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

Good morning. Welcome to the Converge Technology Solutions Corp. Fourth Quarter and Fiscal Year 2022 Results Conference Call. [Operator Instructions] Your main hosts today are Shaun Maine, Group CEO; Thomas Volk, board Chair; Greg Berard, Global President and CEO; and Matt Smith, Interim CFO. Before we begin, I am required to provide the 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 the conclusion, forecast or projection in the forward-looking information. Certain material factors or assumptions are implied in drawing a conclusion or making the forecast or projection as reflected in the forward-looking information. Additional information about the material factors that could cause actual results to differ materially from making a 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. The statements only speak as of the date 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 has no standardized meaning. Please refer to Converge filing of Canadian Provincial Securities regulators for an explanation and reconciliation to IFRS measures. I will now turn the meeting over to Shaun Maine, Group CEO; Mr. Maine, please proceed.

Thank you. Good morning, everyone, and good afternoon to those listening overseas. There are a few items I'd like to discuss prior to our team getting into the detailed financials. And before doing so, let me start by saying how pleased I am to be here this morning as I haven't had an opportunity to address investors these past few months. 2022 was another very active year for Converge. And I remain extremely proud of what all of our teams were able to accomplish. We completed more acquisitions last year than at any time since our inception in 2017, adding incredible leaders, capabilities and customers. We achieved our stated goal of having presence in every NFL city, expanded our practice areas in Canada, extended our geographical coverage in Germany while adding a platform in the U.K. As highlighted in our press release, Richard Lecoutre has resigned due to medical reasons. Matt Smith will return to his role of interim CFO, which he previously held between June 2021 and September 2022. Richard advanced our finance organization with best-in-class processes during his tenure with us and made a long-lasting positive impact on Converge. I personally want to thank Richard for all he has done for Converge and wish him all the best in his recovery. Matt has proven himself as a strong finance executive, and I'm confident in Matt's ability to lead our finance organization again and build upon what Richard has achieved. Additionally, Greg Berard has now assumed the role of Global President, CEO, while continuing to report to myself as group CEO. Greg has been a key executive and personal friend since joining Converge through the acquisition of Lighthouse Computer Services in 2018. Greg has been instrumental in building out our practice areas and structuring the road map for transitioning Converge and its acquisitions into a mid-market leader, focused on cross-selling higher-margin services across our customer base. In his updated role, Greg will continue reporting to me but expand his role to doing what he's been successfully executing in North America to having that same responsibility globally. In addition to advising Greg, as group CEO, I will oversee all corporate functions, including M&A and Portage. While speaking about updated roles, I'd also like to personally highlight the appointment of Sean Colicchio as Converge's Global Chief Information Security Officer, responsible for our physical and digital security strategies as well as the identification and mitigation of potential risks. The addition of a CISO role within Converge organization represents a significant investment in advancing the company's knowledge, recognition and responsibility surrounding cybersecurity practices and will be crucial to the long-term success of Converge's growth strategy. We are fortunate to have someone of Sean's caliber to help protect Converge and our clients. In closing, I'd like to express my personal appreciation to Thomas Volk, who has mentored me since joining our board in May of 2021 and has taken the lead in communicating with markets these past few months. I highly value Thomas' experience as a former CEO of CANCOM and his experience running worldwide sales at HPE. Many of you have gotten a chance to interact with Thomas in person as he's traveled back and forth through Europe and across Canada throughout the winter. For those who had the pleasure of meeting him, you will know why I praise and value Thomas among my leadership team. So with that, I will turn the call over to Thomas to discuss our performance in Q4 and fiscal 2022.

