contract awards, of which 40% were new business. This represents a book-to-bill ratio of 105%, both for the quarter and on a trailing 12-month basis. Revenue of $2.7 billion in the second quarter is up sequentially and year-over-year, reflecting our ongoing ability to convert and expand the pipeline of opportunities in the bookings and ultimately high-quality revenue.

In addition, the planned runoff of low- or no-margin business across Europe was more than offset by a FX tailwind, as global currencies strengthened significantly against the Canadian dollar during the quarter. The magnitude of our planned business runoff is diminishing, while the positive impact on the bottom line is becoming more apparent.

As I mentioned previously, one aspect of our strategy to increase the quality of revenue beyond project runoffs is the divestiture of businesses which are not core to our client value proposition or that are underperforming.

In this regard, to date, we have divested approximately $24 million of annual revenue, which was generating a negative 12% margin. This is an ongoing initiative as we continue to identify areas of the business that meet our divestiture criteria.

Adjusted EBIT grew 31% year-over-year to $341 million, representing a strong 12.6% margin and driving EPS improvement of 29%. We continue to focus on the fundamentals required to meet or exceed our goal of realizing $375 million in annualized cost savings as articulated in our integration program.

Cash generated from our operations were $350 million and over $400 million excluding integration-related expenses. This is indicative of the effectiveness of our business model, the quality of our contracts and our ability to generate increased cash from operations as we complete the $525 million investment embedded in our integration program.

In Europe, quarter 2 book-to-bill was 125%, marking the third consecutive quarter above 100% and was evenly distributed across the key operating segments. As I mentioned on our quarter 1 call, while markets across Europe continue to strengthen, we remain focused on finding clients to longer-term contracts, adding high-quality backlog necessary for profitable growth and operating stability.

A good example is our U.K. operations, where after pruning a significant amount of the revenue base of low-margin business, posted constant currency growth of 2.5% while EBIT grew by 32%.

Adjusted EBIT across Europe was up $82 million year-over-year to $208 million, representing a margin of 12.7%. European revenue and EBIT accounted for 61% of the global totals, demonstrating the effectiveness of our integration program and our ability over time to improve the fundamentals that underpin our acquired business.

In summary, these actions, when combined with strengthening marketing conditions, create additional opportunities for us to continue to improve our performance over time.

Now turning to North America. Revenue in Canada was essentially flat both sequentially and year-over-year. However, book-to-bill was an impressive 121%, the highest point in several quarters.

As mentioned previously, in addition to targeting new clients, we're also focused on successfully renewing and extending existing relationships with marquee accounts across Canada. As an example, I would draw your attention to the recent extension to 2026 of our wealth management work with the TD Bank Group.

Adjusted EBIT improved by $20 million year-over-year to $94 million, representing a margin of 22.3%. This industry-leading profitability reflects an ideal mix of long-term recurring revenue, IT-based services and solutions and an ongoing commitment to operational excellence.

Consistent with last quarter, the U.S. operations were impacted by the temporary imbalance of resources assigned to projects with major milestones, notably state health-care exchange work. In addition, utilizations rates were temporarily impact by our wind-down of the work that we successfully executed on the affordable health-care project. We made important progress with these clients in quarter 2 to better align expectations and clearly outline deliverables within a financial framework designed to reduce future financial exposures. With delivery commitments complete or in transition, we expect U.S. margins to trend back upward for the balance of the fiscal year.

Similar to our competitors operating in the federal government market, CGI's federal performance continues to be impacted by budget headwinds and ongoing delays in procurement decisions, which resulted in most bookings being bridges or extensions to existing contracts. Currently, we have $1.5 billion in bids submitted and awaiting award, of which more than half are expected to be awarded in this current year.

Our analysis of the federal marketplace supports the view that our level of recurring revenue combined with the diverse book of business has better insulated us from the current market conditions when compared to the pure-play government companies.

We continue to see commercial activity picking up across the U.S. as clients increase their technology investment. The result is an expanding commercial pipeline with notable strength in the financial services and manufacturing.

In fact, more than half of the deals expected to close across our enterprise market during the second half of the fiscal year are in the commercial sector.

In line with our balanced global delivery model, we are making additional investments to build out our onshore global delivery network by investing in a new center in Lafayette, Louisiana. This represents our fifth onshore center in the United States and brings with it an increased stability to offer our clients, both government and commercial, greater value in terms of their delivery options, adding to our ability to win new business.

