Earnings Transcript for CTSDF - Q2 Fiscal Year 2024

Operator: Thank you for standing by. This is the conference operator. Welcome to the Converge Earnings Call for the Second Quarter of 2024. [Operator Instructions] I would now like to turn the conference over to Avjit Kamboj, Converge Chief Financial Officer. Please go ahead.

Avjit Kamboj: Thank you, and good morning, everyone. Before we begin, I would like to take a moment to acknowledge the passing of our dear friend and colleague, Lorne Gorber, our Investor Relations at Converge. Loren was a true legend in the PR profession, and we will miss his coming presence, great storytelling and wisdom. His teachings will forever remain with me. Our hearts go out to his family and friends. I would like to welcome and introduce Dennis Fong, who will be assisting me with the Investor Relations going forward. I will now turn the call over to Dennis.

Dennis Fong: Thank you, Avjit, and good morning. Also on the call today to discuss Converge’s second quarter 2024 results are Shaun Maine, Group CEO; and Greg Berard, Converge’s Chief Executive Officer. This call is being recorded live at 8 a.m. Eastern Time on August 8, 2024. The press release we issued earlier this morning is available for download, along with our Q2 MD&A, financial statements and accompany notes, all of which have been filed and are available on SEDAR plus. Please note that some statements made on this call may be forward looking. Actual events or results may differ materially from those expressed or implied and converge 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 converge.com. We 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 the dollar figures expressed in this call are Canadian unless otherwise noted. I will now turn it over to Shaun to begin with opening remarks, then Greg will provide a high-level summary of our Q2 results and business overview for the quarter. Avjit will dive further into the financial details of our Q2 results and provide an outlook for Q3 and the year before we wrap up to take your questions. So with that, over to you, Shaun.

Shaun Maine: Thank you. Good morning and good afternoon to those of you joining from overseas. Welcome to our second quarter 2024 results call. Let me begin by saying how pleased I am to reflect on the significant growth Converge has achieved in the first half of 2024. It is always gratifying to witness the hard work and dedication of our team, continue to translate into record results and the impressive growth Converge continues to achieve. As recently announced, Converge fulfilled the criteria necessary for the deconsolidation of our majority-owned subsidiary, by Portage CyberTech. It was an important step for each company as it allows converge to remain a strong partner in Avoca for Portage’s industry-leading products, while positioning Portage to continue on its own accelerated growth path, operating completely independent of Converge. With the conclusion of the Portage deconsolidation, there is no group anymore, and therefore, my role as Group CEO no longer serves its strategic value. As I said, at the end of 2024, I plan on stepping back from this role at which point Greg will assume all of my executive responsibilities. I will continue to serve Converge as in an advisory capacity while remaining as Chair of Portage. As mentioned over the past quarters, we have continued to put a pause on M&A with a focus on integration, cross-selling and cash generation under one Converge driven by Greg’s leadership as CEO, and Avjit as CFO. The company is on an incredible path that is set to continue with the leadership team we have had in place, and this transition is a natural progression on the road map to converge this next stage of growth. I want to highlight the exceptional job our CEO, Greg has gotten, to build these deep capabilities we have in our key practice areas, particularly around AI, setting the company up to uniquely take advantage of growth opportunities in the IT services marketplace. I look forward to supporting him and continuing this momentum and leveraging my experience to guide the company’s strategic vision. With that said, I’ll now turn the call over to Greg, Converge CEO, to provide a high-level summary on the quarter and dive into our valued partner relationships and operational highlights.

