Converge Technology Solutions Corp. (CTS) Earnings Call Transcript & Summary

Good morning. I'm pleased to introduce our next presenting company, Converge Technology Solutions, a North American hybrid IT solution provider focusing on delivering industry-leading solutions and services. Presenting from the company are CEO, Shaun Maine; and EVP, John Flores. [Operator Instructions] And with that, I would like to turn it over to Shaun Maine. Shaun, the floor is yours.

Thank you, Matt. Much appreciated, and thank you for joining our presentation. So Converge Technology Solutions is a company that has grown through acquisitions. It buys companies that sell hardware, software and services into data centers, and it turns them into hybrid IT providers that sell public and private cloud services to those customers. We've done 8 -- 12 acquisitions in close to 3 years and in a very prescriptive plan that first covered capabilities and geographies, and now we're integrating all those companies. It's a very experienced management team that has done -- no one has not done their functions before. And during COVID-19, I keep saying on our quarterly calls that you can't tell there's a pandemic going on when you look at our financials. And although it is -- has been a very trying market out there because of the sectors we sell into and the offerings we have, we've been very COVID-resistant from a financial perspective. We are -- our ticker symbol is CTS on the venture exchange. So as a hybrid IT provider, the 2 key partners for us are Red Hat and VMware. Those are the partners that allow applications to exist in these multi-cloud world. So they don't have to know if they're on-premise, they're in the cloud. Because of that, IBM, who owns Red Hat; Dell, who owns VMware; and Cisco on the network side are our key vendor partners as well as the public cloud providers. So that's Amazon, Google and Microsoft as well as Ingram Micro, the largest distributor in the world, around $50 billion in size, they are a key partner of ours because when we buy companies, we move spend to them. They've been very helpful, with rebates and funding acquisitions and being a great strategic partner. So when you look at this map, I think we've done a great job of providing coverage for all of our main markets. Our goal is to hit all the NFL cities, that's really where our customers are at. And during COVID-19, having this kind of coverage model has been very, very helpful in continuing to provide services to our customers. We've also been recognized widely for various awards. We are the fastest-growing IT service provider in North America. We are the 50th largest one, which shows there aren't a lot of large ones. It's a very fragmented marketplace. We were Ingram's cloud -- North American Cloud Partner of the Year. We won the IBM Analytics Award and the Red Hat Rising Star of the Year Award. So we're really getting some recognition for what we're providing to the marketplace. So around cloud services. And again, 23% of our revenue is service revenue, and we're kind of hitting that inflection point where our services revenue provides more gross profit than our hardware and software product revenue, that other 77%. But the key capabilities to being a hybrid IT provider, providing cloud services are analytics, and this is not just tools but data scientists, cybersecurity, having a world-class security practice and then cloud migration services as well as your own managed services, hosting applications on behalf of your customers. So as I was saying, when we buy companies, they're really selling into the data center. And although they might play in one of the cloud providers, they really don't have the investment dollars to have the practice areas or the capabilities around all the public cloud providers. And so we have practices around Amazon, Google and Microsoft, the 3 main cloud providers as well as our own private cloud or managed service that we host and operate applications on behalf of our customers, customizing processes to them. And then during COVID-19, there's been hybrid offerings such as VMware's VMC on AWS, a cloud offering that lets you put workloads on to the cloud. And those type of offerings during COVID-19 have been extremely popular. When you look at our gross profit, and this is the best way to really tell what a company is. The people that are resellers that are reselling hardware, their gross profit tends to be 13% to 16%. And they can do it very efficiently; the CTWs, the Insights, the Pivots. When you look at the global SIs, the Accentures, the CGIs, they tend to have 30% gross profit and up. And we tend to look more like them than we do like the resellers. As I mentioned, our gross profit is kind of in that 24% to 25% range. And that tells you the mix of higher-margin services, cloud services that we're providing really contributes to that high gross profit. So we bought 12 companies, but I met with 84, and I chose these 12 by culture fit, by customers, by geographical regions and capabilities. And so we did this over -- and this is really hard to do. We've made it look very easy. But we did know most of these companies going into this. Most of these companies have been around for 25 years. We're from the industry, and so we did take a great selection of companies that have all worked very well together. So I created this plan in April of 2017. I've never changed this slide. This slide, we continue to do exactly what we said we're going to do. And the team has just been awesome in following this plan. Phase 1 provide a broad-brush geographical coverage in Canada and the U.S. and get top-tier with all the vendor partners for enhanced rebates. Phase 2, get all the capabilities around hybrid IT, the analytics, cybersecurity, managed services, cloud. And then in Phase 3 now, integrate all the back offices and take out duplicate costs. And we're taking $20 million of cost out this year, which is almost completed. So one of the things that's been so impressive is our recurring revenue. For a company in -- of our size to have $205 million of annualized recurring revenue is a really large amount. And that's broken up into 3 different parts. 