Finally, I want to reinforce our commitment to remain a well-managed and financially strong company delivering superior results over time. Consistent with this philosophy, we are committed to focus on the fundamentals that are necessary to create and share wealth with our investors.

Accordingly, I would like to take this opportunity to reinforce that we are not compensated for performance that is advantaged or disadvantaged by currency gains, onetime tax benefits or adjustments to acquisition-related provisions, as was outlined this quarter.

Thank you for your continued interest and support. Let's go to the questions, Lorne.

Lorne Gorber

Just a reminder, a replay of the call will be available either via our website or by dialing 1 (800) 408-3053 and using the passcode 9676329 until May 9. As well, a podcast of the call is available for download within a few hours. Any follow-up questions can be directed to me, as usual, at (514) 841-3355.

Melanie, if we can poll for questions from the investment community, please.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Jason Kupferberg of Jefferies.

Jason Kupferberg - Jefferies LLC, Research Division

Nice job on the cash overall here for the quarter, good recovery there with the DSO. But I did want to ask you about the disclosure about the receivables that you sold, I think, about $75 million in the quarter. Does that gave some of the quarter-over-quarter benefit in cash flow? Can you talk a little bit about the nature of those receivables and whether or not you intend to potentially sell any more receivables during the rest of this fiscal year?

David R. Anderson

Well, thank you, Jason, for the question. We do, as a matter of course, have some factoring or receivable programs in place. So there was just one particular one that was of a little bit of a larger size that we had specifically called out here and disclosed. It is something that -- this one is an annual activity. We were expecting to have the cash in before the end of March. It will be -- we will be receiving it in this next couple of weeks here. And I don't really see it as being a major issue or I don't see it as an issue at all here, just something that we are looking at trying to optimize the cash going forward. And from a cash flow perspective, the amount of interest that we actually have to pay on this for the discounting is actually lower than the credit facility. So it comes up with a better financial solution for us to have done what we have done here.

Jason Kupferberg - Jefferies LLC, Research Division

Okay. So in other words, you've done some other similar types of sales in the past, just on a smaller scale?

David R. Anderson

Yes, they are. Yes..

Jason Kupferberg - Jefferies LLC, Research Division

Okay. And can you just talk about some of the other portions of the working capital aside from receivables? Obviously, receivables was where -- was the huge source of improvement. The DSO came down, which was great. But I'm trying to just get a general feel for how you guys think cash flow may play out in the second half of the year? I know you've talked about eventual kind of annual targets of roughly $1 billion in operating cash. Not sure that that's realistic for this year in particular, but how should we be thinking about, directionally, the cash flow trends in the back half, putting aside the remaining integration payments?

David R. Anderson

Yes. I think, here again, as I have stated in the past, is that over the longer term, and that they were the 12 months, and that's why we really keep focusing, keep on looking back at 12 months' worth of cash generation, not just on the quarterly basis because of some of the variations that can happen in the quarter, is to -- is that the change in the working capital itself should pretty much balance out over the 12 months. So if you take a look at the chart that was posted with the deck this morning, it does try to highlight what the net earnings are, what the noncash items are, to come up with a number before the working capital. And that should at least give you a base from which to go from. And then with that, then you can adjust it according to where you think that the integration payments are going to be coming in versus the changes in the cash flow over the quarter. And again, like with milestone billings, et cetera, it does have the tendency to have some variation on a quarter-by-quarter basis, but should roughly balance out over the 12 months.

Jason Kupferberg - Jefferies LLC, Research Division

Okay. And then just to quickly switch gears onto the top line, I mean, I thought the U.K. comments were kind of an interesting case study in terms of how you've repositioned the portfolio. Then I think you mentioned that you did generate some positive constant currency growth there. But overall, obviously, constant currency growth was slightly negative this quarter. How are you guys thinking about trajectory going forward there? Because it does sound like you're getting closer to the pruning of the lower-margin business in Europe. Should we be thinking that over the next couple of quarters, the overall number can get into positive territory in constant currency terms?

