Converge Technology Solutions Corp.

Q3 2022 Earnings Conference Call

11/9/2022

spk05: everyone welcome to the Converge Technology Solutions Corp third quarter 2022 results conference call all lines have been placed on mute to prevent any background noise after the speaker's remarks there will be a question and answer session if you would like to ask a question during this time simply press star then the number one on your telephone keypad if you would like to withdraw your question please press star then the number two Your main hosts today are Sean Main, Chief Executive Officer, and Richard LeCoute, Chief Financial Officer. Before we begin, I am required to provide that forward-looking statement respecting forward-looking information, which is made on behalf of Converge and all of its representatives that are on this call. All statements made on this call will contain forward-looking information. The actual results could differ materially from a 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. Such statements only speak as of the date they are made. Today's discussion also refers to gross revenue, adjusted EBITDA, organic growth, and adjusted free cash flow and adjusted free cash flow conversion, which are non-IFRS measures and have no standardized meanings. Please refer to the Converge's filing of Canadian Provincial Securities Regulators for an explanation and reconciliation to IFRS measures. I would now like to turn the conference over to Mr. Main. Please go ahead, sir.
spk08: Thank you, Michelle. Good morning, and thank you for attending today's third quarter earnings call. We recently celebrated the five-year anniversary of Converge's first acquisition. And it's with great pride that I reflect upon the amazing journey that has led to 35 acquisitions in five years and the successful creation of our leading services-led software-enabled IT and cloud solution provider. I would highlight that the numbers we have just announced show that after nine months in 2022, Converge's revenue, gross profit and adjusted EBITDA are larger than they were for the full year of 2021. a testament to both the success of our acquisition strategy and the successful implementation of our cross-sell plan. In what follows, I will provide a business update on the quarter, beginning with a financial summary and a touch point on our recent acquisitions. I will then discuss our customer segmentation and backlog management, and expand with the development of our managed services and solution offerings. Richard LaCouture will then provide a more detailed walkthrough of the third quarter financial results. To wrap up, I'd like to have an update for you on the majority-owned subsidiary, Portage CyberTech. As we celebrate our five-year anniversary, Converge is honored to have secured a top 20 position in the CRN 2022 Triple Crown Award, which identifies top solution provider rankings on all three CRN lists, including the Solution Provider 500, FastGrowth 150, and Tech Elite 250, all of which Converse has secured notable top rankings on. These awards that recognize our growth are an indication of the size and scale that we have achieved implementing our original three-phase plan. You will recall that Converge had the goal of having a presence in every major US city or NFL cities in order to provide an outstanding customer experience in local markets as mid-market companies move to the cloud. I'm pleased to confirm that we now have presence in every NFL city, and last week were recognized by Cisco for selling at least a million of Cisco products in 31 regions across the U.S. and selling their products in 46 states. This demonstrates why we are such a sought-after partner from hybrid IT vendors by being the trusted advisor to mid-market companies across the U.S. I'm also delighted that we have finished our 2022 M&A activity with the acquisition of Stone Group, which marks our entrance to the UK market and not only strengthens our education footprint, but adds the capabilities of a green alternative through the full recycling of IT hardware, which is a key differentiator in the European marketplace. Converge reported a record Q3 highlighted by 85% growth in our professional services, which is made up of our advisory and implementation services, with managed services growing at 53% and total services growing at 71%, compared to our overall growth rate of 64% year-on-year. Our lower revenue but higher gross profit services resulted in an organic revenue growth in the quarter of 5.9%, but 13% growth of our gross profit. We have continued our industry-leading gross profit growth with 67% gross profit growth to $139.7 million on gross revenues of $731 million, which is three times the industry average. Convergence completed 10 acquisitions in 2022, exceeding our billion-dollar target of acquisition revenue by closing nearly $1.2 billion of LPM gross revenue and $66 million of adjusted EBITDA. with acquisitions both in North America and in Europe. It is important to note the different types of acquisitions that we have done, particularly focused on our advisory and managed services. In the past two years, acquisitions like CBI and cybersecurity, New Comp Analytics, LPA and Carpe Datum and Analytics, and IDX and Cloud have differentiated us to our customers and have resulted in our rapid professional services growth. In the same manner, the platform acquisition of Exactly IT and managed services has given us a platform to onboard managed services portions of companies like TIG, PDS, Viacom, and Infinity Systems. These capabilities have meant that we bring broader capabilities to our mid-market customers, and now over half of our sales reps sell three or more of our practice areas into our customers. The company has also continued its