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

Good morning, and welcome to Converge Technology webcast as part of the Planet MicroCap Showcase. It is now my pleasure to turn the floor over to your host, Shaun Maine.

Thank you. Let's get the slide presentation move over here. So Converge Technology Solutions is a hybrid IT solution provider, we buy VARs, value-added resellers that are selling hardware, software and services into data centers, and we turn them into cloud service providers, selling analytics, cybersecurity, managed services and DevOps. We are around -- according to the analyst, around $1.5 billion run rate revenue, around $100 million of EBITDA, with around CAD 900 million market cap. We've grown our earnings, our adjusted EBITDA by 90% every year that we've been around. So we've bought 19 companies in 3.5 years and integrated them. And our first year, we were notable earnings, then we went to 15.7% then 31.7% and 60.5% this year. So impressive growth rates. We've been a public company for 2.5 years. You can go back and look at the progress that we've made over that time. We buy companies with debt and working capital and don't require equity. Therefore, we had a highly leveraged balance sheet at the beginning of last year. Last year was a real transformative year for Converge, in which, we went and cross-sold. We integrated our 12 back offices, the 12 companies we had at the time. We moved our ABL to a much more cost-effective 2.5% interest rate from over 9% after doing some equity raises. We raised $200 million, including the beginning of this year, and then did 5 acquisitions. So a great year for us last year. We've got a very strong balance sheet now. We've acquired 3 companies so far this year, including Dasher at the beginning of April, our largest acquisition to date. And we've graduated from the venture exchange in Canada to the TSX beginning of February. So this map kind of shows the evolution of Converge and that the plan was always to cover what we call all the NFL cities. Those are where our customers are. We run the company on a regional basis, and our East regions become so large, we've divided it into the Northeast and Southeast, the center and the West and Canada. But you see that geographical dispersion that we have to give that local service level to our customers. And during the pandemic, you definitely saw how -- looking at our financials, you couldn't tell there was a pandemic going on, partially because of that geographical coverage that we had. Red Hat and VMware are our top 2 partners because they enable the companies we buy to then provide cloud-based solutions to their customers. CRN has this -- as the fastest-growing IT service provider in North America, include that we're the 50th largest last year, and that means in a $1.2 trillion market that there's not a lot of large ones. We won the IBM Analytics Partner of the year last 2 years and the Ingram Cloud Partner of the year last year as well, a lot of recognition from the industry. So the capabilities that the companies we buy have are digital infrastructure. The capabilities that they don't have that we're bringing to them are advanced analytics. And this is PhD data scientists that are -- we do sell products like Snowflake, great data lake solution or IBM's Watson. But driving business value on top of that is our team, one of our largest teams in our professional services groups. And these -- we sell into the mid-market which is -- we're the only company in North America with these kind of skill sets selling to mid-market. Most of the large systems integrators sell into large enterprise, which is $150 billion total addressable market. We're in a $650 billion mid-market space with these very specialized skill sets. We also have a world-class cybersecurity group. When you open our portfolio, it's the cloud, you have to have that. Our cloud services group through the use of Red Hat and VMware Kubernetes implementations allow applications to run on big public cloud providers. And then the -- really the pot of gold at the end of rainbow was managed services. This is our high-margin recurring revenue that we transition the companies to. So as I was saying, the companies we buy, sell hardware, software and services into a data center. Through Red Hat and VMware, we enable them to sell Microsoft Azure, which is the best cloud platform for front office applications and windows applications. AWS and GCP are better for Unix applications and back office ones. We have our own managed services. And then during the pandemic, VMC on AWS, Vmware's Cloud on AWS was a great seller of people wanting to access applications remotely in a secure fashion. So the way that you can tell companies apart in this space is through their gross profit percentage and that the VARs that we buy, they tend to be in the teens of gross profit and the ones that sell into large enterprise, that the big public ones are CDW and insight, they tend to be 13% to 16% gross profit. Global size tend to be 30% to 40% gross profit. We tend to be in the mid- to high 20s. And what that tells you is because of the mix of products and services that we sell that we look a lot more like a global SI than we do like a VAR. We buy companies, obviously, that have a majority of hardware spend. We turn them into now our hardware spend is around 50%, it's around 25% of software and around 25% services. But again, the gross profit percentage is the way that you tell companies apart in this space. So very proud of