Michael E. Roach

Well, currently, this is what we would hope for. I think what I was telegraphing that it's starting to diminish. So, in fact, on the U.K. side, as I say, we've now switched over to positive growth. And again, clearly the integration plan, Jason, as I articulated over the last couple of years, is that once we bought them out there, we should start to see us gradually turning the corner. And that's why in the second year of an integration we're focusing heavily on the business development side of the equation. And accordingly, you're seeing the impact of that on the book-to-bill in Europe, and eventually, that will flow down to the top line growth. So that's the track that we're on. But again, it takes some time. And I also called out this time because I don't often talk about it. But meanwhile, in addition to just the running off these low-margin contracts, we're actually -- have identified a portfolio of assets that do not align to our customer proposition or that are not as profitable as they need to be. And we're steadily divesting those. They're -- individually, they're quite small. But collectively, as I say, they're $24 million a year, with a negative margin of 12%. And believe it or not, as we divested that, we actually got cash back for that, not a significant material amount. Net-net, a good business proposition for the company. So yes, the intent is as we bottom out, as the effort on business development takes hold, as that book-to-bill trends -- translations -- transforms into top line revenue, we hope to cross over.

Operator

The following question is from Maher Yaghi of Desjardins.

Maher Yaghi - Desjardins Securities Inc., Research Division

I just want to say, guys, for a company that generates $10 billion in sales, your disclosure of a few hundred -- $10 million, $50 million of changes quarter-over-quarter is somewhat very, very good. And I applaud you for that intricate detail in terms of disclosure, which sometimes people can take negatively, but overall, I think it's good for investors.

Michael E. Roach

Yes, thank you for that, and we take that very seriously. I think it's also important that investors understand what the pure operations are generating, as I say, excluding things like tax benefits and these type of things.

Maher Yaghi - Desjardins Securities Inc., Research Division

So just when we look at the business in general, in Europe, we're seeing nice improvement. I just want to go back maybe to the U.S. side. On the defense side, we've seen the results from competitors highlighting some delays in contracting work on the defense side. Can you talk a little bit about -- you mentioned the backlog there sitting potentially with contracts awards coming in, in the second half. Can you maybe talk a little bit about your expectation for the U.S. business? And how do you see it improving potentially in the second half in terms of margins as well?

Michael E. Roach

Well, again, I -- first off, my assessment is -- and I just came back from our quarterly federal subsidiary board meeting. And it's quite apparent that the impact of the budgeting exercise in the U.S. continues to push work to the right for the whole industry. And while we clearly see some year-over-year pressure there, our assessment is still that our mix of business, split between both defense and civilian, our high recurring revenue, our mix of IP and services, still puts us in much better shape than some of the pure plays who are much heavier into the areas of defense and, to some degree, civilian that turned out to be much more discretionary than the areas we're in. So while we expect some top line pressure year-over-year in the federal business, we still believe that we can generate some healthy margins there and the associated cash. Whether this thing will actually break loose in the fourth quarter, I don't expect to see a lot of awards in the third quarter. If there is some sense that maybe in the fourth quarter, some of the budgeted money will have reached the operating level and that the contracting officers will be able to start moving away from extending existing contracts to new -- awarding new business. My own feeling right now is not likely to happen in the third quarter. It could happen in the fourth quarter. So again, our focus in the federal business is to continue to work very closely with our client, probably bid more of the task orders, the smaller, quicker-turn task orders that are available under the significant amount of vehicles that we have. As you know, we've got about 50 vehicles to bid on. So I think we can do more there in focusing on task orders while we wait for the pipeline to begin to clear. On the other part of the U.S. business, as I mentioned, we've been impacted by a need to dedicate more resources to the projects that have major milestones that are also linked to our cash. And again, I highlighted the state exchanges. But on that front, I feel better about where we are now. I think we've made a lot of progress with the clients in second quarter. We have a much better alignment on our expectations and responsibilities between us and our client. We have a much better handle on the deliverables. And we've attempted to work in each of these cases within the financial framework that's really designed to the extent possible to limit our exposure really to the first half of the year and put us in better shape in the second half of the year to actually see a recovery in our revenue and margins in the U.S.

Operator

The following question is from Richard Tse of Cormark Securities.

Richard Tse - Cormark Securities Inc., Research Division

Yes. Mike, so now that you've got Logica pretty much, it looks like, under your belt here, what do you see as other opportunities for acquisition, say, over the next 12 to 24 months?