European expansion with the UK addition of Stone Group, serving both the public and private sectors, expanding on the previously announced German-based acquisitions of GFDB, allowing us to become a leading education provider in both Germany and the UK. These acquisitions will contribute to enhancing and growing solution offerings and services for our clients in Europe and make us more meaningful to our vendor partners in education like Apple, Intel, and Microsoft. Last quarter, I presented this slide which shows how Converge's combination of acquisitions and organic growth have resulted in three times the average gross profit growth compared to the rest of the IT services industry. In addition to this gross profit growth, it is important to understand how large our services organization is compared to others in the industry. Although these numbers are based on LTM Q2 numbers, The increased growth of our professional and managed services have resulted in nearly 500 million annualized services business, providing a large talent base of technical resources into our customers at a time when our mid-market customers are struggling to find people to help them implement their digital strategies. As mentioned on previous calls, Converge targets acquisitions which have mid-market customer bases that are moving to cloud-based services models. Analyzing our sales for Q3, 24% of our revenue came from healthcare sector, 23% from the technology sector, 16% from government and education, 11% from finance, and 26% from other sectors. It is also important to understand the strong demand environment Converge is selling into. When conducting quarterly business reviews last week with our regional sales managers, they reported no signs of reduction in IT spending in Q4, and particularly in the US saw strong demand continuing into 2023. We also have seen large successes in Germany, where this past quarter we announced that RedNet had secured a 156 million framework contract, Euro framework contract, for a large public sector in Germany, allowing public and local authorities and universities to procure needed technology to modernize education. While this is a digital infrastructure heavy contract, it was another important milestone driving our joint German and European growth strategy and securing notable wins in the education sector. Q3 saw reduction in our backlog for the first time in the past year, with product backlog decreasing from 507 million at the end of Q2 to 433 million at the end of Q3. Where last Q3, some vendors were providing delivery dates in two to three months while not being able to deliver for four to six months, now we see the opposite, where vendors are conservatively providing longer delivery dates but being able to deliver more quickly, since lessening consumer demand has assisted the supply chain available to businesses. And we are expecting the supply chain to get better in Q4 and normalize by the end of Q2 2023. I will now hand over to Richard to go through a more detailed discussion of our financials.
spk00: Thank you, Sean. Good morning, everybody. I hope you're all well, and thank you for joining the Converge Q3 earnings call this morning. Before getting into the financials, I just wanted to say that it's great to be sitting here with Sean and talking to you today as a member of the Converge team. I've been really impressed by the Converge team and the people I've met thus far, and I'm excited and proud to now be part of it. What the team has achieved in a relatively short time is remarkable. I could already see the ingredients for further success in IT service provider industry and that has proven itself to be pretty resilient to the challenges posed first by the pandemic and now the economic turbulence that we're currently experiencing. So getting into the financial highlights for Q3 FY22. As Sean has highlighted, we continue to see robust demand for our products and services and that has translated to strong year-over-year revenue, gross profit and adjusted EBITDA growth. In what is seasonally acquired to quarter, gross revenue of 730 million Canadian dollars was 55% up on Q3 last year. And on a year-to-date basis, gross revenue of $2.13 billion is now up year-on-year by 60%, with the growth driven both from acquisitions and organically. I'll be speaking about organic growth in more detail later, but as displayed on the bottom left of the slide, organic gross revenue growth in Q3 was just under 6%, while organic gross revenue growth on a Q3 year-to-date basis is 12.5%. Net revenue after the IFRS 15 principal agent net down of $603 million Canadian dollars was up 64% year-on-year in Q3 and is 71% above last year on a year-to-date basis. Growth profits, our most important trading performance metric, of $139.7 million was 67% ahead of last year in the quarter and now stands at $381.9 million on a nine-month year-to-date basis, 66% up on last year. As with revenue, year-over-year gross profit growth was driven both by our M&A activity and also healthy organic growth. Organic GP growth in Q3 was 13%, while organic growth at 15% was reported on a Q3 year-to-date basis. Adjusted EBITDA was $31 million in Q3, up 64% on prior year, and the year-to-date adjusted EBITDA is now just shy of $100 million, representing 68% growth over last year. Despite completing on the significant TIG and GFTB acquisitions in the quarter, completed on 1st August, adjusted EBITDA as a percentage of GP was 22.2%, and that was consistent with last year and in line with expectations, given the operating leverage effect that the Q3 holiday season has on turning Q3 GP into EBITDA. as evidenced in our 2021 reported numbers.
spk12: Significant revenue growth was generated in all areas of Convergys portfolio of products and services.