Greg Berard: Thank you Shaun and good morning and afternoon to everyone. Before we get started talking about Q2, I wanted to personally thank Shaun for all his leadership and support over the years. Shaun had a vision when he founded Converge and has done a phenomenal job getting us to where we are today. His hard work and efforts have created a company that went from $0 in 2017 to over $4 billion today, an amazing accomplishment and testament to Shaun’s leadership. So thank you, Shaun, for all you have done for Converge. I look forward to working closely with you during the transition. I also want to thank Thomas and the converged Board for all of their support in me and the executive team as we continue to take Converge to the next level in 2025 and beyond. Now let’s talk about how we performed in Q2. I am pleased to report we have exceeded over $1 billion in gross sales for the fourth consecutive quarter. Over the past 12 months, we have achieved a new level of scale that demonstrates the breadth and depth of our solutions and partnerships while highlighting Converge’s unique set of services offerings as a leading North American IT end-to-end solution provider. As you will see, we continue to outperform the market and prove the cross-sell and AMS strategy we have implemented will continue to help us grow organically and be the trusted adviser for our clients for all of their strategic IT initiatives. In Q2, we reported $1.06 billion in gross sales, representing an increase of over $106 million and gross sales organic growth increase of 11.1% year-over-year. Our gross profit increased by 2.1% to $179.3 million and our adjusted EBITDA of $45.1 million was up 8.6% from last year. We delivered a strong quarter, specifically around our strategic focus areas

Avjit Kamboj: Thank you, Greg. In my review of Q2 2024 financial results, I will refer to some measures that are non-GAAP, including gross sales, organic growth and adjusted EBITDA. For a detailed description and reconciliation of our GAAP to non-GAAP measures, please refer to our MD&A filed this morning. I’m happy to say the integration of our acquired businesses into one Converge is continuing to progress well, and we’re well on our track with the operational milestones we’ve internally set for this year based on our principles of product and services discipline, operational discipline and financial discipline. And one of those milestones was deconsolidation of Portage, which happened at the end of Q2. I can’t say enough about our team’s focus and dedication in delivering double-digit top line organic growth despite a challenging macroeconomic backdrop and while executing our internal transformation and driving efficiencies. It’s been an incredible effort across the organization. Delivering on our promise of providing additional transparency in our business, you might have noticed that we have now provided full segment disclosures by region being North America, Germany and the UK, along with constant currency analysis in our MD&A. We will continue to strive to add additional disclosures over time and strive to provide more transparency based on what we deem to be appropriate measures of our business. Our cash generation and the conversion of cash from an adjusted EBITDA continues to be the highlight, and we are focused on balancing the investments we make to organically grow the business with the returnable capital for our shareholders to maximize shareholder value. As you’ve probably seen in the release, we took a significant non-cash impairment charge against our German operations in Q2, and this drove our reported GAAP net loss this quarter. I will speak to this a little later. I would like to emphasize that this impairment impact was all non-cash. Also note that our operating results in Q2 still include the consolidated results and negative adjusted EBITDA of Portage, which was deconsolidated to the end of the quarter on June 27. Starting this quarter, Q3, our financial results going forward will exclude financial results of Portage in gross sales, revenue, gross profit, SG&A and adjusted EBITDA. We will recognize our 51% share of Portage net loss through loss from investment in associates line in our income statement, and we will back out this loss from adjusted EBITDA calculation going forward. Let me begin with a review of Q2 top line results. Gross sales were approximately $1.06 billion for the quarter, representing 11.1% growth year-over-year, and this makes the fourth consecutive quarter with over $1 billion in gross sales. The growth is all organic, and it’s remarkable given the economic volatility and uncertainty affecting customer spending and in a market environment where IT budgets continue to be scrutinized. We are outpacing the market and our peers by supporting our customers’ most critical projects and technology investments as a trusted business partner. Including the 11.1% growth in gross sales between products, managed and professional services and maintenance support and cloud product growth sales, which includes hardware and software sales, grew by 12% this quarter and maintenance support and cloud growth was 29.6%, while professional and managed services gross sales declined by 17.6%. Product growth sales growth was all driven by strong software sales with over 50% growth in software sales year-over-year, while hardware sales were relatively flat. Growth in maintenance support and cloud was all driven by public cloud solutions such as AWS, Google Cloud and Microsoft Azure. We did experience a decline in our professional and managed services sales this quarter, driven by three key events

Operator: Thank you. [Operator Instructions] The first question is from Robert Young from Canaccord. Robert?

Avjit Kamboj: Rob, are you there?