Michael E. Roach

Well, as you know, our industry continues to consolidate. The Steria-Sopra announcement is another piece of the consolidating puzzle here. I would say that, as I said before, we're still obviously very interested in acquiring assets that are in line with our overall strategy. We continue to analyze and study and discuss with other businesses what their long-term strategic aspirations are and how we could meet them together. My sense is, in the near term here, we're probably more focused on discussions. And our management and leadership time is focused on really completing the Logica acquisition, slowly bringing down our debt, buying our shares as opportunities present themselves and really continue our work on ensuring that the operating model is optimal. And while we've made significant progress in Europe and, again, I really applaud the team we've got on the ground there, there are still opportunities there to improve. I think as we've now put in our financial system around the world, our line operating people are much -- in a much better position to identify opportunities here to drive performance. So I think from a shareholder standpoint, we create more value here by continuing our focus on the operations for the next 6 months while continuing to analyze and have discussions for assets that might be interesting to us should the opportunity come forward. Again, U.S. is a very accretive place for us in terms of an acquisition. And again, IP-based services and solutions are also an area that are of great interest us. Maybe one other thing is that one of the trends we're seeing globally now is many international companies are consolidating the number of vendors, in some cases, going from hundreds of vendors down to 15 or, in some cases, less. One of the things we look at is, frankly, some of those smaller vendors that may be currently working with a client who may have unique industry expertise that benefits the customer. These are also companies we will look at in terms of acquiring them and, in doing so, add to our business knowledge, add to our benefit to the customer and, in the process, improve our chances of making that short list of preferred vendors.

Richard Tse - Cormark Securities Inc., Research Division

Okay. And then with respect to Europe, you guys have target operating margins, I suspect, there, like how close are you to getting to that point? Or is there still stuff that you're still uncovering as you announced with the integration?

Michael E. Roach

Well, again, I think honestly, Richard, there's always things we uncover. The thing that we've got to continue to work on is anticipate opportunities, get on them faster. And that takes time; that takes experience. It takes time for people to work with the information that the systems are now producing. So again, my sense is there will be fluctuations in the margins in Europe. For example, I think the quarter coming up, there's 3 less billable days in France, as an example, because of the holidays. So there will be some seasonal adjustments there. But again, what I'm pleased about is, if I look across the European operations, we started to build some consistency here in our ability to continue to generate very solid margins across Europe and across the various countries that make up our European business.

Operator

The following question is from Justin Kew of Cantor Fitzgerald.

Justin Kew - Cantor Fitzgerald Canada Corporation, Research Division

Great. So, Michael, just if we look at EBIT margins in France, they were particularly strong, at 17.5%. Was there anything in that, where that was -- that stood out? Like you did talk about billable days going down for -- in a -- there could be some, on the top line, some compression there. But was anything that stood out in the quarter for France?

Michael E. Roach

Well, again, I -- first, I want to say that the France operation has been a very strong performer within the integration. There's a lot of time and material business there. And of course, as you increase your utilization rate in that line of business, your margins increase. But as we pointed out in the MD&A, the -- there was a impact relating to the reversal of the acquisition-related provision adjustment in France in the month. So this is one of the reasons, again, that we're very transparent, so that you're able to understand where those type of adjustments are actually impacting the EBIT and, ultimately, the NPS -- the net earnings. So again, solid operations, obviously a temporary uplift in the quarter associated with that reversal.

Justin Kew - Cantor Fitzgerald Canada Corporation, Research Division

Okay. And then just going back to Richard's question, just in terms of seeing acquisition and opportunities on the acquisition side, where are you seeing those? And do you know with the large -- now based on the Logica side, are there -- do you see more opportunity with kind of tuck-on acquisitions on the European side as well as the U.S. side?

Michael E. Roach

Yes. I think if I could give you a bit of a context, I think if you look at the company acquisitions over the last 10 years, we've essentially been growing very wide. So we've been extending our footprint and our reach in the markets that our customers are operating in and in doing so, better position us to retain those clients and actually grow our share of wallet with them. Our sense right now is that we should be going deeper into various verticals in which we operate. And again, I give you the example of various customers in manufacturing or finance that are consolidating vendors and picking up unique or competitive skills and knowledge through tuck-in acquisitions that better serve those customers, and those verticals is important to us. IP-based service systems and solutions are very important to us. As I mentioned numerous times, we now have a much larger market and network to pull through the services and solutions associated with IP, which makes the opportunity for us to acquire in that area and reach our accretion goals much more realistic now post-Logica than it was previously. So we're looking at all those areas. On the other side, though, we have to keep our eye on the type of transformational deal, à la Logica, that might come available, that would allow us to take another kind of large step forward in building out our capabilities and footprint around the globe.

