Converge Technology Solutions Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 10, 2023

There are 16 speakers on the call.

Operator

Good morning. Welcome to the Converge Technology Solutions Corp. 1st Quarter 2023 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer Before we begin, I am required to provide the forward looking statement respecting forward looking information, which is made on behalf of Converge and all of its representatives that are on this call.

Operator

All statements made on this call will contain forward looking information. The actual results could differ materially from conclusion, forecast or production in the forward looking information. Certain material factors or assumptions are applied in drawing a conclusion or making a forecast or a projection as reflected in the forward looking information. Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward looking information and material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection as reflected in the forward looking information are contained in Converge's filings with the Canadian provincial securities regulators. Converge does not undertake to update any forward looking statements.

Operator

Such statements only speak as of the date made. Today's discussion may also refer to gross revenue, adjusted EBITDA, Organic growth and adjusted free cash flow and adjusted free cash flow conversion, which are non IFRS measures and has no standardized meaning. Please refer to the Converge's filing of Canadian Provincial Securities Regulators for an explanation and reconciliations to IFRS measures. And I would like to turn the meeting over to Sean Main, HOOPP's CEO. Please go ahead, sir.

Speaker 1

Thank you, Sylvie. Good morning, everyone, and good afternoon to those listening overseas. Thank you for attending today's Q1 earnings call. For those of you who recently participated on the 2022 full year financial results call, we discussed Being well positioned for a strong Q1 that would be comparable to Q4, despite typically being 20% to 25% sequentially lighter seasonally than Q4, which is traditionally our strongest quarter of the year. We are now pleased to deliver these record Q1 results to you today, where we achieved gross sales of $965,300,000 gross profits of $171,600,000 growing by $8,500,000 and $3,400,000 respectively from our reported Q4 numbers.

Speaker 1

We also demonstrated very strong cash from operations, generating $28,800,000 from operations compared to using $30,200,000 last year, a change of $59,000,000 and pointing to very strong cash generation in 2023. Despite current macroeconomic uncertainties and recent disruptions in the market that some believe may point to declining IT spend in certain sectors, Our Q1 performance demonstrates the resiliency of our business model and the continued strong demand we are witnessing from our mid market customers. We are confident that Converge continues to be well positioned to navigate current market conditions, and we generally expect to outpaced market growth rates for hardware, software and services powered by our cross sell strategy and strength and breadth of our practice areas and capabilities. Before I continue expanding on the quarter and outlining the remaining roadmap of our 2023 corporate objectives, I'd like to pass the call to Thomas Voh to make a

Speaker 2

Thank you, Shawn. Good morning, everybody. Over the recent 6 months, The dedicated special committee has been working deliberately through the different strategic alternatives for the company. While there was no shortage of interest, all different alternatives were reviewed and several transaction opportunities were evaluated. Finally, the Special Committee concluded none of these alternatives offered evaluation for the company, which reflects our true potential.

Speaker 2

In cooperation with the financial advisers, the Special Committee recommended to the Board to have the company continue to execute the business plan, Demonstrating the operating leverage afforded by the full integration of all acquisitions, prioritizing organic growth improving our cash generating ability. Based on this recommendation, the Board endorsed the conclusion of Special Committee and approved determination of the strategic review process and hence dissolved the Special Committee. The Board of Directors is fully supportive and confident in management's ability to deliver this plan successfully for the benefit of the company and its shareholders. I will now pass back the call to Sean Ming. Thank you.

Speaker 1

Thank you, Thomas. With the special committee process concluding, I wanted to provide some commentary and outline a few corporate objectives our management team is now able to pursue over the upcoming fiscal year that we believe will help create value for our shareholders. After acquiring approximately $1,200,000,000 of gross sales through 10 acquisitions last year, We paused to focus on integration, cross sell and cash generation. Listening to our quarterly business reviews last Friday, It is clear that the strategy is working, but it's also clear from our stock price that the value we are creating is not currently reflected in the market. Therefore, our Board and management team have decided to prioritize organic growth over acquisitions in the short term to really highlight the success we are Our integration team has completed 20 over 20 integration projects in Q1 with 23 of our 30 non portage companies being fully integrated, And we are targeting to have all integrations complete by the end of the year.

Speaker 1

The combination of the growth of our services and managed services combined with the operational efficiencies, results in strong cash flow. As stated in our earnings press release, We plan on returning capital to shareholders in 2 main ways. The Board of Directors has authorized a quarterly dividend starting with a 1st quarter dividend of $0.01 per share. Additionally, the company will resume purchases under the NCIB and actively buy back our own stock With Converge being the strongest acquisition the company can make today, especially with our stock price at its current levels. Joining us to assist with these matters, I would like to officially welcome Abhijit Kamboj back to the Converge team as our new Chief Financial Officer.

Speaker 1

Abhijit is well known by Many from his time at Dienturham, and we are pleased he is returning to Converge for the next stage of our evolution. Some of you may not know that Ajit was Already a key member of our leadership team during the initial phase of our growth as a private company in 2017 2018. I will work closely with him in his new role As we transform our finance organization and processes, as we look to align to best in class reporting, forecasting and disclosure. Abhijit will assume overall responsibility for finance, accounting, tax, financial planning and analysis along with Investor Relations, which I look forward to partnering with him on to further converge along this growth and value creation path. Turning the conversation back to our earnings results, I'd like to discuss the supporting details that helped secure such strong first quarter results and substantially year over year growth.