Robert Young: Sorry, I was on mute. I just wanted to start on that last comment you made around the large incremental AI deal that’s potentially in the pipeline. Can you just maybe give a little bit of context around that? Would that be a repeat deal or would it be an existing?

Avjit Kamboj: Yes, Rob, as we’ve mentioned on previous calls, we worked on a number of large HPC deals with customers in the healthcare, financial services, automotive space, and it’s with one of our clients that we continue to do business with.

Robert Young: So that’s a potential repeat deal with an existing customer. It’s not something that’s new.

Avjit Kamboj: It’s a growth yield, correct.

Robert Young: Okay. And then second question for me to just be on good to hear that the ERP deployment is on track. Avji, maybe if you could just give us a quick summary of what the expected benefits. Maybe you give us a time line on how that might influence the financial performance and reporting. What benefits are you expecting to see come as a result of that through, I guess, 2025?

Avjit Kamboj: Yes. So as we’ve talked about, we do not expect to receive any benefit for the remainder of this year. We will start having benefits from efficiencies within our operations starting Q2 of next year. And outside of the efficiencies, it will provide us more visibility into our business, allowing us to continue to operate on our disciplines of products and services discipline. We continue to do that today, but this will provide us more information and transparency into our business to be able to make the right decisions on what we sell and what we don’t sell. And then also be able to make decisions on our operational and financial discipline based on where we need to make the investments in our business and where we can streamline our operations. We have not quantified the dollar impact of these. We will expect to do that once we have gone live.

Robert Young: Okay. Is there any way to maybe phase the benefit, like you said, there is not likely to be a benefit until 2025. Would you see immediately – would you see benefits early in 2025 or is it something that would phase through 2025? Maybe just some context around how investors may see the benefit.

Avjit Kamboj: Majority of the benefit is expected to happen in the second half of 2025. That’s when it will start. And it will be phased.

Robert Young: Okay. Thanks. I will pass the line.

Operator: The next question will come from Christian Sgro from Eight Capital. Christian, go ahead.

Christian Sgro: Hi. Good morning. When you segment your customers either under the spectrum between large enterprise and SMB, could you comment on the health of either of those two segments? And then I think last quarter, you were a little bit more focused on the enterprise market. Is that still the case maybe in the context of what you are seeing?

Greg Berard: Yes, Chris, we will continue to balance the business across both where we continue to see a large volume of transactions in the SMB space, but we continue to see more and more large enterprise transactions as well. So, maintaining that balance both across customer base and obviously, the portfolio will continue to be a priority for us.

Avjit Kamboj: And maybe just to add to that as well, Christian, our focus is not SMB, it’s mid-market.

Christian Sgro: Understood. And maybe for the second question here, maybe the ones to poke at Portage and the strategy suppose to consolidation. Is there a refresh that you want to provide maybe on what the 12-month to 24-month plan is, Converge’s willingness to operate and run and support the business, but also what the plans are not that they are a little bit more separate?

Greg Berard: Yes. So, Portage, its key growth with the advent of the 3.0 release last September is U.S. expansion. And so that’s their focus. Converge continues to be a good partner as a channel partner like we are with other ones, but key expansion. They have done a great job in Canada, both on the identity side and their portal business for municipalities, but really the key expansion is to the U.S.

Christian Sgro: Okay. Thanks for taking my questions and I will pass it on.

Operator: Our next question will come from Stephanie Price from CIBC. Stephanie, go ahead.

Stephanie Price: Just wanted to understand kind of what’s going on in the German business a little bit more. Thank you for the increased segmentation. It looks like revenue growth was okay, but profitability is maybe worse than the rest of the business. Just trying to understand a bit what’s going on there and how much that drove the revision to the full year guidance.