Justin Kew - Cantor Fitzgerald Canada Corporation, Research Division

Okay, good. And then just final question, so the U.S. side on -- we should see an uptick on -- kind of in the second half. What is the quantum of how that plays out? Do you think it's -- is it kind of a linear between Q3 and Q4? Or is it more kind of Q4-weighted?

Michael E. Roach

Well, it'll be gradual. But as I said, our -- what we attempted to do here was, frankly, limit the kind of impact that some of these contracts are having to the first half of our year and to put this behind us and move forward to a more normal state, if there is such a thing, in our business in the U.S. I mean, I have to kind of reinforce again, we've got a great franchise in the U.S. run by very, very good people. Clearly, some of the work around the health exchanges have temporarily had an impact on the business. But again, much like the federal side, we're confident that we can work through this and put the customers and us in a better place. I'll take the opportunity again to reinforce, despite what you hear in the papers, we have not been fired from any health exchange. We have not received a letter of termination for cause or convenience from anybody. So the reality on the ground versus the perception in the press, there's a big gap there. We're dealing on the reality side here, and we're taking what I consider prudent business actions to ensure that -- as I mentioned, that we have a better alignment of expectations and that we're clearer on what deliverables need to be realized, all within the financial framework here, and to ensure that we get paid for the work that we've done. So we're working through that. Obviously, a conference call like this is not the place to go deeper into it. But I just want to reinforce again that our company, when it comes to the health-care business, were -- was hired by the federal government and numerous states, and we have not been fired anywhere.

Operator

The following question is from Scott Penner of TD Securities.

Scott Penner - TD Securities Equity Research

Mike, could you just spend just a minute and describe the U.S. government project from Stanley that's mentioned in the MD&A, whether this is a deal, for instance, where a renewal maybe didn't meet your hurdles and is being discontinued? And then any sort of help you can give us to quantify the impact and whether this is something that will affect the next 3 quarters' year-over-year comps, for instance.

Michael E. Roach

Yes. No, it's a good question, Scott. Again, in full transparency, this was probably the last significant piece of the Stanley acquisition that really fell in that category of significant revenue, of very low margin. And again, in our approach to acquisitions, in some cases, you have to let those contracts run the term, because you can't sit down with a customer and say, "I don't like the margins. I want to wrap it up now," especially when you're dealing with a marquee client such as we are with the U.S. federal government. So this contract actually has been running down for 2 or -- quarters or so. And what is happening is that in this quarter, it finished. And to give you some idea, the contract value is roughly $100 million. But during the runoff period, our team on the ground was able to backfill about $80 million of other higher-margin business. So again, as is happening in Europe, in this case, we took a hit on the revenue temporarily here because, again, our intent is to continue to backfill revenue with higher-quality revenue. But actually, our margins and our cash flow actually improved as a result of the -- of that situation.

David R. Anderson

Those numbers are...

Scott Penner - TD Securities Equity Research

Okay, that's helpful. Just to...

Michael E. Roach

Those are annualized -- sorry, those are annualized numbers, obviously.

Scott Penner - TD Securities Equity Research

Right. Just, yes, on the same kind of theme, maybe this is something better for David, just looking at the go-forward, yes, EBIT margins in Europe, you called out the $11.7 million adjustment that's in EBIT. But are there -- just in reading the MD&A, there's obviously that $10.6 million in France from the renegotiation. Is that a onetime item? Or is the $11.7 million the kind of adjustment we should make when thinking about going forward?

David R. Anderson

No, the $11.7 million is for all of the geographies, and this -- and it is really related to the -- what we had called the PPA. These are the acquisition-related provisions. So had we not have the 1-year cutoff, these would have been items that would have gone against the balance sheet, not had been benefits flowing into the P&L. There are some other actions which we have taken, some in France, some in a couple of the other geographies that we've called out here, that are onetime items. And that's why we itemized them in the MD&A, so that you would be able to get a better perspective as to what the out periods could look like. So again, just trying to give you some transparency, some visibility so that you don't run off thinking that France is going to be able to repeat a 17.4% EBIT next quarter. Even my own perspective is that's a couple of points too high. But we want to give you some numbers so that you can then make your own estimates and judgments from that. And Mike had also mentioned, in the case of France, we had -- there's going to be 3 vacation days coming up in May, which we're just keeping a pretty close eye on just to try and understand what the financial impact will be of those.

