Softchoice Corporation

My name is Lara and I will be your conference operator today. At this time, I would like to welcome everyone to SoftChoice Q3 2023 Earnings 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 for analysts. 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. Thank you. I would now like to turn the conference over to Mr. Tim Foran, Investor Relations. Please go ahead, sir.

Thank you, Lara, and good morning, everyone. Welcome to SoftChoice's Q3 2023 conference call for the period ended September 30th, 2023. A reminder, for the purpose of the recording, today is Thursday, November 9th, 2023. I'm joined today by Andrew Caprera, SoftChoice's CEO, and Jonathan Reuter, CFO. Andrew will provide highlights of the quarter and update on the demand environment and speak to our execution in our strategic focus areas. And then Jonathan will do a deeper dive on our financial performance and we'll end with Q&A. The company will make forward-looking statements on our call today that are based on assumptions and therefore subject to risks and uncertainties that could cause actual results to differ materially from those projected. The company undertakes no obligation to update these statements except as required by law. You can read about these risks and uncertainties in our earnings press release today, as well as in our filings with Canadian securities and regulatory authorities. Also, our commentary today will include adjusted financial measures, which are non-IFRS measures. These should be considered as a supplement to and not a substitute for IFRS financial measures. Reconciliations between the two and relevant disclaimers can be found in the company's MD&A, which is available on our investors' websites. Unless otherwise noted, percentage growth rates that we refer to today are for the identified period ending September 30th, 2023, compared to the same period ending September 30th, 2022. Finally, please note that because the company reports in U.S. dollars, all amounts discussed there in U.S. dollars, unless otherwise indicated. With that, I will now turn the call over to Andrew.