Avjit Kamboj: Hey Stephanie, it’s Avjit here. The way our German operations is all primarily in the education sector and public sector, and the way the public sector and education sector in Germany works is all predicated around framework agreements. And as those framework agreements come to conclusion, you are required to do full RFP and bid on those framework agreements. What you saw in top line growth and decline in margin was driven by the product mix. We had significantly our professional services and higher profitable hardware sales in the previous years compared to this year. You are starting to see some traction within the business where we are starting to win more and more framework agreements, especially around some end-user devices, but we have not been able to win our high-value businesses in Germany. And we are currently focused on investing in the business in terms of making sure we have the right sales team in place and the right operations in place. We have been expanding our teams, and we do expect to recover, but it’s not going to happen quickly. This is not a commercial sector. This is government and public sector and recovery is generally slow as you bid on these framework agreements and slowly over time mine these framework agreements.

Stephanie Price: Okay. That’s great color. Thanks Avjit. And then when you are thinking about the Q3 outlook and the revisions to the full year guidance, can you kind of talk about the buckets? I know maybe the demand environment has not improved to the extent that you were thinking and Germany, it sounds like it’s a headwind there, too. But maybe just walk through how you are thinking about the rest of the year.

Avjit Kamboj: Yes. So, the first big bucket was deconsolidation of Portage that led to gross profit reduction of $7 million for the second half of the year and increasing our adjusted EBITDA by $1.2 million for the second half of the year, given that Portage has negative adjusted EBITDA. The second item we looked at was end-user device through a fresh cycle. And that significantly reduced our outlook for the second half of the year. And lastly was, I think I have mentioned on the last quarterly call, we were expecting Germany to recover in the second half of this year, but we do not see that recovery at all. And lastly, is just the market sentiment. I think you are seeing this across the board, with our peers or industry competitors, they are all either declining or seeing relatively flat while we are continuing to grow, but the growth is not what we had expected at the beginning of the year. So, we are in line with what the market is expecting and what the sentiment seems to be, we are revising the guidance for that. That being said, as I talked about on the call, there is this large AI deal that we are currently continuing to track. As you know, our growth last year in Q3 was actually pretty much all driven by high-performance compute. This is a similar type deal. If that deal comes in, we will actually be in our originally provided guidance.

Stephanie Price: Okay. Thank you so much.

Operator: Our next question will come from Jerome Dubreuil from Desjardins. Jerome, go ahead.

Jerome Dubreuil: Yes. Thanks for taking my questions. The first one is on the managed services segment that you have reported a decline and you have been transparent with what happened there. Wondering what percentage of this segment in terms of revenues that is in your focus areas where you have seen double-digit growth?

Avjit Kamboj: So, our double-digit growth that you saw was all coming from the high practices that we are focusing on. And that’s the trend in the market as well, whether it’s AI, cloud compute, so helping our midsized customers move to the cloud and providing professional services and software around the cloud migration. And then also cybersecurity, which is one of the biggest topics today, so that’s where we are seeing the growth in those practice areas. But where you are seeing the decline offset this growth is in our traditional, what we call digital infrastructure and these are device business.

Jerome Dubreuil: Thank you. With regards to the CEO, I guess kind of transition, I wouldn’t expect too much change in the strategy, but still asking, is there any strategy tweaks related to that transition?

Shaun Maine: So, no, it was – again, with Portage being deconsolidated, a group CEO of one company doesn’t make sense. Greg has been operating Converge already. So, it’s more of the same. We have received feedback from our shareholders that it was confusing, the two roles. So, I would say it’s going to continue to do what he has always been.

Jerome Dubreuil: That makes sense. And finally, on the potential large contract, I mean would the margins on that contract be similar to what you would expect in the rest of that business? Thank you.

Shaun Maine: It would be consistent with the margins within our product sales categories, but we do not split out our margins based on individual deals.

Jerome Dubreuil: Yes. Fair enough. Thank you.

Operator: The next question will come from Divya Goyal from Scotiabank. Divya, go ahead.

Divya Goyal: Good morning everyone.

Avjit Kamboj: Hi Divya.