Speaker 1

We try to provide transparency about our backlog management as our teams continue create and seize opportunities to land and then expand into a global client base. As stated on our Q4 call, Converge witnessed strong demand in Q1, particularly for its managed and professional services as mid market customers continue to invest in their cloud and hybrid IP journeys. After receiving over 90% of our Q4 backlog invoicing Q1, New product orders that did not invoice in Q1 added $479,000,000 to our Q1 backlog for a total of 5.20 $7,000,000 in our product backlog entering Q2. Given that $234,000,000 of orders that came in Q1 invoiced in Q1, This means we received $713,000,000 in new orders in Q1, showing the strength of demand from our mid market customers For analytics, cybersecurity, cloud and managed service and digital infrastructure and digital workplace offerings. Based on this backlog, at this point in the quarter, Q2 is looking very similar to Q4 with a similar net down since Q2 and Q4 traditionally have a higher mix of software compared to Q1 and Q3 under the new IFRS fifteen guidelines.

Speaker 1

Although backlogs have improved With some product categories like endpoint devices normalizing, network gear and some high end computing platforms still have not normalized, And we conservatively suggest that backlog levels remain elevated for the remainder of the year. The key to our resiliency truly derives from our ability to constantly be bringing scarce capabilities to mid market customers. The best technologies, the best advice and solutions and the highest level of service excellence. That's what builds loyalty and we will continue to support profitable organic growth for Converge. Today, we service a diverse global and balanced customer base As demonstrated by the makeup of our Q1 revenues, with 22% from Healthcare, 16% from Technology, 19% from Government, 12% from Financial Services And the balance 31% spread across various other industries such as manufacturing, retail and automotive.

Speaker 1

As government was the least prepared for the work from anywhere movement during the pandemic, They invested heavily, particularly in endpoint devices throughout. And although require services like managing end user security, The refresh cycle for these devices is in the future, resulting in government hardware spend being down year over year. As endpoint devices tend to be lower margin, we have maintained strong gross profit through services into this sector. However, This is being offset on the commercial side with particular strength in the healthcare sector and we have seen broad mid market demand for our hybrid IT services across all sectors. Notably, our financial sector has remained strong as we have not had exposure to companies affected by the recent regional bank difficulties in the U.

Speaker 1

S. It is an important differentiator and central to our strategy to understand the Key profile differences of the mid market customers. The reason we highlight how many practice areas our sales personnel are achieving is because it demonstrates strong cross selling through over 90% of our sales reps selling more than one practice area And over 50% of them are selling 4 or more of our practice areas. Traditional VARs do not have these capabilities, especially around AI, security and managed services, And mid market customers are really struggling as they try to train their internal IT teams to implement these projects, which are often unsuccessful. As a byproduct of our positioning, we have consistently displayed strong net new logo growth on a quarterly basis once again, and having 103 net new logos this quarter.

Speaker 1

I'd now like to pass the call over to Matt Smith to discuss our financial results in further detail.

Speaker 3

Thank you, Sean. As Sean highlighted, Converge continues to see robust demand for its products and services, which has translated to strong year over year revenue, Gross profit and adjusted EBITDA growth. Beginning with our revenues, Q1 gross sales was $965,300,000 Growing 43% from Q1 last year, which was driven both by acquisitions and organically from companies we've owned in the current and prior periods. Dollar terms, gross sales organic growth contributed $45,700,000 to our Q1 results equating to 6.8% year over year organic growth. On a net revenue basis, company reported $678,200,000 for Q1 2023, Increasing by $184,200,000 or 37 percent from 2022.

Speaker 3

Q1 product revenue, which includes hardware and software, Increased 35 percent to $536,700,000 from Q1 last year. Q1 professional and other services, which includes the net revenue from public cloud resell and product support, increased 51 percent to $106,100,000 over Q1 last year, reflecting the benefit of our ongoing investment in our key consulting practice areas, including analytics, cloud and cybersecurity. Managed Services revenue increased 34 percent to $35,400,000 from Q1 last year, implying annual recurring net revenue today of $141,600,000 Excluding all third party maintenance and cloud services, our Pure Services business for Q1 was 100 And $17,200,000 in revenue terms, we are poised to continue growing this organically in 2023. Looking at our gross profit. Gross profit performance was strong in Q1, growing by 57% from Q1 last year.

Speaker 3

While our acquisition strategy was a key driver behind reported GP growth, organic GP growth was a significant contributor as well organic growth of 16.5 percent in Q1 behind strong software and services growth, meaning that our existing portfolio of companies has generated an incremental $17,900,000 of GP compared to prior year. Reported gross margin increased 25.3% compared to a margin of 22.1% in Q1 last year, largely driven by a decrease in device sales to the Canadian government, which are high volume but low margin that was replaced by higher margin software and service revenue in the quarter. In the near term, gross margin It still reflects the impact of recent acquisitions that sell proportionally more hardware when we acquire them. But as we go forward and execute on cross selling higher margin services, We expect to see margin expansion. Adjusted EBITDA as a percentage of reported net revenue was 6.1% in Q1 compared to 6% last year.