1/4 of that is private cloud, which is us hosting applications on behalf of our customers. Those are 3-year deals, monthly recurring revenue, and that's recognized gross to net. 1/4 of that is public cloud. Those are 3-year deals with Amazon, Google and Microsoft. And then half of that is we sell a lot of software, 20% of our revenue is software. And when you do that, you get an annual recurring revenue for patches and upgrades. So that makes up -- and you'll see the incredible growth. We grew that recurring revenue over 80% in a single year. And you continue to see that move during COVID-19. So the $1.2 trillion IT services marketplace, the large providers tend to gravitate to the $150 billion of large enterprise spend. We find ourselves in the $650 billion mid-market spend, in the upper end of the $400 billion of SMB, not competing against any of the main providers. We end up competing against mom-and-pop shops, and it's very fragmented marketplace. The margins are better and mid-market companies need help getting to the cloud. So this is a European strategy that CANCOM, Bechtle, Softcat and Atia followed, but North America, it seems that they haven't. And so therefore, we've been -- we do not face competition in the mid-market for our services. So although the logos on the left-hand side show our bigger customers, we've got this wonderful, diversified customer base made up of this mid-market. And as I said, when you look at our financials, you can't tell there's a pandemic going on, particularly because of the sectors that we sell into. So in the first half of the year, 22% of our revenue has come from financial services, 20% from technology, 20% from government and state local and education, 12% from health care and 6% from manufacturing. Of the other 20%, not one sector makes more than 4% because utilities, industrials and down from there. And we have no exposure to or very little exposure to oil and gas, luxury, retail, hospitality and travel. Also, in the first half of the year, over 105 of my customers purchased at least 1 million of products and services from me. So when you have this wonderful diversified customer base in the right sectors, selling the right cloud-based offerings, that's why our number has been so impressive this year. So this is another slide that I've never changed, that we have -- here's our secret sauce, we buy companies 3%, we add 1.5% in rebates, volume rebates. So this is 3% EBITDA margins. Last year, on my $687 million of revenue, I had $10 million of rebates or 1.5%. And then this year, I'm taking 2% of cost out, 1% from the front office, 1% from the back office. That's the way I take a 3% EBITDA company to get to 6.5%. We also -- small guys don't get the best working capital terms. So we buy these companies with debt and working capital because when we -- after we buy them, we extend terms for our suppliers. So this integration, I couldn't have been prouder about how we have done this. During COVID-19, we haven't changed our integration schedule at all. All 12 companies will be integrated. We've done -- just completed numbers 8 and 9 of the 12 companies on September 1. #10 will be done October 1 and 11 and 12 December 1. That takes -- integrating those back offices takes out $9 million of annualized cost. And in the beginning of April, we took out $11 million of duplicate front office. That's a lot of senior management, sales, marketing and engineering. So in total, we're taking $20 million of cost out. Now that's happening during the year. So you'll really see that in our G&A in Q3 and Q4, but you'll see the full impact as you get into Q1 next year. So that is very meaningful, obviously, as we look to the bottom line. So the reason that's so impressive is that at the same time, when you look at the 12 quarters that we existed, going from $52 million to $228 million in 11 quarters, going over 5x of gross profit and getting our gross margins up to the 23%, 24%. I mean this is just really impressive, both inorganic through acquisition growth, but also organic growth. And if you look at our adjusted EBITDA, really, when you look at the last 3 quarters, Q4, Q1, Q2, we did 3 acquisitions in Q4 last year. You really see the kind of new potential that we have. And as we get back and doing more acquisitions, you see how that really bakes in. And when you really -- you add the rebates, you take the cost out and you're adding these higher-margin cloud services. It really is pretty starkly impact that has on the financials. So looking at our balance sheet. We are a highly levered company. We are very confident in the levels of our leverage. And you saw this year was really the inflection point year, where we went from really getting to generate free cash flow. When you look at our financials, we have over a $5 million a month in interest payments because of interest -- high interest paying of our debt and over $5 million in noncash items on a depreciation and amortization. On the interest side, I will be looking to move from our very flexible but expensive ABL, which is kind of 9% interest rates, to a more traditional ABL in the 2.5% range before the end of the year. And so that will have a material impact on our interest charges that we'll pay in Q4 and then into 2021. So we also recently did a $20 million financing that happened in the summertime, and we are trading strongly since that time as well as a lot of institutional shareholders came up for it. So when you look at our share capital, we have again, fully diluted, 117 million shares. Management has 20% of those shares. I don't believe in stock options. I'm the largest shareholder. I think stock options are dilutive. I have our own employees buy stock. And so that you look at -- we've taken Constellation Software's comp model where 25% of all executive variable comp goes to buying stock on the open market, not from treasury. We have an employee stock purchase plan, where they can buy stock on the open market that we match 20% again on the open market. Also when we did our public round, 60% of it was from my own employees at the exact same prices to shareholders. So our employees are definitely lined up with our shareholders. Then as I mentioned, this team is -- has just performed so well during the most trying conditions during COVID-19. And they're a mix of the old and the new. So I've known our Chairman, Gord McMillan since university. Gord is really instrumental in structuring our acquisitions and getting them from LOI to close. Don Cuthbertson, I also went to university with, he is our CTO and President of Canada. He sets our technical direction as well as he runs Canada. Cory Reid, our COO, who I've been working with over 30 years with. He is responsible for all the integrations of our back offices. Carl Smith, our CFO, just joined us in March, and he came out of the software space from Espial and really helpful on the public market side. Greg Berard, our President, who's responsible for all this cross-sell and software-enabled with Red Hat and VMware. He was the President of Lighthouse that we bought at the beginning of -- sorry, December 2018. Cari Hash, who runs enterprise sales; and Tommy Whatley, who runs services, they were part of my last consolidation. And then Vanita Patel just joined us out of IBM. She runs our Red Hat relationship. And Rhonda Hanes has just done a tremendous job during COVID-19. We've got 30 offices, keeping our employees safe and meeting the various requirements of the different places. So this team has just performed so well during COVID-19. So I've run through that very quickly to leave some time for questions. So Matt, I'll turn it back to you to see if there's any questions.