Michael E. Roach

Just to add to that, a number of those items, like the rent one, are actually part of our integration program. So what you'll find, there's a number of those, and we did call out throughout the whole time that on the leasing rent part, there were items that would take longer for us to actually materialize the benefit. So that's one example. Another example would be the action we took in one of our geographies to address a wind-down of a defined...

David R. Anderson

Nordics.

Michael E. Roach

Pension plan. And again, these are things that we identify and have done in North America to limit our exposure going forward. But it does take time to actually execute those. So again, as they get executed, as part of the integration plan, you'll see those benefits appear in the various geographies.

Scott Penner - TD Securities Equity Research

Mike, do you have the -- of the bookings in Europe, the percentage that was new business this quarter?

David R. Anderson

45%.

Michael E. Roach

Yes, about 45%. I think the flip side of that is the renewal rate is extremely high. And again, we've been able to shape those deals better in terms of bringing benefits to the client and margins to us. And again, one of the things that we have made significant progress, and that's what you're seeing in these EBIT numbers in Europe, is we have driven down the SG&A and overhead significantly, over, I would say, at least 5 points, which, again, you're seeing that drop right to the bottom line and also making us more competitive in terms of recompetes and new business.

Operator

The following question is from Paul Treiber of RBC Capital Markets.

Paul Treiber - RBC Capital Markets, LLC, Research Division

Just on the U.S. business this quarter, could you clarify, were there any unusual charges or write-downs that impacted the margins this quarter? And then related to that, could you remind us, at what point, you would write down aged accounts receivables?

Michael E. Roach

Aged accounts receivable? I don't write those down because I go and I collect them. Yes, we don't have a habit of writing off aged receivables here, Paul. I guess the only time that would ever come is if the customer, in fact, was out of business. But for the most part, as I say, we have very good contracts, and we have good processes to collect our money. In the U.S., as I said, we took action in the quarter that would design to reduce our future financial exposure. We don't disclose individual provisions against contracts. Obviously, this is something that we do if we feel there could be a risk going forward. But as a normal course of business, it's obviously not something that we would put out there for our clients to see, especially if we're in discussions. But clearly, that action did impact the performance, both top line and bottom line, in our U.S. segment. Accordingly, hence, when I look forward to the back half, if we've been successful in containing it, which I believe we've taken significant steps to do so, hence, the expectation that the business will rebound to a more normal level in the back half of the year.

David R. Anderson

If I could just maybe add to that, there is a principle that accountants have to follow, which is to recognize all losses and bookings in the quarter that they can be estimated. But if you have future gains, you cannot book those. So what we've done here, very simply, is we've come up with our estimates as to what we think the financial impacts are of these projects. We've had the discussions with Stanley [ph] as to make out is it really the right estimate? And then we have recognized that in these accounts, and I think that's where we are right now.

Michael E. Roach

Time will tell as to how good our estimates were.

Paul Treiber - RBC Capital Markets, LLC, Research Division

Just more broadly speaking, some of your peers have mentioned that there's some pricing pressure in application outsourcing. Could you remind us how large is your application outsourcing business and then if you're seeing any pricing pressure in that?

Michael E. Roach

Well, again, as I said a number of times, Paul, as long as I've been CEO, I -- there's constant pressure on the pricing because, in fact, there are more levers and enablers for a company like ours to reduce costs and bring more value to our clients. I'm not seeing any predatory pricing moves by anybody out there. The application maintenance is obviously an area that falls into that first category where there are more enablers to bring down the costs to the client of application maintenance. And again, I would refer you to our decision to open a fifth center near shore -- our home-shore center in the United States, in Lafayette. This type of operation allows us to get a better handle on our costs on the long term and allows us to be more competitive in terms of bidding. There's also a lot more, I would say, process improvement and discipline around application management today than there would have been 3 or 4 years ago. I think a lot of companies, including us, have invested significantly to improve productivity in that area and in doing so, contributes to continuing downward pressure on the top line in that area but also, in my view, over time, really creating more opportunities in a very large market.

David R. Anderson

I would say our application maintenance -- Lorne may be able to get back to you on it -- but I would say it's probably 30% or so of the revenue.

Michael E. Roach

[indiscernible]

David R. Anderson

Yes.

Michael E. Roach

Maybe I'd just add to that is that whenever we are looking at larger bids coming through for application maintenance, we do take it upon ourselves to challenge the team if we have enough working done either through the home-shore or through the offshore operations. So if you remember, we have a fairly large operation in 4 cities within India, we have large operations in the Philippines. So we do have some offshore capabilities that can make it the solutions that we craft for our clients a lot more competitive.