Thank you, Tim. Welcome, everybody. In Q3, we continued to show solid execution and demonstrated continued resiliency of our software and cloud solutions-led business. Our Q3 financial performance was highlighted first by continued double-digit constant currency growth in software and cloud and a strong quarter for services. These drove growth in gross profit, our measurement for top-line sales, reflecting healthy demand from mid-market customers for our mission-critical digital workplace, cloud, and security solutions. Second, our gross profit growth drove a strong increase in EBITDA, bottom line profit, and margin expansion because of the natural operating leverage in our financial model and our prudent cost containment efforts. And third, we ended the quarter in a robust financial position. Our net leverage was at 1.1 turns, a full turn less than the 2.1 we were at last year. We have tremendous flexibility to continue our balanced allocation of capital to internal investments that will drive growth while returning significant capital to shareholders. In terms of operational highlights, we continue to execute successfully on our growth strategy. We increased the size of our customer base by 108 customers in Q3 and 220 over the prior year, which is a 5% increase. This growth is attributable primarily to the 10% growth of our frontline sales force over the last 12 months, along with increased overall sales tenure and retention. A secondary but still notable driver of this growth was our success in the public sector, where winning a procurement vehicle would result in the acquisition of several customers. For example, we recently became one of only four providers authorized to sell Microsoft into the state of Texas and its agencies. In Q3, we also increased our average LTM gross profit per customer by supporting our expanded sales force with advanced technical and specialty sales expertise to help drive deeper engagements with customers and deliver higher margin and stickier IT solutions. Turning to slide five, in terms of the demand environment, Q3 trends were similar to what we've seen through the years so far. Specifically, accelerating growth in our strategic focus areas, temporarily impacted by the industry-wide postponement of hardware devices such as laptops. On a year-to-date basis in constant currency, software and cloud gross profit has increased 14% and services 19%, both higher than their average historical growth rates. Combined, these two solution types comprised approximately 77% of our gross profit over the past year, compared to 69% in 2017. The strength in our core solutions is what gives us the conviction that our strategy is working and we have solutions that our customers value in this environment. We're taking share and can continue to invest in future growth ahead of lapping the hardware weakness that we've seen this year. And hardware, which was 23% of our gross profit over the last 12 months, has declined 17% due to that industry-wide reduction in discretionary purchases. Some of this decline reflects the decline in server purchasing as more customers move to the cloud, a trend that we expect will continue and which ultimately benefits our software and cloud first approach. However, the vast majority for us has been in laptops and other peripheral devices. As organizations will not be able to postpone refresh cycles indefinitely, we expect to lap this temporary weakness sometime in 2024. And for context, if hardware was even flat in 2023, our overall gross profit would have increased 11% year to date in constant currency. While devices have been a modest drag on our results this year, it's been more than offset by demand in our strategic focus areas, which is what drives our excitement about future growth. We outline these on slide six. In terms of software asset management, we continue to successfully leverage our capabilities in this area to lead our reduce, optimize, innovate, or ROI go-to-market approach. For example, we're going to save one new customer in the legal industry more than $32,000 per month on costs across two cloud providers by helping them manage their consumption. This reflects the value we create for customers when we mobilize our tenured account executives and our technical experts to help them solve a critical problem for customers. And it's that reduced motion that helps our customers free up resources to engage us on further projects, creating value for them and for us. The cost optimization of public cloud spend remains a priority for customers. It's an area where we deliver quantifiable results through our multi-cloud FinOps and cloud governance practices. As customers pursue application and data modernization programs, they want financial planning and reporting built in so that they can accurately forecast and account for the value that cloud consumption is driving back to the business. Our skill set in this area aligns with what we've already been doing in recent years, helping customers navigate the change to subscription software models by helping them adapt the way they assess, analyze, transact, and manage software spend. However, it's not just cost optimization opportunities driving growth. Building or refactoring applications using cloud native tools has also been a growth driver for us. This is a result of significant investments in data and application development capabilities that we've made over the last several years to support our customers more deeply on their cloud journeys. Additionally, within public cloud, one of the trends that has been fueling our strong growth is the pace of new public cloud logos. We've been discussing this all year, and we still expect it to accelerate because customers are more often adopting multiple cloud environments to solve discrete needs versus using one cloud environment to solve all the needs of the business. This makes their environments more complex to build and manage, and so they need our expertise. Our continued success here is due to our ability to map those unique business needs to the solutions available across Azure, AWS, and Google Cloud as well as our ability to enable customer adoption of a single operating model across these multiple cloud environments. These new logos provide an important pipeline for our future growth. New cloud logos typically are of low consumption value when we first win them, but they grow over time under our management. One of our aims is to drive that by attaching services that will accelerate the time to value for our customers and correspondingly the pace of consumption. Now looking at our digital workplace and collaboration strategic focus area, we continue to see sustained momentum in our Microsoft E5 business and within our Cisco and Adobe portfolios. This has been driven by demand for software solutions that enable more agile and secure collaboration while remaining flexible to shifts in workplace policies regarding remote and hybrid work arrangements. Within security, which underpins all of our solutions, We're seeing increased demand for modern security solutions with the continued adoption of the Microsoft M365E5 solution set. The security tools generate a wealth of signals that can be used to better predict and detect security risks. Now, those signals require the tools and processes to properly collect, analyze, and manage them, which is driving customer demand in this area. Azure Sentinel is a primary solution to solve this, and we're also seeing the entire ecosystem of threat detection response players rise with this trend. Also within security, there's been an increasing demand for managed security services because many customers can't manage the threat data and response on their own, and the risk of not doing this right is increasing every day. We have a portfolio of managed service partners designed to cover the different security platforms our customers are using. Therefore, we've been able to capture a broad amount of demand for this in our customer base. And turning to slide seven, we're taking an early leadership position in the enterprise adoption of AI. We have all the core attributes that a customer needs in their AI journey, including expertise and experience in design thinking, consulting methodology, application and data modernization capabilities, data security and governance services. and the end user adoption planning and support to make sure that people know how to use these effectively. This is converting into a strategy for us with three key elements. One, our own internal adoption of AI. We're already testing a broad range of use cases with tools like Copilot for M365. So one of the handful of large scale partners invited to participate in Microsoft's Early Access program. We're also evaluating and building generative AI use cases on Azure, AWS and Google Cloud. The aim here is to create competitive advantages in how we accelerate the time and value of functions across our own business, while enabling the hands-on experience we need to take this to our customers. Second, the existing services that we already deliver are being adapted to include AI opportunities, such as generative AI enabled automation in application development services. And third, new services are being developed across each of our solution areas, For example, in Workplace, we've seen great interest in our Microsoft 365 Copilot readiness services, which enable customers to perform use case identification, data planning, system integration, and end user adoption planning, all in preparation for the launch of Copilot. We're all seeing equal interest in more customized generative AI solutions built on Azure, Google, and AWS. Each of these solutions are front-ended with consulting workshops where we bring together IT with lines of business to align use case planning and outcomes before selecting the language models and compute platforms best suited for those outcomes. We expect to see more customer demand beginning in Q4 and coinciding with the rollout by Microsoft of M365 Copilot to enterprise customers on November 1st and Google's rollout of Duet AI on Workspace. To really provide anticipated financial contribution to our business, we believe it will be a material contributor over the medium term.