the plan that I put together in 2017, we're actually going to finish at the end of this year. The management team has done just an amazing job of executing against this plan. The numbers aren't necessarily correct because I've never changed this slide. I've just showed how we moved from one to the next. So Phase 1, we had a broad brush geographical in Canada and the U.S., and we've got top-tier with our vendors to get those higher-margin volume rebates. In Phase 2, we built out all those capabilities around hybrid IT. And then in Phase 3, this was last year, we really integrated the back offices, taking $20 million of cost out. As I mentioned, our goal is always to get to kind of a $2 billion run rate and $100 million of EBITDA by the end of the year. The analyst that we mentioned, now have us with our current slate of companies at $1.5 billion run rate and $100 million of EBITDA. So the financial engineering aspect of what we do is how we acquire companies. So per $100 million of revenue, a hardware-centric VAR has about 3% EBITDA margins. We pay 4 to 5x, or call it, $15 million of purchase price per $100 million of revenue. We structured the deal so that 56% of it's upfront, or call it, $9 million upfront and then $6 million over a 3-year earn-out. We buy them cash-free, debt-free with normal working capital. So they've got a clean balance sheet. So we use our asset-backed lending facility to finance their invoices inventory to pay them the $9 million upfront check. And then we use their own profits to pay them the earn-out $6 million over 3 years. And then because they're small, they receive money from the customers on 54 days, but they have to pay the suppliers in 45 days. The day after we buy them, Ingram Micro gives us 75 day terms. Per $100 million of revenue, what that does is increase payables and increase cash. So it services $3 million of working capital per $100 million of revenue, paying down the $9 million upfront to $6 million. So that's the way I'm able to buy them with debt and working capital. And then I moved them from 3% EBITDA margins to 4.5% through volume rebates, and then I move them up to 6.5% by removing 2% of cost, 1% from the front office, 1% from the back office. And then I moved their margin up higher, their gross profit on its way to 30%, their EBITDA on their way to 9% through the cross-sell of higher-margin cloud and managed services. You can really see this happen last year. We integrated the companies, and we took a majority of the cost in Q2. So in our Q3 financials, you'll see a 27.4% gross profit, a 7.4% EBITDA margin, and in Q4, you saw an 8% EBITDA margin. So really saw the movement there. As you buy new companies, they tend to be in the teens gross profit and 3% EBITDA. So the mix blend it down, but you really saw that there when we pause on acquisitions. As far as acquisitions go, we bought 2 at the end of '17, 4 in '18, 5 in '19, 5 in '20, 3 so far this year against our stated goal of buying 4 to 6 a year. We have very good visibility to buy 4 to 6 a year for the next 3 years. In addition to doing this in North America and maintaining this pace, we will start to acquire companies in Europe starting this quarter. So we'll start off with -- in Germany and in the U.K., focusing in on German companies between EUR 75 million and EUR 200 million and U.K. companies between GBP 75 million to GBP 200 million. In Germany, we've announced that [ Doris Albia ], who used to run channels for Dell in Germany before they run channels for IBM, who knows a lot of the companies in the space for 30-plus years, she introduced us to 64 companies in that space. We targeted 16 and have 4 under NDA. So we're optimistic that we'll be able to add to the acquisitions we've been doing in North America with the ones in Europe. So 2 of our core competencies are cross-selling and integration. These are 2 things that a lot of companies really struggle with. As I mentioned last year, we took out $20 million of cost. We bought 7 companies in Q4 and Q1 and took $7 million of cost out in March, so already, and then the back-office integration will happen according to the schedule. So the team has gotten -- it's a well-oiled machine that's really getting used to how do we integrate these companies and how we cross-sell. And this takes out meaningful amounts of cost from the organizations that we acquire. So the customer segments that we have are some great sectors that we do target. Again, our acquisition kind of priority list is culture-first, then customers, then location, and then capabilities. Last year, we had 22% of our customers were from financial services, 20% from government and state local and education, 18% from technology, 13% from health care, 9% from manufacturing, and of the other 18%, no one sector made up more than 4%. Our top 10 customers make up 20% of our revenue, so very good diversification. And 141 of my customers bought at least 1 million of my products and services. So we've got this wonderful mid-market, diversified customer base. The -- as I mentioned before, it's a USD 1.2 trillion market break, total addressable market in the U.S., which $150 billion is large enterprise. And that's not where we focus, that's where everyone else focuses. We focus in on the $650 billion mid-market and the upper end of the $400 billion SMB space for a total addressable market somewhere in the $800 billion range. So I mean, our financial performance is quite staggering. As I mentioned, every single year, we've grown our adjusted EBITDA since