Speaker 3

Adjusted EBITDA as a percentage of GP, which removes the noise of the net down of certain software and services, which we believe is more meaningful measure of how effectively we turn gross profit into Bottom line profit was 24% for Q1 as compared to 27.2% last year. As a reminder, between Q4 and Q1, We've executed on cost takeout that will result in approximately $15,000,000 in annualized SG and A savings with the benefits to be realized throughout 2023. Despite these significant savings, in the interim this metric also reflects the investments made in our services organization, which we expect will yield Finally, looking at our balance sheet, we finished Q1 with a strong cash position of $139,000,000 February, we announced the exercise of our accordion feature under existing credit terms, increasing our revolver credit facility by $100,000,000 for a total borrowing capacity of $600,000,000 As a result, with our cash on hand, plus excess capacity on our revolver, we exited Q1 with approximately $280,000,000 in available In terms of cash flow, we generated cash from operations of $28,800,000 in Q1, Increasing from cash used in operations of $30,200,000 in Q1 last year, representing an increase of $59,000,000 year over year.

Speaker 3

And what is seasonally a lower cash from working capital quarter, we are pleased with the fact that cash from working capital sources increased $46,000,000 from Q1 2022 on the strength of especially strong cash collection from our U. S. Companies. We noted on our Q4 call that we expect cash from operating activities to revert closer to levels we And as expected, our Q1 results reinforce that we're on track to do so. With that, I'll turn the call back over to Sean.

Speaker 1

Thank you, Matt. As promised last quarter, we have broken out financial information on Fortaj Cyber Tech to offer a better indication to investors of its scale, its rapid growth trajectory and ultimately the untapped value of this asset gem. To illustrate, its Q1 revenues are $4,700,000 on track for its next phase of rapid growth. Fortaj exited Q1 with $16,600,000 annualized recurring revenue, up from $15,200,000 at the end of Q4, an increase of 9% in 1 quarter. Fortaj has been helping Canadian municipal and provincial government organizations Responsibly accelerate digital services to citizens across Canada, and it looks forward to expanding these services to the U.

Speaker 1

S. During its expansion phase. In this regard, Converge will be an excellent channel partner for a growing product company like Portage. Portage targets at least 25% As many of you are aware, we concluded 2022 with strong run rate financials on a pro form a basis and delivered Q1 as predicted. We will continue to integrate and gain efficiencies as we focus on organically growing by helping mid market customers on their digital transformation journey.

Speaker 1

With the conclusion of the special process, I look forward to engaging with investors at our upcoming Investor Day and our Annual General Meeting to provide further details on the success we are having with our strategy and our plans to reward shareholders based on operating cash flow. In particular, I will aim to expand on our integration achievements and outline the ESG roadmap opportunities that lie ahead of us. I will now open the floor up to questions.

Operator

Thank You will then hear a 3 tone prompt acknowledging your request. And your first question will be from Robert Young at Canaccord. Please go ahead.

Speaker 4

Hi, good morning. In the release In the comments, you said you received a number of proposals for transactions through this process. So I understand you may not be able to divulge any Specific bids and that sort of thing, but any color here would be helpful. If you give us a sense of where the interest was coming from, what type of valuations, What was the range of multiples that they were looking at? What type of investor was it?

Speaker 4

Any type of color to give investors a better understanding of what happened through this process?

Speaker 1

I'll take one over to Thomas.

Speaker 2

Good morning, Rob. How are you?

Speaker 4

Good morning, Tom. So

Speaker 2

as we stated, we have had Several interested parties from the beginning. We also had several proposals from interested parties, It's different type of alternative in terms of how we want to move and structure the company going forward. But based on That those proposals and then the evaluation, the strategic committee went through together with the financial advisers, It actually led to this conclusion as we described that we believe the company has a better potential going forward as a public company. Now getting to your question in terms of we can't give you ranges or obviously data points It's all confidential, but we can clearly state that we went through an exhaustive process, which included different ways of analyzing the Proposals versus the potential of the company, and we also had, obviously, feedback from several shareholders on their expectations. And at the same time, as we all know, the macroeconomic environment created some challenges also for the interested parties, especially The financial crisis in North America with some of the banks and also with our stock price being under so much pressure, obviously, That also was not helping in the overall process of getting proposals in at the level where we Wanted or shareholders wanted to see that.

Speaker 2

So based on that, we came to the conclusion that at this point, the best it's the best interest of all stakeholders That we continue as a public company, that we execute our plans. And I think what we saw with the Q1 results and the way we how much cash we generate now and how We actually are able to turn our business plan into success. We feel that we evaluated and came to the conclusion that this is In the best interest of everybody.

Speaker 4

Okay. Thanks for that color. Maybe If there's if you're going to pause M and A for a longer period, I think you said short term, Sean, so maybe give us a sense of what that is. And What does a slowdown in M and A imply on your longer term targets? And what are your plans for the cash balance going to be if you're not

Speaker 1

Yes. So with our stock at these prices, the only acquisition that makes sense is buying our own stock. It doesn't make sense for us to look at any other M and A targets with our So we've been definitely investing in our own organic growth. That's something that was already in place and we'll be focusing prioritizing that organic growth And we'll aggressively buy our own stock back.

Speaker 4

What does short term mean like a pause? I mean, are you just going to evaluate in the context of the market or are you setting a frame?