spk00: Q3 product revenue, which includes both hardware and software, increased 64% to $474 million from $290 million in Q3 last year, driven by the 12 acquisitions completed since October 1 last year and helps by conversion of our prior period backlog as product delivered to customers in the period. Q3 Professional and other services, which includes the net revenue from public cloud resale and product support, increased 71% to $98 million in Q3 from $57 million last year, as we continue to invest in our key consulting practice areas, including analytics, cloud, and cybersecurity. Managed services revenue increased to $31 million A year-over-year increase of 53%, implying annual recurring revenue from managed services now of $124 million. And pleasingly, revenue from our pure professional services, which are our advisory and implementation services, increased 85% year-over-year in Q3. This was the highest growth part of our business in Q3 and is an indicator of convergent migration to be a higher value-add, higher margin, services-led business. And when combined with our managed service business, we execute Q3 with a pro forma services business approaching $500 million in revenue terms. And we're poised to continue displaying growth in this area, heading into Q4 and beyond. Converge has now completed 10 acquisitions in the calendar year 2022, including our most recent, the acquisition of Stone Group, the closure of which we announced on Monday of this week. All of these acquisitions performed in line with expectations in the quarter. And this M&A-led growth was complemented by 6% organic gross revenue growth in Q3. And on a year-to-date basis, organic revenue growth of 12.5% means that in the nine months to September 2022, an incremental 167 million of revenue has been generated by the existing portfolio of companies compared to the first nine months of 2021. GP performance was strong in Q3, with growth of 67% over Q3 2021. While our acquisition strategy was a clear driver of the reported GP growth, organic GP growth was a significant contributor, with organic growth of 13% achieved in Q3. And in year-to-date terms, organic growth of 15% means that our existing portfolio of companies has generated an incremental $34.5 million Canadian dollars of GP compared to prior year. Gross margin of 23.2% in Q3 2022 was up half a percentage point compared to Q3 last year, despite the recent hardware-focused acquisitions, reflecting the mixed impact of our highest growth professional services business. We continue to see opportunity for gross margin accretion as the cross-sell benefits that converge adding its higher margin cloud and managed service offerings into those recent hardware-focused acquisitions starts to accrue. And as an indicator of just how big Converge has become, the end of September last 12 months gross profit is now almost 500 million Canadian dollars. And if you were to pro forma that number, allowing for a full 12 month contribution from the 12 companies acquired since 1st of October last year, that figure is higher still.
spk12: Adjusted EBITDA was 64% up on Q3 last year and 68% ahead on a Q3 year-to-date basis.
spk00: EBITDA as a percentage of net revenue was in line with last year for both the quarter and year to date. EBITDA as a percentage of GP, a more meaningful measure of how effectively we turn gross profit into bottom line profit, for Q3 was 26.1%, 0.3 points ahead of last year. In Q3 itself, EBITDA as a percentage of GP was down 0.3 percentage points, reflecting the expected impact of recent acquisitions and associated SG&A costs. Heading into Q4, we expect to see gross margin rebound in line with the quarterly product mix trends that we usually see in the business, which, together with integration-related cross-sell and cost optimization benefits, will drive an increase in EBITDA as a percentage of gross profit growth.
spk11: Moving on to organic growth.
spk00: The slide that you can see shows growth in gross revenue and gross profit for FY20. FY21 and FY22, with FY22 shown quarterly and on a year-to-date basis. There's a lot of data on this slide, but the key takeaway is a consistent record of organic growth in gross revenue and gross profit. As you would expect, and as shown in the bottom table charting where reported GP has come from, our M&A-led strategy means the M&A contribution to GP growth exceeds the organic contribution, but the organic contribution has nevertheless been significant and consistent. And as I've already stated, on a Q3 year-to-date basis, organic gross revenue growth is 12.5% in 2022, while organic GP growth for the first nine months of this year is 15%.
spk12: Moving on to cash flow, and in particular, our financial position.
spk00: Adjusted pre-cash flow, which we calculate as adjusted EBITDA, less recurring capex, and payments of lease liabilities, was $24.7 million in Q3, representing free cash conversion of 80%, consistent with last year on a quarter and Q3 year-to-date basis. Working capital outflow in the quarter of $7.8 million was caused by the impact of acquisitions in the quarter, together with selected advanced supplier payments to secure pricing advantage on a few specific deals. This is a timing issue, and cash generation continues to be fundamentally strong. Looking at our balance sheet, we finished the quarter in a strong financial condition after having invested over $354 million Canadian dollars net of cash acquired in the nine acquisitions completed during the first nine months of 2022. At the end of September 2022, when combining our cash position of $172 million with Headroom under our updated revolving credit facility of $500 million committed and $100 million accordion, at the end of September, we had approximately $400 million of available funds. The new RCF has a leverage covenant and an interest cover covenant, as shown on the slide. And while we don't disclose our RCF covenant levels, at 30 September 2022, Converge was in comfortable compliance with both. And finally, as we previously announced, Converge obtained approval from the TSX to make a normal course issuer bid, which launched on August 11th and will terminate one year after its commencement. or earlier if the maximum number of common shares under the NCIB have been purchased or the NCIB is terminated at the option of the company. Under the terms of the NCIB, Converge may purchase for cancellation up to an aggregate of 10.7 million common shares, representing 5% of the issued and outstanding common shares at 31 July 2022. And at the 30th September, just over 5 million shares have been purchased under the programme, reducing our issued and outstanding shares 210.3 million.