Divya Goyal: Hey. I wanted to get a little bit more color on this revenue mix details that you provided. So, you noted that there was a pickup in the software sales and the public cloud sales versus the services, which saw a decent enough decline. What can we expect to see, or what exactly is in your pipeline for the remainder of the year? And just to add on to this question, are these software sales potentially longer term contracts or shorter term? And if they are shorter term, how do you expect to continue to strengthen your pipeline?

Avjit Kamboj: Yes. So, the product mix will continue to shape our profitability as we focus more on professional services and managed services. As I mentioned in my remarks, maybe I will address the professional services and managed services decline first. Part of it was intentional and a part of it was circumstances driven. So, a big portion when I say intentional, it was really related to us making conscious decision on our operational and our products and services discipline that we will not provide these resale services anymore and focus on our in-house services. That was number one. Number two, there were certain professional services that we were providing that were non-core and utilizing a significant number of our resources internally. So, we decided to cut back on those services and focus on our four practice areas that I mentioned that are growing double digit. And then the unintentional part that happened as part of market events was two of our large clients that were using staff augmentation services that we provide. So, it’s not really internal services we are providing. We are effectively providing people as a staff augmentation basis. And those two contracts came to conclusion as those customers moved all the spend in-house. So, that’s on the professional services side. We do expect our professional and managed services to continue to grow. If I split out between professional services and managed services, managed services, which includes our IP 4G continues to grow at a rate that they were acceptable internally. It was professional services on the resale side that we saw a decline. But in Q3 and onwards, we show that we are currently expecting and forecasting to have an increase in that business. And within software and hardware, given this it is a cyclical industry, and as we talked about, generally, Q2 and Q4 are higher software sales quarters. So, that’s where you saw the double-digit growth on software. What we are seeing, I think we had talked about right outside of the cohort or maybe earlier last year, customers were tending to sign more shorter term software deals. We are seeing that trend reverse now where customers are more open to signing multiyear software deals. So, when I look at our software sales this quarter and our cloud, these are all multiyear software deals.

Divya Goyal: That’s very good color. Thank you. So, my second question on the capital allocation strategy. You did mention that you are making significant internal reinvestments, including the sales force. What exactly is your target sales force addition like, are you looking to add more software-related account executives, hardware-related, or is it going to be a broad mix? And then just to tag on to that, I understand that the focus is on organic, but could there be a potential M&A, say, ‘25 onwards even if it’s a tuck-in? Thank you. And that’s all for my question to you.

Greg Berard: Thanks Divya, it’s Greg. So, in terms of targets, we have stated we want to grow our sales force by 10%. Our goal is to bring in a mix of sellers, experienced sellers that bring accounts with them as well as an understanding of the portfolio we have, right. So, we are bringing in a mix of sellers that have professional and managed services experience so we can hit the ground running and drive some of those higher-value solutions. But we set a target at growing our North American sales force by 10%, and we are confident we will hit that number here in 2024. And we have also, from an organic perspective and continue to invest in thought leaders in the industry around AI and cyber, etcetera, so we can continue to grow the portfolio that we are investing in. On the latter part question around M&A, we are absolutely looking to continue strategic acquisitions. We are building a pipeline now and we continue to have active conversations, so.

Divya Goyal: That’s helpful. Thank you.

Operator: The next question will come from John Shao of National Bank. John, go ahead.

John Shao: Hey. Good morning. Thanks for taking my question. I just wanted to get more color on the two contracts that a customer moved in-house. Should we see them as an isolated case?

Avjit Kamboj: Yes. These were two isolated cases. This is where the customers were significantly – these are, call it, on a large projects that the customers were working on. And as these projects came to conclusion, part of it was to bring a portion of that spend in-house and then a conclusion of those contracts effectively resulted in us declining our talent services. But these are one-offs.

John Shao: Okay. You also talk about hardware reflection cycle and recovery of the German business, are the same in terms of the timing and the trajectory of the recoveries?