Paul Treiber - RBC Capital Markets, LLC, Research Division

Just lastly, on the cross-selling of Logica IP or CGI IP into each other's installed base, it seems like the pickup in the U.S. commercial space is a good opportunity to do this. Also, just you were approved for cloud services in the U.S. federal space. Could you update us on where you stand in that process?

Michael E. Roach

Well, again, we're still, I would say, at the early stages there in the sense that where we are -- as I've mentioned, we have identified all the IP. We're segmenting it in IP that requires investment to either bring it up to technology standards or to make it more acceptable in the market. We're also looking and are making investment in taking a portion of that IP globally. And in Europe, we have identified a pipeline now of IP that would have originated out of CGI classic that is already fitted to work in the international markets. A good example of that is our Trade360 offering, which is a SaaS offering. It already has a global footprint. And now with Logica, as I said, we have a much deeper client base, so we've put that in front of a number of clients. We've got a pipeline there that we're tracking very closely. We have the same in collections. And on the other side, the -- Logica had and has solutions in the financial vertical, BESS, which is a payment service, and also a fraud system that is very competitive in that space and also an area where financial institutions are looking at very deeply. So it's work in progress. But again, we've made significant steps here in terms of identifying the IP and making the investments, which, by the way, again, back to the whole discussion on cash, it's consuming cash, obviously. But our strong belief is that this part of our strategy is very, very key to us continuing to build a very strong recurring revenue base, have a deeper relationship with the business side in addition to the IT side that we already have with customers and also helping us to increase both margins and cash flow over the long term.

Operator

The following question is from Thanos Moschopoulos of BMO Capital Markets.

Thanos Moschopoulos - BMO Capital Markets Canada

Mike, it's actually just on the outlook for the U.S. federal and U.S. commercials businesses. I don't think you touched on what you're seeing state and local in the pipeline there, so can you provide some commentary on that?

Michael E. Roach

Okay. I think again, if you look beyond the health exchange business, in some cases, there are opportunities there for some follow-on business, probably won't get as much publicity as it would under normal circumstances. But again, we are the experts in the health exchange business, so we have opportunities to continue to leverage that expertise. But beyond that, I would remind you, we've got a very deep portfolio, especially in the IP side, that relates to the state business. So our Advantage ERP is still the leading ERP in the state and local business. We've put it on the cloud, so we're going downmarket on that. So again, we are going to continue to see wins and bookings in that area. And of course, on the tax side, we continue to work hard with California and present our capabilities to other states, where we can help them collect previously uncollected taxes. And we're also looking at leveraging a solution that we've built in Canada here that helps governments address lost taxes in restaurants and other establishments where people may pay cash. And the work we've done in there would demonstrate a very significant and immediate payback of that solution. So we're looking at how do we get that solution out, not only in the U.S. but globally. So our franchise in the state business is strong. We like the state business, and as you've been -- determined, we have very good relationships with many large states, including California. And again, if you've seen the announcement with Lafayette, you can see again that we have a very strong support in a number of key states for our company and for the products and solutions that we bring to that segment of the market.

Thanos Moschopoulos - BMO Capital Markets Canada

Great. And then just one last one, in Canada, you keep on surprising us in terms of the strong margins and the EBIT contribution there. And so in recent quarters, has that been a function of operational efficiency on the cost side or more a function of the revenue mix in driving up the IP components?

Michael E. Roach

It's probably more of the revenue mix. In some areas in Canada, we still have an opportunity to increase our utilization rates. I mean, in our business frankly, that's the biggest lever we have to drive margins. So it's an area not only in Canada but around the globe where we focus very heavily in ensuring that we know who's unbillable, who should be billable and to call out the plans to increase utilization amongst the designated workforce. So in Canada, even though we're operating at those margins, we continue to look at utilization. I would also say that -- I didn't comment at it, but across the company, the amount of projects that we have in the RED status that relate to financial pressures have come down massively over the last 12 months. And as a result, every time we address that with a customer, we get healthier on the bottom line. So this is a constant focus for us, so you will see various quarters where a number of those projects get resolved and the financials begin to get better, frankly, very rapidly, because we are no longer transferring wealth from our shareholders to the customer shareholders. We're delivering value to the customer and value to our shareholders. So that's another impact that I would say that has helped us drive the kind of margins that we have here across the globe so rapidly. I personally spend a lot of time every month walking through these projects and really ensuring that we're aggressively addressing problems rapidly and correcting them to put us in better shape. And that's still a big opportunity because it's not only projects where you're losing money, as I've explained before. There's margin leakage, where we're delivering the project profitably but not at the profitable thresholds that we built into the business case or the customer proposition. That represents a huge opportunity in all services businesses and one that we're particularly, I think, early adopters that focusing on that as a source of creating additional value for the shareholders and, again, also for the customers because customers don't like to be disappointed. They need us to deliver on time and on budget, and that's exactly what we're committed to doing.