spk11: Moving to Outlook.
spk00: The company recognizes the uncertain macroeconomic situation as the world emerges from the COVID-19 pandemic and residual supply chain impacts it caused and also deals with the higher inflation and interest rate environment as well as geopolitical conflicts in Ukraine. However, we are pleased with underlying trading in the seasonally quietest quarter, Q3, and demand for convergers IT capabilities remains resilient amongst our large and well-diversified customer base. As a result, the company expects to see the high demand for our services-led software-enabled hybrid IT solutions continue for the remainder of 2022, with Q4 growth rates consistent with Q3 year-to-date, circa 60%, and this high demand continuing into
spk11: Now turning to a brief ESG update.
spk00: When I joined the Converge leadership team, it was important to me to understand the culture and the fundamentals that are driving Converge's success. In my short time at Converge, I'm proud to see that Converge embodies their company mantra, better together. From recruitment to employee retention, From ongoing development of employee interest and awareness groups to company wellness initiatives and financial success programs provided to our teams, it is evident that Converge is a people company. We continue to strive to offer new up-to-date resources and regularly consult with our employees, inviting feedback on areas in which we can do better. We're really pleased that in our most recent company-wide survey done in Q3, 85% of our employees surveyed responded saying they feel valued at Converge. Looking ahead into Q4 and into 2023, in addition to continuing to promote and protect our social well-being programmes, we will also focus on environmental and governance plans and targets, including potential alignment to organisations such as the Science-Based Targets Initiative and UN Sustainable Development Goals. Reducing energy consumption and consolidation of offices, further improving diversity and inclusion in our recruitment and management level representation, Increased community involvement and the creation of an enhanced risk management framework are all examples of things we will be working on. We recognize that establishing consistent ESG practices with such significant acquisition activity is not always a straightforward task. However, we are confident in our company culture and our ability to extract influences from new acquisitions as we build the ESG roadmap for years to come. The recently announced acquisition of Stone Group is a great example of that. as we look to leverage their class-leading sustainable IT asset disposal capabilities throughout the Converge group. Thank you.
spk11: I'll now turn the presentation back to Sean. Thank you, Richard.
spk08: Our cybersecurity and identity management product provider, Portage, having completed five acquisitions, is having a real impact enabling governments to provide digital identity services. With over 80% gross profit from its products and unique IP in the space, it is poised to provide converged shareholders benefit through a spin-off when market conditions improve. Portage's incredible journey has been enabled and fostered by the support of Gatineau and the Province of Quebec, and I would like to take this opportunity to thank them while asking for understanding of my less than perfect French accent. Le Québec a été une partenaire très utile pour le partage cybertech depuis le début. Nous avons reçu un financement dans le cadre du projet PIC, le Programme d'innovation en cybersécurité du Québec, via PROMPT. Nous avons obtenu des ressources d'ingénieurs via Conoxyté au pire de la pandémie, alors que le recrutement était presque impossible. And with that, let me open the floor to questions.
spk05: Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session hosted by company representatives Sean Main, Global Chief Executive Officer, Richard LaCouture, Global Chief Financial Officer, and Greg Berard, President and North American Chief Executive Officer. If you would like to ask a question, please press star followed by the number one on your telephone keypad. You will hear a three-tone prompt acknowledging your request, and your questions will be polled in the order they are received. If you would like to withdraw your question, please press star, followed by the number two, and please keep in mind if you are using a speakerphone to lift your hands up before pressing any keys. One moment, please, for your first question. Your first question will come from Christian Scrow of Eight Capital. Please go ahead.
spk02: Hi, good morning and thanks for taking my questions. The first one I wanted to ask is on the product backlog. I was just wondering how you would characterize the current product backlog and if there's any commentary you could share on how it's trended since the quarter end.
spk08: Sure. So what you've seen is, as we stated, Q3 was the first quarter that it declined from approximately $507 million of product backlog to $437 million at the end of Q3, with our services backlog being kind of standard. And what you've seen is the lessening of demand on the consumer side has really provided a The couple laggards are the network guys and HPE, so those are the ones that are still there. Although, as I stated in my comments, when you were there a year ago, you were seeing companies hoping to be able to deliver in two to three months and actually delivering in four to six. And that's turned around now where they're giving longer lead times and then they're being able to deliver earlier. And so we saw the older backlog has the ones that were multiple quarters old has basically disappeared. you're going to see an improvement in Q4, but there's still going to be, it won't all come out in Q4. You'll also see that happen in Q1 and Q2. So for the next three quarters, we would expect by the end of Q2, notwithstanding anything new that happens, that you would have a normalized supply chain from Q2 onwards. Does that help, Christian?
spk02: Yes, that's very helpful on the backlog and the cadence there. The second question I'll ask today is more on the core business in North America. I wanted to ask When you go to markets in the mid-market, what's the tip of the spear for Converge in the current macro? Which practice areas are you leading with? Where are you seeing the best cross-sell opportunities, whether it's cyber or data? What's leading and what's the upsell in your markets?