Speaker 1

No, no, no. Ashley is if our stock price was materially to change, we would reevaluate those decisions. We are exceptional at Buying and integrating and cross selling with companies, but at the stock price, it makes no sense to do that.

Speaker 4

And then the cash, are you going to pay down Debt in addition to buyback or would you consider a large one time buyback or a SIB? There's more cash here I think than your NCIB would have.

Speaker 1

Yes. So again, the first step is to continue on the NCIB that we had paused previously. Obviously, With such a strong cash generation, we'll be looking at how we can provide benefits back to shareholders. Also there's the Portage asset that we have as well that can also contribute that. So definitely we're going to be focusing on You've got a small dividend, which allows access to the income investor.

Speaker 1

We'll be actually in the NCIB and then look for other ways of giving back to shareholders.

Speaker 4

Okay. Thanks. I'll pass the line.

Operator

Thank you. Next question will be from Christian Escrow at 8 Capital. Please go ahead.

Speaker 5

Hi, good morning. I feel the enterprise part of the market appears have called out more bureaucracy or red tape Maybe in purchasing decisions, but you've expressed some confidence in

Speaker 1

what you're seeing in the mid market. Is there any comments there

Speaker 5

you could offer on their buying habits, who's making the decisions there? And it sounds like you're seeing no slowdown or uphill battle this year, so far, which is good.

Speaker 1

So what you see in the and when I say enterprise, I'm really speaking to Fortune 500. The way that they purchase is not in the mid market you're buying through the business. In large enterprise, you buy into procurement And they have a network procurement group. They have a storage procurement group. They've got a services procurement group.

Speaker 1

It's done you're 1 of the 3 into procurement. It's a very different buying environment that you go versus the mid market where they're looking for solutions. We have multiple areas all part of one solution. And so when you're decoupled like that in the large enterprise in the Fortune 500, they make decisions to Slow down spending. They'll have refresh rates or projects that during tougher economic times they'll slow down.

Speaker 1

A 3 year renewal will make it to a 1 year renewal. So there's different When you have customer concentration, that's a real issue. Our top 10 customers make up less than 20% of our revenue. Most of our customers Our $1,000,000 to $10,000,000 in size, that's kind of our sweet spot. So you really that well diversified customer base By sector as well, really kind of insulated us during the pandemic and you really see that's where the strength is coming from.

Speaker 1

And these mid market companies Are really struggling to deal with these new technologies. They can't find the resources in cybersecurity that CBI provided to us or in the 5 analytics companies we bought, these are resources they send their internal IT staff on courses and then we'll come by with a Red Hat workshop where they're coming to see Yes. Our experts in the field know why are we trying to do this ourselves? Why don't we let Converge help us with these problems? So that's where our success has really come and really The structure that Greg has put into place around the practice areas and embedding the solution specialists into the regions, we're seeing tremendous success with it both Ozi moved to the cloud and then realized, wait, some of those workloads might come back from the cloud, but in those journeys and being their partner to the business as opposed to the large enterprise to procurement.

Speaker 5

Okay, perfect. And one more question from my end. On the Q2, you called out it will be similar to Q4 and those are the 2 strong software quarters. Just wondering what other color you could provide around maybe how it will be similar in terms of revenue and margin And then on the product backlog, you gave some good color in the opening remarks, but no crystal ball, tough to see how it unwinds, but Do you see all of this giving good visibility into the June quarter end here?

Speaker 1

So first off, I was too optimistic last Sure about the supply chain normalizing, so I want to be really cautious when we look forward. What I see at this point in the quarter and realize this is much earlier in the quarter Then last quarter, we did a call in March where you're pretty near the end of the quarter. And it's not about demand, it's about timing of shipment and things like that. When I say it's looking like Q4, I mean from both a revenue perspective and a net down perspective. You will see our revenue in Q4 and Q1 were remarkably similar, But the net down was very different because now under the new IFRS fifteen guidelines, we had I think it was $30,000,000 more of net revenue in Q1 than we did in Q4 even though gross revenue only was up by $8,000,000 So the net down in Q4, we see similar revenue levels to Q4 With the net down being more similar and similar gross profit and EBITDA.

Speaker 1

So that's a general indication of what we see at this point in the quarter.

Speaker 5

That's all very helpful, Sean. Thanks very much

Speaker 3

for taking my questions this morning. Thanks, Christian.

Operator

Next question will be from Deepak Kaushal at BMO Capital Markets. Please go ahead.

Speaker 6

Hi, good morning. Thanks for taking my questions. I've got a couple, if I may. First on the M and A environment, I know that You're pausing M and A and you said that for a while. But I know you guys have relationships throughout the industry with lots of With lots of companies and you were actively looking in Europe, what are you seeing in terms of private company valuations?

Speaker 6

What are those management Team saying and how has that environment changed in Q1 with the macro?

Speaker 1

We've got a very robust pipeline of acquisition. There's no shortage of companies to buy, but right now the prices of those acquisitions make no sense compared to our stock price. So, yes, We're very good. I think we've done a wonderful job in the last five and a half years of showing how we can go through acquisition. Now we believe the market will Reward us more if we focus on organic growth, and then the best acquisition we can make is our own stock.

Speaker 1

So all the acquisitions are out there in a very fragmented market don't make sense for us right now.