Lorne Gorber

Melanie, we'll have time for one last question if there's one.

Operator

The following question is from Michael Urlocker of GMP Securities.

Michael Urlocker - GMP Securities L.P., Research Division

I'll be as quick as I can. I just want to ask about 2 areas of the business that are probably not especially meaningful financially, but I think they would help us understand the business opportunities. So, Michael, when you acquired Stanley a few years ago, I think at that time the Canadian Defence -- Department of National Defence business was 0 or close to 0 for CGI. I wonder if you could describe whether there's been any improvement there or what the prospects are.

Michael E. Roach

Again, Michael, I -- to be clear, we have not made the progress that we had anticipated there. The procurement environment in Ottawa is much different than what it is in the United States. Canada continues to procure, I would say, manpower on an input basis versus an output basis. So that has not generated revenue up to the expectation that we've had. On the other side of the more of the civilian side of the Canadian government, we continue to find opportunities in there through the shared services and some of the transformational work that they're doing on the civilian side.

Michael Urlocker - GMP Securities L.P., Research Division

So if I were to hazard a guess as a Canadian taxpayer, I think we might assume this tells us a little bit more about Canadian DND procurement than anything else. Is that fair?

Michael E. Roach

A lot of things in life are fair and unfair. I'll leave you to your opinion. But in a business, at some point, you have to allocate your resources where the return is the greatest. And while we continue to look at opportunities in that space, most of our attention in Canada is turned to the civilian side, where there's a lot more investment going on in terms of transforming the government into a shared-services entity.

Michael Urlocker - GMP Securities L.P., Research Division

And then another one that's a small part of your business, but it might be instructive, I did pass through Holland a couple of months ago, and I managed to sit down, not with some CGI people but with others in the IT services industry. As I'm sure you can appreciate the Netherlands as a small country, so anybody in this business seems to be well known, and the sense from the industry at that -- in the Netherlands was that CGI's operation and acquisition of Logica was performing exceptionally well. I think there was a kind of funny commentary that as a foreign owner, CGI seemed to have an appropriate and respectful approach to allowing the local management to run the shop on an optimal basis, so to speak, without interference. So I wonder if you could just put that in a context for us. When you look at your full performance in Europe and the Logica acquisitions, is the Netherlands operation especially more effective than the rest? Or is this just on par that all of the units are now coming to perform strongly?

Michael E. Roach

Again, I would say 2 things there, Michael. The kind of feedback you've got is in line with our operating model. I would say that -- I could stand to be corrected, but I think this is the first year in 3 years that Logica, CGI combined would have made money and generated healthy margins in Netherlands. So again, I think if you look at the integration strategy that we implement, the first year is really focused on restructuring the business, addressing the overhead, making the tough decisions that put us in a better competitive position and also allow local management some breathing space to go the second leg, which is to develop and change that revenue mix. And that's kind of where we are in the Netherlands. The team is working extremely hard to bring on additional top line, and that would be similar in some of the other entities. But I would say, for the most part, we've got a good handle on the cost side of the business. We know where there are additional opportunities, and we're focused on those. But the real thing now is to really participate and drive along the economic recovery that seems to be under way in some of the key markets in which we operate in Europe. And I think that gives us a very good opportunity. We did some internal analysis in terms of had we looked at acquiring Logica against today's valuations? And our sense is that we probably would have paid closer to $7 billion as opposed to $3 billion. So I think our sense is there is a significant value in that asset, and our teams on the ground are working extremely hard to surface that value. It will take time, but we're convinced that the actions we took in the first 12 months have laid the foundation for us to take the business to a more consistent higher level of performance over time.

Lorne Gorber

Thank you, Michael. Thank you, everyone, for joining us. I do hope to have you back again at the end of July for our Q3 results.

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