we've been formed by at least 90%. Last year, our revenue grew by 38%, and our adjusted EBITDA grew by 91%. So just fantastic numbers. You also see how the EBITDA percentage has grown over time from 3.6% for '18, to last year, the full year, it was 6.4%. In Q4, you really kind of saw also the kind of extension of these changes as we grew our revenue by 35%, $290 million for the quarter, but our adjusted EBITDA grew to a record $23.4 million, which is an increase of 98% year-on-year. And then again, you see the adjusted EBITDA percentage on Q4 was 8.1%, up dramatically from the year before, really showing the cost out as well as the cross-sell and the rebates. So as I mentioned, we have a very strong balance sheet. We started last year with a highly leveraged one and through a series of equity raises, we really strengthened our balance sheet. Also mentioned that they're unable to change our asset-backed lending facility to one that's now $190 million with a group of banks led by CIBC, which we paid around 2.5% for down from over 9%. Last year, we paid over $20 million of interest costs, and that will be dramatically reduced, more than cut in half from last year. We also started the year with a strong financing, which really strengthens our balance sheet. We have 168 million shares fully diluted, of which, management owns around 10% of this. We have no options. There are no warrants. We are very much aligned with our shareholders in that management, 1/4 of their bonus -- variable compensation goes to buy stock in the open market. This is a plan that we bought from Constellation Software, who has done a great job with it. Also, our employees also have an employee stock purchase program or they buy off the open market and the company matches with 20%, again, bought off of the open market. So again, our stock purchase program is very much aligned with shareholders. So the management team that's done this is a wonderful combination of people that I have known for a very long time, along with people that we've met through the acquisitions. So Gordon McMillan, our Chair, who structures all of our acquisitions and get them from LOI to close. I've known since the late '80s when we went to Queen's University together. As I went to Queen's with Don Cuthbertson, our CTO, who runs Canada and that's our technical direction. Cory Reid, our COO, I met in 1992 at Bell Northern Research up in Canada. And he's the one responsible for doing all these integrations. Yes, Carl Smith, we just brought on as the pandemic started, and he's done a super job with the analysts raising capital and moving the ABL. Greg Berard, our President, who does such a super job on the cross-selling and the software-first strategy came from our Lighthouse acquisition in December of '18. Cari Hash and Tommy Whatley joined me from my last consolidation. Vanita Patel has done a super job coming out of IBM joined our Red Hat relationship. And Rhonda Hanes, can't speak how we met. She came out of the Corus360 acquisition, the first one. And during the pandemic, what a wonderful job she's done of keeping our employees safe and all of our office is compliant with all of the COVID restrictions. So that's the formal part of the presentation. So happy to answer any questions that might come up.

And so if the -- Matt, the -- so I do have some here on the Q&A slide. So why don't I -- I'll go through those. So the first question is, is what tends to be the organic growth of companies you've acquired before acquisition? So they tend to be GDP growth rates. So a VAR who's selling hardware, network service storage into data centers tend to match GDP growth rates. Actually, Gordon talked about it last year during the pandemic, the worldwide IT spend was down 3.3%. But this year, they view a bit of a comeback, especially the stimulus, who have growth of enterprise software by 8.5% and hardware by 7%. The cloud service providers tend to -- cloud companies grow in the healthy double-digit rates, so 33% to 66%, and that's why the mix is much higher for hybrid IT provider. And the next question I've got here is, who would you say are the company's closest comps from around the globe? And those are in Europe, so no one else is doing this strategy in North America. But in the U.K., there's a wonderful company called Softcat that's selling in the mid-market. Their gross profit percentage is lower than ours at 22%, but they do software first, their EBITDA is around 10%. And they actually trade, our -- we're trading at somewhere around 9x this year's EBITDA, they trade at 31.5x, a 3.5x revenue, we're less than 1x revenue. So we're very favorable comparable there. They do grow organically, not inorganically. A company called BYTES on the London Stock Exchange as well. Again, creating a much higher multiple, but sells in the mid-market as well. 2 companies in Germany, CANCOM and Bechtle, which, again, much higher multiples, but more of this mid-market strategy and Atia out of the Nordics. So those would be the comparables that I -- the public company comparables in Europe. In North America, you don't see -- I think we're the only company fully following that strategy. If there's any other questions, please post them. Well, if there's not any more questions, then I'd like to thank you all for listening, and still we look forward to meeting some of you in the various sessions. So thank you very much for your time today.

Thank you. This does conclude today's webcast. Thank you for your participation, and have a wonderful day.