Avjit Kamboj: No, they are not. When I talk about end user device cycle, that is a global statement I am making. That includes North America, UK and Germany operations that we do not expect to have the refresh cycle happen in the second half of this year. It’s not a matter of – if the refresh cycle will happen, it’s a matter of when. And part of that, I think what you are seeing is decision-making around refresh cycle is customers are looking at, including AI, you are seeing all these AI PCs come out. And I think the decision makers are having to make a decision whether to refresh now or wait for new devices as they come out. That’s one. Two, and just being cautious in the market, we do live in an uncertain market right now, and customers are pushing out some of these decisions. So, if it doesn’t happen this year, then it will likely happen next year. On the Germany side, the recovery is much slower. As I mentioned, these are large framework agreements, multiyear agreements that you have to bid on and win and then deliver over a period of time. So, we do not expect the recovery, I am going to say, call it, at least over the next 12 months to 18 months in Germany.

John Shao: Okay. Thanks for the color. I will pass it on.

Operator: The next question will come from David Kwan from TD Cowen. David, go ahead.

Unidentified Analyst: Hi. Good morning. This is Solman [ph] on behalf of David. First question for Avjit. Avjit, can you talk about what kind of training is involved in the Phase 1 of the ERP migration you were talking about? Like how much time will employees have to spend getting trained and anything related to that?

Avjit Kamboj: Yes. So, we have actually taken a much, much deeper training approach. Generally, what you will see is a lot of companies when they are training their staff, whether it’s virtual meetings or in personal classroom trainings, we are actually doing, I am going to call it, on-the-job training. We are having most of our employees within sales, operations and finance team spend whatever they do on a day-to-day basis and the existing ERP have similar subset number of those transactions be performed in our new ERP environment. And that’s our approach to training. And we are monitoring that almost on a daily basis and weekly basis and addressing any gaps in that training as we go along.

Unidentified Analyst: Understood. And just one more, maybe this one for Greg. Greg, can you talk about what the sales cycle for AI projects is looking like right now? Are customers still hesitant? Are they still in the training and learning phase, or are you seeing a little bit more willingness on their behalf to start spending dollars on the projects more quickly?

Greg Berard: Yes. What we are seeing is a combination of a couple of things, right. We continue to see the larger enterprises spend on building up their clusters to support the AI workloads they want to run over the next couple of years. In parallel, we are seeing more and more conversations around how they can leverage AI and do design-thinking workshops. So, we are putting our teams on site and doing workshops with our clients. And the third piece I will talk about is just more on the solution side, right. So, leveraging AI to build more solutions, specifically in the automation space, we are having a lot of conversations around automating their environment and driving efficiencies. And that’s where you are seeing more and more spend right now. So, you will see us continue to focus and roll out solutions that help our customers drive the operational efficiencies in automation in their environments.

Unidentified Analyst: Alright. Thank you.

Greg Berard: Thank you.

Operator: We have one more question, and it will be coming from Rob Goff of Ventum. Rob, go ahead.

Rob Goff: In fact, with the question there would be more about timing or competitive dynamics or some mix of the two.

Greg Berard: Sorry, Rob, you cut off in the beginning. Can you please repeat your question?

Rob Goff: With respect to the large AI contract that’s outstanding, would your uncertainty be about the timing of determination or it’s a competitive situation?

Greg Berard: Yes. So, for us, Rob, it’s a timing on a ‘24, ‘25 kind of conversation. They continue to invest heavily in the AI space, and we have been their partner of choice. So, for us, it’s a timing conversation.

Rob Goff: Okay. Thank you. And my next question would be for Avjit. With respect to your free cash flow, can you talk a little bit more about the leverage you have in front of you? And are they fully pulled with respect to things like accounts payable, accounts receivable, inventory, sales commissions?

Avjit Kamboj: Yes. I would say our working capital is pretty much normalized now. It’s not the one-off levers that we had pulled in Q3, Q4 and Q1 of this year. Now, this is just maintaining and managing our working capital effectively. But we do have the levers, obviously, in making sure I would say, inventory, AR and AP, the three items that go hand in hand.

Rob Goff: Very good. Thank you and good luck.

Avjit Kamboj: Thank you.

Operator: This concludes today’s conference call. We thank you for participating and ask that you please disconnect your lines.