Speaker 6

So is that to say that the valuations of private companies haven't changed in the last 6 months?

Speaker 1

They definitely have. So you have seen some Trends there, but we are not we're never going to be the top bidder. I don't want to say we're the constellation of the VAR world, but we're not far off. And so So when we go in, we usually do not take part in processes. We're usually these are people we know That are we're kind of negotiating 1 on 1 and we buy more hardware centric VARs, we're buying for customers and we turn them into We add the capabilities to turn them into cloud and hybrid IT providers.

Speaker 1

When we buy for capabilities, that's a different kind of story. But This hasn't been something that we've been a part of a lot of processes. I can talk about how those are running. And again, we haven't done any acquisitions since Q4. For us, that's a long time since Q4.

Speaker 1

But yes, we've maintained discussions. When we go around to industry conferences, we constantly are seeing Companies that are in the space and always have very good relationships with them. And so at some point, if it does make We actually have the capabilities to go back on that trail, but at these stock levels that doesn't make sense.

Speaker 6

Okay. Thanks for that color. I appreciate it. And then I know you in your prepared remarks, you called out resilience in the financial services vertical through this regional banking crisis. But when you step back and you talk to your SMB customers as a whole across the board, What are they saying about the regional banking crisis?

Speaker 6

Are they concerned about rising credit constraints? And what are your expectations here on the impact of that Through the balance of the year beyond Q2?

Speaker 1

Yes. So Deepak, I want to be careful about how we define what SMB is. We're selling into mid market, which are not the smaller guys. So mid market kind of for us in the U. S.

Speaker 1

Goes from 500 to 10000 seats. And we went and asked this to all we did the QBRs last Friday. We asked all the regional sales leaders, Have you seen an exposure impact? And the answer is no.

Speaker 6

Got it. Okay. And then I just wanted to clarify, if I may, one last question, maybe for Matt. What was the targeted annualized cost savings in SG and A this year? And what can we expect from non recurring costs, The cash drag on that for the calendar year, for the fiscal year this year, just to set out our EBITDA versus cash flow expectation.

Speaker 7

Yes. Deepak, you saw

Speaker 3

some non recurring costs in Q1 in our special charges related to the amending in our credit facility in Q1. And obviously some costs associated with buying back 25% of RedNet. So you will see the nonrecurring costs kind of taper off in Q2 to Q4, as we focus on organic growth, we did realize savings from the SG and A takeout in Q1. Some of that is offset, as I mentioned in my remarks, with the investment in our services organization, but you will see that savings Spread out through the balance of the year.

Speaker 6

Okay. And did you say in your prepared remarks $50,000,000 in annualized SG and A savings? That's the target?

Speaker 3

$15,000,000 cumulatively between Q4 takeout and Q1 takeout.

Speaker 6

Okay. That's 5.0, right?

Speaker 3

15, 15, sir.

Speaker 6

15, okay. Sorry, apologies. I missed hearing everything this morning. I appreciate you taking my questions and I'll pass on.

Speaker 1

Thank you, Pat.

Operator

Thank you. Next question will be from Rob Goff at Echelon. Please go ahead.

Speaker 8

Thank you very much and good morning. Active. And in turn, how does that impact your outlook on dividends or potential

Speaker 1

Maybe I can abjit, can you handle just our philosophy on the dividend?

Speaker 7

Yes. Actually, maybe I'll just talk about the capital allocation as well. I think what you're hearing about the acquisitions, the company is really playing to its strengths. What we're good at and what our skill set is, We're great capital allocators. We're making the capital decisions based on what we see in the market.

Speaker 7

And as Sean mentioned, the best allocation of our capital today is Organic growth, so investing in ourselves and investing in our shareholders, and that's where you're seeing the dividends come in. There's few reasons for the dividend we We initiated 1 was to provide some return back to the shareholders and number 2 was to Large and broadened our investor base for value investors or investment investors that only invest in dividend stock. As we move forward, as we prove out our cash flow from our operating activities to prove out our organic growth, We will continue to evaluate growth of our dividend as well. So capital allocation from our perspective is not a Set in stone decision today, we will continue to evaluate where our best capital is and the worst invested.

Speaker 8

Thank you. And as a follow-up, you did discuss the $15,000,000 of annualized Savings. How should we look at the Q on Q progression of net savings As we go through the year and to what extent should the integration onto one platform realize additional savings?

Speaker 1

So as we've mentioned, we've got 23 of our 30 non Portage acquisitions that are fully integrated. We've got some big ones that we acquired last year that are still to be integrated. And As we go through and have that completed before the end of the year, that will provide additional synergies. Again, as Matt mentioned in his remarks, We've also invested in our services. Going to a growth model where you're adding salespeople and more particularly engineers Means you're making those investments.

Speaker 1

We now have growth reps where as before we buy basically buy companies for the salespeople and engineers. You're buying sales reps. Now we're looking at a growth model for there and both to our services organization. So there is some offsets. As you Part of the not buying additional companies means it provides much more clarity on that cross selling growth.

Speaker 1

And so there is The synergies you're getting from your integration and then the investments leading to the higher growth, particularly you see that strength in the higher gross profit growth and then you see the synergies happen later on in the year As those resources become fully utilized.

Speaker 8

Thank you very much. Good luck. Thanks.

Operator

Next question will be from Jerome Dubreuil at Desjardins. Please go ahead.