spk06: It really depends on the client. The fact that we have all these practice areas gives us the flexibility to either go in based on the customer needs You know, we have a lot of examples where our traditional digital infrastructure clients are leveraging us for our analytics capabilities or our cloud capabilities. So we may go in with cloud, and then that may morph into an analytics conversation where we would then bring in our analytics practice, right? So it really depends on the client need and requirement. The good news is, you know, our account executives are understanding what we offer and are selling multiple practice areas. As Sean noted earlier, over 60% of our sellers are now driving three different practice areas into their account set.
spk02: Perfect. Thanks for the color on the sales strategy there. Yes, it does help, Greg. Thanks for taking my questions, and I'll pass the line.
spk05: Your next question will come from Rob Young at Canaccord Genuity. Please go ahead.
spk07: Hi, good morning. I think you said in the prepared comments that there was a bit of a cash outflow to secure pricing. I think is this going directly to the OEM rather than through a distributor? Yes. Maybe if you just back up from that a little bit, just talk a little bit about the vendor terms and how, if they are changing, do you anticipate them changing going into a recession? Do you think that discounting will be harder to get? So two-parter there.
spk00: Rob, I'll take the first part of that on the supplier payments. To distribution, those were to distribution. And important to note, that's going to be a timing thing, so expect that to come back in Q4.
spk08: We do not expect terms to change. What you saw, when you close large acquisitions like TIG and GFDB on August 1st, it takes a full quarter to get through to the new payment terms. We've seen this in the past. I think when Viacom Infinity was closed on December 31st, there's On the balance sheet, there's a transitionary period before you get to your longer terms. But we would expect those to stabilize. So what we've also seen, as I think we've mentioned, is that as we're moving people on to converged U.S., common systems, so all of our acquisitions are merged into the U.S. structure. Moving them over in that transitionary period sometimes gives customers an excuse to delay things as they put the new details in, again, transitionary in nature. So we do not see the macro environment really impacting that, and we suspect that to be normalized in the quarter.
spk07: Okay. And then since we have Greg on the phone, I was curious, I've seen a few different opinions through the supporting season on the health of the mid-market. And so I was curious if you're seeing any change in behavior or any change in the health of the demand. I know you've already said demand is very strong, but just specific to the mid-market and where that goes relative to if there's an erosion and if we're heading into a recession or whatnot.
spk06: Yeah, we have not. So the outlook continues to remain positive for us. And I think the good thing for us is we have so many solutions and capabilities now to offer our clients, right? So where we were traditionally just selling cloud only or security only to a certain client, our account executives now have the ability to sell across the entire portfolio, right? So we're not seeing demand slow down at all in our customer base, and we're continuing to see more and more cross-sell happen across North America.
spk00: I'll just add into that as well, as well as that diverse product offering that Greg's mentioned there, you've also got a very diverse customer base. It kind of insulates your risk because of the diverse customers and diverse industries that we serve, so that helps with that too.
spk07: Okay, and last little one, just if you could clarify the statements on the pace of M&A. Can you just talk about if that's an intentional slowdown, how long you intend to slow down, if there's opportunistic acquisitions that you might look at through that? Just be more specific around your statements on the pace of M&A over the near term, and then I'll pass the line.
spk08: Sure. We're very thrilled that we exceeded our acquisition target already this year. So we've hit our target. We feel that we've, again, when you look at our last year's base was $1.5 billion, and we added $1.2 billion of revenue. That's a lot. And so we'll focus in on consuming, cross-selling, and integrating. I think back in 2020, you'll recall that we took a pause in Q2 and Q3 from acquisitions and And you really saw those percentages go up. One of the challenges we have with so many moving parts through acquisitions is really getting that clarity and especially around things like organic growth. And so we feel that really that focus will really help show that. Again, when we target a billion a year of acquisitions, as a percentage basis that goes down over time. So next year, we'll focus on the back half of the year. But obviously, we have a very large pipeline. And opportunistically, as things come up, if they were there, we would do them. But we really feel that the focus on our organic growth and integration is the right one for the rest of the year and the beginning of next year as well.
spk09: Thanks a lot.
spk05: Your next question will come from Rob Gough of Echelon. Please go ahead.
spk03: Good morning and thank you for taking my question. It was encouraging to hear that the Q4 outlook calls for consistent growth versus the year-to-date basis. Could you talk to how that might apply when you look within the revenue line? Are you seeing consistent growth within product versus managed services versus the professional services?