And as we wait for people to poll for questions, I'll just kick it off with the first one. In terms of competition, can you describe the landscape for listeners and what you believe to be Converge's most sustainable advantage?

Yes. So most of the large players, and these are really the global SIs, are providing cloud migration services to large enterprise customers. What we are targeting is mid-market customers. And although we're buying people that are reselling hardware and software and services into them, we're migrating them into a cloud services provider, and that's both from operating them as well as a lot of the consulting services around analytics and cybersecurity and devops. And so we -- when we're competing in that mid-market space, it's, again, a lot of regional family-run firms that don't have data scientists or software people that migrate applications and that kind of people with expertise because all of the, like the Accentures, the large SIs are all spending it on the Fortune 500, and we don't really touch those guys. So I think that's been -- one of our big advantages is they're not playing in the space that we are. And we've got a presales model. There's a common theme I've heard from people that you can't make money in the mid-market. Well, we run a very efficient presales model, where mid-market customers will come to us. So we run these workshops like a Red Hat's management platform, Ansible, will bring in up to 65 customers to come to us to trial it out, have our world-class experts show them the technology. And that's been wonderful in getting that conversion to customers and net new logo. So I think the space we're playing in, the fact that most of the prevailing knowledge is just go after large enterprise, and we're going after the mid-market, and the way we're about doing it and doing it cost effectively, I would say, is one of our biggest competitive advantages.

A short question from the audience. In your opinion, what is one thing about your business that is either misunderstood or underappreciated by the investment community?

Oh, so when you look at our earnings growth is basically 50% year-on-year, and yet the multiple that people ascribe to our business is single digit. So the problem when you're earning growth is not tracking your multiple is that the calendar gets in your way. So when we -- the analysts have us in the low $50 millions of EBITDA this year and yet mid-70s next year, when do you start trading on next year's numbers. And so I think -- as you -- and we're a newer public company, so as we continue to demonstrate these quarters of growth, when you see the cost out, when you see the continued acquisitions and the performance, I think that will -- over time, that will fix itself. But that's been, I think, one of the challenges when people see the companies we bought, who tend to be more reselling, and what we've turned them into is these cloud services providers, and even cloud services providers were not getting the multiple of those type of things. Our earnings growth rate versus our multiple has been a major disconnect.

That's a great answer. One additional question. So M&A activity has been heating up lately in the space from Computacenter's planned acquisition of Pivot to the speculation around Platinum buying Ingram. Shaun, it would be good to hear your thoughts on the recent activity, associated valuations, and what it means for Converge.