Speaker 9

Yes, thanks. Good morning, everyone. So just to continue on this $15,000,000 synergy savings, how should we approach that? I'm guessing it's Not just taking the current SG and A annualized that do minus 15%. Is this some sort of the same percentage Throughout the year and then removing $15,000,000 just so we take into account the growing scale of the business.

Speaker 9

So if you can just Work us through the mechanic of the $15,000,000

Speaker 1

Yes. So that is a headcount savings that you've seen in that reduction based on the synergies From our integration efforts, you'll continue to see those, but I think we'll fully elaborate these more on the Investor Day and at the AGM Where we can provide a more robust model because you say there are a lot of moving parts and we'd like to provide more clarity on that. So, if you give us a chance to come back to you, It is out just first day as well, so

Speaker 7

And maybe just to help you from a modeling perspective, as Matt and both Shawn both mentioned in their remarks, We did have $50,000,000 annualized savings, but that was offset by investments we're making in our internal capabilities. So as we realize the benefits from these from a modeling perspective, I think

Speaker 9

And then second question, We used to talk a lot about how our revenues from the managed services operation were trending. Is this a renewed focus with the change in terms of the strategy or we're focusing on what we used to do?

Speaker 1

No, no, absolutely. Managed services is a key focus as is our services, services and managed services. And when you why we point so heavily to 53% of our reps in North America are selling 4 or more practice areas, including managed services. That recurring revenue, the high margin recurring revenue It's of highest value to us and it's very differentiating. One of the reasons we also went after kind of Education and Healthcare customers last year with more logistics operations is because With those multiple touch points, it's either to transition to additional managed services.

Speaker 1

So absolutely, managed services is a key part and growth and focus for us. And really what we've added, we've added a lot. And so what used to happen in 2020 is pretty well quarter over quarter you're seeing the massive Our gross profit got over 27% in Q3 of 2020. I think EBITDA got to 8% in Q4. It takes longer when you buy $1,200,000,000 of revenue to make those adjustments.

Speaker 1

And so that's where you'll see it happen over this year, but it's not as much quarter over quarter we need a little bit more time.

Speaker 10

And the other thing I'll mention is when you think about our Investor Day, right, we will focus on our AIM strategy. We talked about this on the last call, our ability to advise, implement and manage. So It's not just about managed services. You have to look at it holistically as professional and managed services because we're driving those high value services with our clients and that's going to touch all three components there.

Speaker 1

So Yes. Gerald, that's Greg Groder, Bolzio.

Speaker 9

Yes. And then one last one, just because The strategic shift is significant from what I can understand. It also gives you an opportunity to look more at your own business and you touched on the integration On Rod's question, but is there maybe examples you can provide on what there was I thought that there was room for improvement for in terms of maybe the cross sell, some products that are not well sold across All the acquisitions you've made and maybe in terms of financial dashboard, maybe improvement that you can see going forward?

Speaker 1

So all of the above, right? When you integrate companies until you get great porting, it makes the cross sell harder. The thing that really stood out to me at our QBRs last Friday was what a great job, Greg and the team have done In embedding the security architects into the region, the CBI acquisition and how well that's worked and where That's the model that we need to perfect around managed services and all the different practice areas where we've been so effective in cross selling all of those High end cybersecurity services around those accounts and the reps are doing a great job of it and just making sure the rest of the groups have that as well. So Definitely, when you buy again, we bought some a lot of companies last year, a lot of revenue and getting that right will make it more effective to do these things. You see the That's all ready and it's just driving more of that success into those accounts.

Speaker 8

Great. Thank you. Sure.

Operator

Thank you. Next question will be from Gavin Fairweather at Cormark. Please go ahead.

Speaker 11

Hey, good morning. Just going back to the mid market, what are you hearing from customers on Overall budget levels this year versus 2022?

Speaker 1

Yes. That's the weird part. We have not again, we really but Greg was really focusing that And on that with all the regional sales managers, in the U. S, we have not heard about eroding IT budgets in the mid market. So they have all these projects that they They are behind on moving to the cloud, move to hybrid IT environments that they still need help.

Speaker 1

I mean, there's still scarce resources. So Again, not SMB, not Fortune 500, but in the mid market, we have not seen shrinking IT budgets in the U. S.

Speaker 11

Got it. Good to hear. And then just secondly, you've mentioned a few times the investment in managed services and professional services capacity. Can Can you give us a sense of the magnitude of the organic investments that you're making, the number of heads that you're adding? And how should we think about kind of what's been added in recent quarters versus

Speaker 7

What you're

Speaker 1

going to

Speaker 8

add over the balance of 2023?

Speaker 1

So part of this and we'll really expand on this in the Investor Day is when you have the regions Identified that you have to have local presales support in architects in regions to effectively get the cross sell. So in the U. S, we have 5 regions and 1 in Canada. So embedding those practice areas, so you buy a CBI, you need to make sure that those are all represented in the region. So especially on the sales enablement side and those pre sales architects which are partially billable, they really need to be in region.

Speaker 1

So you're Adding those people, but we'll provide more of the quantum of that in the Investor Day.

Speaker 11

Sorry, go ahead.