spk08: Those. The growth of professional services has exceeded the rest of the growth. And then you've got a few moving parts, Rob, which makes it hard to predict exactly how much of that backlog is going to come through in Q4. So one of the things we've noted is that you see the services backlog doesn't include any managed services, but it does include services to onboard customers to then lead to the managed services. So as we talk about our advise, implement, and manage, you're kind of The leading indicators are advise, then you've got implement, and then you've got manage. So you'll see those kind of things through where you'll have above average professional services growth followed by your implementation and then the managed services. But again, the services obviously is the most profitable part of the business and the most differentiating part as well. But there is a real mix there in the Q4. Does that answer your question, Rob?
spk03: That does help. On the M&A side, we understand you're focused on integration right now. Could you talk to the market conditions, though? Are you seeing a greater availability of prospective acquisitions looking further out?
spk08: Absolutely. So the thing that we've really noticed, though, is I think people didn't understand our capability of buying advisory companies in cybersecurity and analytics for VAR-type multiples. And I think that's why we try to call out the differentiation there is we've been very disciplined buyers of companies for right rates, but we've been able to get so much more in the modern climate because there are very few buyers. What are rarer are the platforms. And why I was thrilled to get RedNet last year and Stone this year is there are very few platforms. there is an abundance in a very diversified market of those customer-centric ones that you buy and then implement in your cross-sell. Really, you're buying them for their customer access so that Greg can run the cross-sell strategy. Still, it's an incredibly diversified marketplace made up of a lot of smaller players. Again, We act like 35 companies in five years is normal. It's not. Our competitive advantage is our buying companies, integrating them, and cross-selling, and most people struggle with that. And it's a culture thing as much as anything else and who we know, but there's still a lot of opportunity. We're very mature now. It's the capabilities in North America. We've hit all the NFL cities. We've got all those capabilities around football. cyber analytics, cloud demand services. In Canada, we've really added to those offerings, and you'll look to see that same path of growth happen in Northern Europe in the future as well.
spk00: Rob, I'll just add a little bit of color. I think Sean kind of touched on it there, but the IT market, whether that's in North America or in Europe, is very fragmented. It has been for years and continues to be very fragmented. So in terms of opportunities for M&A moving forward, there's still a hell of a lot out there as a result of that fragmented nature of the industry.
spk11: Thanks, guys.
spk05: Your next question comes from Deepak Kaushal of BMO. Please go ahead.
spk04: Hi, good morning. Thanks for taking my questions. I've got a couple on acquisitions and then one on organic growth. Sean, you mentioned three different types of acquisitions that you're doing, VARs, boutiques, and platforms. When you first started, you had a target model to bring like a six times EBITDA multiple down to two times EBITDA multiple on a VAR. What's kind of your target and aggregate for these three different types of acquisitions or just at a high level? What's kind of the target return on capital that you look for across your types of acquisitions?
spk08: So you're absolutely right to call it out, and thank you. Your report actually gave me a better framework to communicate with people, so I do owe you for that one. And really, the standard metric of buying bars at three times and moving to six and a half times is really on the implement side. We haven't provided the guidance on the other two areas. We're going to be doing a capital markets day next March, and we'll really be expanding on that at a more – expanded basis at that time where we'll really go through that. So you're absolutely right. You should think about that model we provided to be really on the implement side and we'll provide further guidance in March when we have our capital markets day.
spk04: Got it. So I'll be patient for that. But following on the M&A side, the level of integration of acquisitions. You talked about back office ERP. Wanted you to talk about the other buckets like front office, technical sales teams, branding, cross-border. What are the big buckets of integration that you've done and what's yet to be done?
spk08: This is full integration. We deconstruct these teams. Every single U.S. employee is on a U.S. payroll, every Canadian employee. And so there is now 11 of the companies we acquired no longer exist. Like Lighthouse Computer Systems no longer exists. Those are all converged employees, converged email addresses. You know, BCT, key information systems, those companies no longer exist. Once you pass that three-year earn-out period, like first year, we leave the brand and make them a converged company. But we're talking full integration, everything from Salesforce to their expense systems to their – you don't get synergies with your people, even if they're the same system but different implementations. If an inside salesperson has to log on to one and log on to another in order to support different salespeople, you can't get synergies of a consolidated back office. So this is full systems, and this is something that at the Capital Markets Day as well will really draw out the amount of integration we've done. Because again, it's something I should talk about a lot more because it is a core competency and it really does drive efficiencies, not just on the cost side, but when Greg talks about the amount of our sales reps that are able to cross-sell other practice areas. The systems really enable that. In Salesforce, when they reach a certain level, it gives them case studies of other customers doing that. So that's really the details around the systems and the systems integration, which is complete, is very meaningful to our ability to cross-sell as well.
spk06: Yeah, Deepak, I'll just jump in here too on the services side, right? Every time we acquire a company now, what we do is we go through the technical capabilities of every resource on the team right and we actually shift those resources into the individual practice areas that they specialize in right so as we talk about our ability to cross sell and our ability to drive high value services with our clients those skill sets are coming from every organization we're acquiring right so the mass we have and the breadth and depth of every single practice area continues to grow significantly after every acquisition okay great so out of the 35 how many would you say are are fully integrated obviously not stone yet but
spk08: Yeah, so, again, we'll go through it in detail. We do it by region, and so I separate out the five in portage because those are not fully integrated, I think. Actually, we can get back to you with the full numbers of integration, but, again, you know, with the 10 this year, some of them already are. There's a couple that are still in, and obviously Stone is. We haven't completed the ones on August the 1st yet, but we can give you, like, there's a status update that gives by region the integration, so we can provide it to you as well.
spk04: Okay, and my last question, if I can sneak it in, given it's my first call for you guys. On organic growth, there was some slowdown. You did mention the shift in mix to services, which has more of an impact on the top line. How much of that organic slowdown was that mix shift and how much was seasonality and how much was just kind of macro factors?
spk08: So I wouldn't say macro factors at all. I think what you've seen is as the supply chain has normalized, you saw the leading area was devices come out, which are very high revenue and lower gross profit. Now you're seeing the other side. So there are a bunch of factors in that, but definitely I'm not seeing this as not a demand issue that we're seeing. It's more of a product mix issue. And again, the very high services growth really shows that demand up.
spk04: Okay, that's helpful. Thank you for taking my questions. I'll pass them on.
spk11: Thank you, Peg.
spk05: Your next question will come from Jerome Dubreuil of Desjardins. Please go ahead.
spk01: Hi, thanks for taking my question. This is Phil Serco on for Jerome. I just had a question around cloud growth. So we saw cloud growth kind of slow down at Google Cloud, Azure, and AWS, and I was just wondering if you saw this slowdown at all felt in your cloud migration demand from your clients. Thanks.
spk08: So although it's down, say, 5% at Azure, it's still a really, really big number, right? And we still have mid-market companies that are desperately needing to get to the cloud. When you look at these traditional businesses, they used to grow at GDP growth rates because they were selling data center equipment. Cloud growth rates are so much larger. And so just the pace of cloud growth is why companies in the IT services space are even having interesting conversations. So it's still, when you look at all the areas of growth, cloud is by far the largest. And so when you have Amazon, Google, and Microsoft providing numbers that are worldwide in nature, They realize there's some currency impacts there, especially in, say, Europe and Asia, but also the North American demand I do not see as being impacted like there might be in some other areas. So, one, it's a very big number, and two, I think you have to remember the U.S. guys reporting on global numbers and in U.S. dollars has an impact there as well. But we're definitely not seeing a lowering of demand in the mid-market of companies wanting to move to the cloud.
spk11: Great. Thank you. I'll pass the line.
spk05: Ladies and gentlemen, once again, if you would like to ask a question, please press star 1 at this time. Your next question will come from Gavin Fairweather of Cormark. Please go ahead.
spk09: Oh, hey, good morning. Just wanted to start out on the services side. Given the growth that you're seeing in that business, can you just discuss capacity utilization of those teams and your plans to invest in this business with organic hires versus M&A?
spk06: Yeah, absolutely. So utilization is something we look at on a monthly basis, right? So we're always looking at what does the team utilize that today? And then what are the needs coming from the pipeline? So overall, utilization is strong across all our practice areas. As Sean mentioned, we've made a significant amount of acquisitions with LPA, CARPE, CBI, et cetera, for each of the practice areas. But we're also organically hiring as well. So we're looking at technical resources across the board. As you can imagine, with the The environment and the way it is today, demand is hard around these resources, but we're continuing to be able to find the right skill sets and the right expertise to deliver on those projects, which is why you're seeing our services growth, right? We're able to leverage the acquisitions we've made, but also leverage the talent that's out there and leverage our internal talent team, too, that's been able to help us recruit and bring in that high-value services people.
spk08: And one thing I'd add to that, when you bring in acquisitions, they provide teams of people that work together, right? So you can augment that with organic, but I love our model where we partner with services companies and then acquire them that have prebuilt teams. And also, when you have that talent, that also attracts other talent. If you go some places and you're the only smart person in the room, then, you know, that's a lonely place. And so the culture is incredibly important in attracting and retaining this top technical talent and having the base key resources. And, again, we've seen it with, say, the three analytics companies, LPA, Carpe Datum, you know, with the existing X-State, and now with New Comp Analytics. really working together on that. So I think it's the combination and really getting that kind of the acquisition part that brings in those teams that you can augment with, as Greg says.
spk09: That's helpful. And good to hear that the sales team is still hearing strong demand from your mid-market clients. I guess I'm curious, if we did get into kind of mid-next year and demand did start to slow down a little bit, how would you change how you're managing the business in that type of scenario?