Speaker 2

I was going

Speaker 10

to say one of the things to think about right is the presales solution architects and the solution specialists in region and then also some of the investments we're making around some of the solutions we've built Like IP4G, like IBM Guardian's data protection solution. So not only are we making investments in resources, but also in building out The technology and the solutions that our clients are driving, right? So we're seeing the momentum behind some of those solutions that we announced in the second half of last year Really take hold now and the pipeline is growing significantly. So think of it as an investment in resources in region. So we align with the account execs that have the We'll talk more about that at the Investment Day.

Speaker 10

But You need to think about not only investment in resources, but also investment in solutions and building some of those out to drive deeper capabilities across our portfolio.

Speaker 3

Got it. Thanks so much.

Operator

Thank you. Next question will be David Kwan at TD Securities. Please go ahead.

Speaker 12

Good morning. I guess I'm happy to hear That you guys are increasing the focus on buying back your shares, but as well kind of pushing out the acquisition activity, I guess, at least the shares remain at current levels here. I think the extended pause in this M and A activity should help you drive stronger margins. So maybe can you talk about How we should think about your adjusted EBITDA margins here as we progress throughout the year? Kind of what kind of margin expansion do

Speaker 1

you think you can achieve this year? I think again, one of these things that we'll have to do is kind of go through it in more detail at the Investor Day. The timing of this, again, we ask you to be more patient in the transitions, whereas In 2020, you saw it happen, all happened in the quarter, whereas some of these things, the longer sales cycle around managed services means like the investments we made even in Q1 in IP per gs up here in Canada, It will take by Q3 or Q4 to really see the impact of those. So it will happen throughout the year. You'll see the improvement.

Speaker 1

But to really model it out, I think at the Investor Day, we'll spend

Speaker 12

Okay. Thanks, Sean, for that. You talked about Some of these organic investments that you're making, some of these growth sales reps, etcetera, etcetera. Can you talk about the labor markets and how easy it is to try to find these type of people? Or at some point, I know you talked about from an M and A perspective, Particularly North America that you might look to acquisitions, maybe not these share levels, but do you feel that you can meet The customer demand across your various IT solutions just by organic hiring or do you feel at some point maybe you might need to make an acquisition?

Speaker 1

Yes. I think this is a very different labor market. Again, it's amazing how in the last 3 years you've had different labor markets. This is one where you can find people. But also I think One of the things that really attracts high talented, especially in the engineering side, is our teams of existing people that are very specialized And the culture that you create for them.

Speaker 1

Retention, it's not just about money, it's way more about culture. This is a people business and How you retain talent, a lot of times we've been partnering and acquiring with some of the services partners, a lot of it is around culture. So How you attract and retain talent, I'd say a lot of it is culture and but this environment as well has changed. Now None of these resources around cyber or analytics or managed services, these resources don't grow on trees. I mean, these are specialized resources, but people From these spaces, no other good people.

Speaker 1

And what you don't want to be is the only smart person in a group who has to do all the work. So smart people attract other smart people. They love working On cool projects and again with over 100 solutions engineers in each one of our practice areas, We have a critical mass in all of them where we can really make a real impact. So Greg, anything to add to that?

Speaker 10

The only other thing I would add is when you think about it from a sales In the portfolio we have, right, it's easy for us to recruit high end sales specialists because they want to drive the portfolio and value with their clients, right? But Sean touched on it. The good thing for us is we have the ability to train these architects and train these technical resources across multiple practices.

Speaker 1

So it gives them the growth opportunity as well from a career perspective.

Speaker 10

So between the portfolio we have for our sellers and the deep Tech capabilities we have across the solutions, it gives us the opportunity to recruit on both ends.

Speaker 12

Thanks, Greg. And John, last question here. Just on Portage, can you just maybe talk about what you're looking at doing in terms of monetizing your 51% stake there? Like are You're running a formal sales process. What types of transactions are you contemplating?

Speaker 1

So originally, we had planned on going public. The markets have not been conducive To that, so we are exploring several various options to continue Portage and its journey. It's done a super job in Responsibly enabling digital services to governments in Canada and the services they provide to citizens. So it's really how do we best support them and we're looking at a range of options. This market is not one of the best market to look at alternatives, but we keep them all open.

Speaker 1

We're progressing down that path. So we'll keep you updated as we make progress. All right. Thanks, guys.

Speaker 8

Thanks.

Operator

Next question is from Divya Goel at Scotiabank. Please go ahead.

Speaker 13

Good morning, everyone. Thanks a lot for all the color thus far. I wanted to understand, so working capital this quarter was a very important Driver for the overall cash flows. Could you help us understand the sustainability of the numbers? We understand this quarter it was the government contracts With the short order of the government contracts, but how can we model those in on a go forward basis given NCIB dividends, everything else is dependent on that?

Speaker 7

Hey, Divya, It's Abjid here. From a working capital perspective, our strategy and our goal has always been to keep working capital either slightly negative or positive. Ultimately, the goal is to keep it at 0 levels. And from a go forward modeling perspective, I'd say starting from Q3 onwards, that's how we should model it.

Speaker 13

That's great color. On the European expansion, Sean, if you could provide a little bit more color on What are some of the regions where you're looking to expand in some of the industries? The company already has good presence in the education sector and we talked about it. But if you could help us understand where things are going from a broader European expansion standpoint and how are you seeing the markets react overall?