spk08: So these businesses are absolutely, you look at how your quarter's gone and you make investments or you take costs out depending on that. So if utilization rates go down, again, what we've seen is incredibly high demand for technical resources. And when you actually look, people aren't firing cybersecurity and analytic people, right? You cannot find those skill sets. So I don't think those are people that you're finding are going to be out in the street. So these businesses, you always watch your cost, and when the utilizations are down, then you make changes. And when you've got high demand like we have now, you're constantly hiring. So if it's something on a quarterly basis, that's the way we manage the business.
spk06: I think the diversification of our solution set helps there too, right, Gavin? So we can look at the pipeline now, now that we have all the sellers on Salesforce, and look quarters out and see where are we seeing the demand, where are we seeing the growth, right, and make the investments now and be able to just keep a real close pulse on the business.
spk09: That's it for me. Thanks so much. Thanks, Evan.
spk05: Your next question comes from David Kwan of TD Securities. Please go ahead.
spk10: Hey, guys. I just want to go back to Deepak's question on the organic growth. I appreciate the gross profit organic growth, which I think is a better way to look at the business. But just given it was lower than what we've seen year-to-date, An explanation you gave would seem to make sense on a gross revenue basis, but on a gross profit basis, I'm not sure the revenue mix is necessarily as applicable here. So just trying to get an understanding if there's maybe something else at play, given what we've seen with the backlog that actually declined this quarter and also the tailwind from the stronger U.S. dollar. I'm just wondering if there's something else at play there.
spk08: On the FX side, the euro decline kind of offset the U.S., dollar tailwind. But again, you say in the quarter, what you see in a gross profit growth is organically similar to the year-to-date numbers. What you saw in a revenue is a mixed thing. Q3 does have its idiosyncrasies around vacations and things like that. But again, it's the same as last year. There will be some variances, but I definitely don't see it as a demand issue.
spk00: Let me just add a bit of colour to that as well, David. If you look at a constant currency comparison of net revenue and gross profits, so net revenue, as we reported, was 64% up. If you constant currency that, that increase comes down to 62%, so only a small difference. On the GP side, we reported 67% growth, and if you constant currency that, it comes down to 64%. So again, minor differences. effects of FX benefits, that US dollar Canada offset by Euro Canada. So it doesn't really change the optics of it. There's a small headwind, but it's not really material. It doesn't change the view of performance in the quarter.
spk10: Thanks for the help and the clarity on the FX in particular. Two more questions. First off, can you talk about what you're seeing in Europe and how that compares to North America? You're kind of talking about very strong and robust demand in North America, but given Some of the more challenges that we're seeing in Europe, I'm curious to see what you're seeing there.
spk08: So in the education space, so 90 plus percent of our business is education. Those are long-term contracts and those are very well-funded projects. So both in Germany and now in the UK, the focus on education we feel is very resilient. There is a lot of uncertainty in the marketplace around energy prices and what that's going to mean for various industries, but we don't see that impacting education. But Richard, would you like to add to that as well?
spk00: Yeah, I mean, the European perspective, as you know, come from Softcat. Softcat released their results beginning of last week, and they've reported consistent results. maintains demand in the second half of their year and positioning their outlook statement as that continuing. So I think the European position, whilst you'd expect there to be potentially some softening given the macro climate and what's happening in Europe and the Ukraine crisis, et cetera, cost of living, energy costs, all of those things, that's not translating into demand for mid-market and IT budgets in European customers. That's certainly what Softcat experienced. I know Bytes came out as well and they've said a similar thing So the demand picture, the demand pattern that we're kind of talking about, I think that applies to Europe just as it does to North America. That's where I'm at.
spk10: Thanks. And just my last question. On leverage, net debt to EBITDA jumped closer to, I think, roughly two and a half times this quarter, which is higher than the two times you talked about not wanting to exceed in the past. Given your plans, I guess, for a slowdown in M&A, is it fair to assume here that You know, you're planning to allocate more of your free cash flow to reducing your leverage in the coming quarters, and maybe where do shared buybacks fit in, especially where the shares are trading right now?
spk08: Yeah, so I mean, our shares are very attractively priced for us to implement the share buyback program. As we announced that there's a 10.7 million share program of which at the end of Q3, we had bought back 5 million shares. So we'll continue to be buyers of our shares. And in addition to that, we generate a lot of cash. Q4 is very cash generative, as is we've become a very large company generating a lot of cash. So that'll be used to pay down debt and to buy back shares until we start the acquisition trail again. Would you go beyond the 5%, Sean? At this time, that's what's been approved by the board. And so, say, we can look for, once that's done, the board can assess the situation and see where to go. But right now, there's lots of headroom to complete that program.
spk11: All right. Thanks.
spk05: There are no further questions at this time. I would like to turn the conference back to Mr. Main for any closing remarks.
spk08: Yeah, really wanted to thank everyone for joining today and your continued support, and thrilled that Richard has now joined us and able to contribute as well. So thank you very much. Thanks, everybody. Thank you.
spk05: Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank everybody for participating, and you may now disconnect your lines.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

-

-