Speaker 1

Yes. So Honestly, we're very, very strong. And what are if you go back to our Phase 1 strategy, Red Hat and VMware were clearly differentiated ways of getting into Commercial sector and we have incredibly strong relationships. John Telstra, he's a strong channel from IBM, has great relationships there as well. But that's the Same as we move from education into the commercial sector, we're able to do that based on a lot of the solutions and successes we had in North America In both Germany and the UK, we will be focusing more on organically than originally it has been planned to do it on M and A.

Speaker 1

But the same type of strategy just happens When you're doing it organically, it takes a little longer to do. But going from education, you've got a base in management, then you're really investing in from kind of the hybrid IT Skills and software into the commercial space in Europe.

Speaker 13

So should we expect if anything, should we expect to see M and A in Europe More than in North America, given that's going to be one of the regions of expansion. And do you have any targets in pipeline, which might not materialize now, but towards the later part of the year?

Speaker 1

So we absolutely have targets in pipeline, but as I mentioned, no acquisition makes sense with our stock at these prices. So we wouldn't do them now, but absolutely we have a long list of targets of

Speaker 7

And maybe just to clarify the capital allocation. Obviously, our goal is to buy back our shares as much as you can at these prices. 2nd would be continued investing in our organic growth. Sarah, would it be looking at external M and A or repaying our debt?

Speaker 13

That's helpful. Thanks, guys.

Operator

Thank you. And your next question will be from Stephanie Price at CIBC. Please go ahead.

Speaker 14

Hi, good morning. Hey. You mentioned that Q2 should look a lot like Q4. Just hoping you can dig into that a little bit. Were you talking Strictly about revenue growth there?

Speaker 14

Were you saying about margins? Or how should we think about that comment?

Speaker 1

Yes. I think all of the above. I think it's a good model to view it as A heavier software quarter and with the backlog being where it is, I think looking very much like Q4 would be a good guidance to give.

Speaker 14

Okay. That's helpful. And then hoping you can dig a little bit more into the growth you're seeing in the managed services business and how you're thinking about ARR targets for the year. I think in the past You provided some.

Speaker 1

Yes. So we're not providing targets, but we are investing heavily in the growth. And so the real investments we've made around IP4 gs, We're seeing that development. So that's something in the Investor Day as well to pay particular attention to is the IP4 gs and how that very specialized solution Allows us to get into customers and then land and expand around those managed services. So these are customers and yet when you provide Very specialized solutions that others don't.

Speaker 1

Again, working in Europe as well where we have the IP4 gs data centers there and providing customer solutions they Cannot get from other people and then from there going and cross selling the other parts of the solution stack. So I think we're using this differentiator. Our Net Promoter Score Remains high over 50. These are key parts of having these managed services customers that are happy that we upsell. The big difference is the sales cycle It's much longer around these deals than it is for our traditional, either product business, hardware software or our services business.

Speaker 1

So the pipeline is what we're kind of we need to have a better way of communicating that to you so you can Better gauge how to look at that, but it's an area we are investing heavily into and we'll talk about more of that at the Investor Day. And Greg?

Speaker 10

Yes. And one other thing I'll comment is we talked a lot about investment Regionally, right. So within the managed services team, we've invested with solution specialists in each region. We also instituted a client success manager program in 2022 Going after our current installs, so we're seeing our upsell cross sell within our managed services portfolio grow. We've seen our overall managed services pipeline grow 60 So we're really seeing the team start to work together and drive more and more transactions across not just IP4 gs, but the entire managed services And that CSM team will help us drive more up selling cross sell across the teams as well.

Speaker 14

Okay, great. That's helpful color. Just one more for me. Just on the Investor Day, I'm not sure I saw a date on that. Has that been announced here?

Speaker 14

How are you thinking about the timing there?

Speaker 7

We have not announced the date yet Stephanie. We will in short order as soon as we We wanted to make

Speaker 1

a chip more than one day before we have to

Operator

buy that. Fair.

Speaker 14

Thank you very much.

Speaker 1

Thank you.

Operator

Next question will be from Stephen Lee at Raymond James. Please go ahead.

Speaker 15

Hey, Sean. I heard you say you wanted to be a little bit more conservative. Are you comfortable with consensus EBITDA at 191 for the year or you'd rather it be a little bit conservative? And the reason I'm asking is because Based on what you said for Q2, so your first half EBITDA is going to be about 84%. And so that would imply 107% in the second half.

Speaker 15

So then second half would be up

Speaker 7

I think as of right now, we're probably in that ballpark, but I think for Your modeling purposes, I would be a bit conservative.

Speaker 15

All right. Thanks.

Speaker 7

And it's primarily driven by all the internal investments we're making. So as we've talked about, we're investing in more and more people internally. That's going to drive our SG and A a little bit higher. And those benefits may start will likely start paying off in Q4. So for the full year, we might not be at the 190 mark.

Speaker 7

So I think from a modeling perspective, If it's a bit conservative, I think that would be better.

Speaker 15

That's great. Thank you.

Operator

Thank you. And at this time, gentlemen, we have no further questions registered. Please proceed with closing remarks. I

Speaker 1

wanted to thank everyone today for participating on our call. We look forward to updating you at both our Investor Day and our AGM. Thanks all.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a great day.

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Earnings Conference Call
Converge Technology Solutions Q1 2023
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