Thank you, Shaun. 2022 was another milestone year for Converge as the company made major progress on the execution of our corporate goal to become the leading provider of IT infrastructure technologies and services for the mid-market customers in North America and Europe. Converge grew faster than any comparable provider globally, expanding gross revenue by 57% year-over-year to $3.1 billion. We improve the value to our existing mid-market customers with our organic gross profit of 10.6% and with the gross recurring revenue reaching $525 million, which demonstrates the long-term commitment of our customers. Not only has Converge grown the net revenue from $1.5 billion in 2021 to $2.5 billion in 2022 based on historical accounting policies, but it also has surpassed its acquisition target by growing approximately $1.2 billion gross revenue and $68 million adjusted EBITDA throughout the fiscal year '22. This exceptional growth in revenue and profits instill the confidence in the execution of our business to realize the vision of becoming a $5 billion company in the next 3 to 4 years and to improve our EBITDA margins towards 10% through the growth of our services and managed services businesses. Our positioning has also been recognized by the IT market through a number of industry awards achieved throughout the year. This includes being named as 2022 Triple Crown Award winner by CRN, earning a spot on each of the Solution Provider 500, the Fast Growth 150 and the Tech Elite 250. More recently CRN named Converge to its 2023 Managed Service Provider 500 list in the Elite 150 category. This is recognizing us as one of the industry-leading managed service providers in North America, driving a new wave of growth and innovation through forward-thinking approaches to managed services. As well our very own, Rochelle Manns Vice President of Cloud Platform was named Women in Cloud, Female of the Year leader. In addition, we were recognized with Partner of the Year awards from Pure Storage Cisco and Ingram Micro. Each of these awards reinforce our evolution towards a higher-value services company and perhaps the best demonstration of all of value we are adding is the addition of average more than 100 net new logos within each quarter of 2022. As the company's reputation continues to advance, we have been fortunate to earn the attraction of world-class IT talent, enhancing both our Board and our leadership teams over the last year. In early 2022, we introduced John Teltsch, as the Chief Revenue Officer. John has been joining Converge with 40 years of leadership experience following decades long global career in IBM. John Teltsch has done a magnificent job at strengthening the overall company culture within the Converge sales organization while working alongside Greg Berard, whose role has been expanded to Global President and CEO, as Shaun already mentioned. Elected at the 2022 AGM, the Converge Board of Directors welcomed Dr. Toni Rinow, who displays over 20 years of international experience as a transformational Finance and Business leader with an impressive education portfolio. This includes Master's of Business Administration, Master's in Accounting, a PhD in Biophysics and Chemistry and trained in Artificial Intelligence at MIT. The accumulation of various individuals highlighted here, along with the additional 1,300 employees joining us throughout 2022, will continue to strengthen Converge's unity becoming better together. As outlined generally on previous earning calls, Converge has dedicated itself to promoting equality, diversity, equity and inclusion throughout its workforce and partners. At the beginning of '23, we have further supported this commitment with the official launch of our Converge Core Values. Our Core Values have been created as a commitment guideline in which we treat our customers, employees, partners and co-brokers. Converge will demonstrate integrity in being honest and transparent with our employees, customers, partners and stakeholders as we continue to evolve as an organization. Our motto of #BetterTogether is evident in the unity we have created as part of our culture. We believe that the relationship build along with the contagious energy has created an environment that separates us in the IT marketplace. We continue to foster diversity and inclusion, giving the space for our employees to be themselves. Our passion is evident throughout Converge at our commitment for all employees to feel valued and appreciate is at the forefront of our daily decisions as an organization. It is this drive for continuous improvement that creates a foundation for our leaders to be the very best while also attracting like-minded industry leaders. This mindset of excellence will remain an important thread by which we measure ourselves as we move towards the next phase of our growth strategy. As a symbol to honor the commitment from leadership, every employee is receiving a coin that displays these values as a reminder of Converge's unified devotion to being better together. While hybrid work models continue to lighten our ecological footprint, Converge remains committed to conducting operating business in a manner that reduces environmental impact while striving to conserve and protect through some business practices. It remains a top priority to learn and advance from practices discovered through new acquisitions, such as our first U.K. acquisition Stone Group. Sustain They were the largest U.K. -- they were the U.K.'s largest privately-owned IT hardware manufacturer, displaying exemplary sustainability goals. Sustain (sic) [Stone] was the winner of the international CSRA excellence award in 2022. This is reflecting companies that have recently received CSRA accreditation silver award for the company's many environmental efforts, including reduction in carbon impact, shares of donations in support of social environmental initiatives and which have commitments to a zero waste policy. Stone identifies sustainability issues through continued 360-degree engagement with all relevant stakeholder groups and this strategy are clearly communicated to outline the company's intentions with respect to financial targets, employee development, trading and supply chain parts, environment and social development. Now let's turn our attention to the financial and operational performance of Q4 and all of 2022. Let me give you an overview on the financial highlights. Beginning with our full year financial highlights despite ongoing supply chain challenges and general macroeconomic uncertainty that companies are facing, Converge continues to see robust demand for its products and services, which has translated to strong year-over-year revenue, gross profit and adjusted EBITDA growth. 2022 gross revenue exceeded $3 billion for the first time, growing 57% from 2021. This was driven both by acquisitions and organically. Gross profit, our most important rating performance metric of $550.8 million was 59% ahead of last year and adjusted EBITDA was $142.9 million, which grew 52% over '21. As with revenue, year-over-year gross profit growth was driven both by our M&A activity and healthy organic growth. On an organic basis, we grew gross revenue by 8.6% in the full year and achieved double-digit gross profit organic growth of 10.5%. As a reminder, we measure organic growth based on actual reported gross revenue and gross profit for companies we owned in both the current reporting period and prior periods so that we are comparing consistent portfolio companies. Net revenue, consistent with prior reporting treatment was $2.52 billion for fiscal year '22, which is within the stated range in our preliminary Q4 and full year news release that was published in February. In Q4, the company adopted an accounting policy change in response to emerging IFRS guidance that introduced new interpretations of a company's role when it resells certain OEM software licenses. This strongly points companies like Converge that previously reported software revenue on a gross basis to move that to a net treatment. The accounting policy changes applied to the full year audited results with 2021 comparative numbers we classified to conform to this new presentation. As a result of this accounting change, the company reported net revenue of $2.17 billion for 2022, adjusted down by $356.8 million to reclassify the vendor cost on certain software licensing transactions from cost of sales against revenue. For 2021, net revenue previously reported at $1.53 billion; based on this new treatment, is now at $1.33 billion to reflect the same accounting impact in the prior year. As a result, on a like-for-like basis, net revenue increased by $834.9 million, which is 63% from 2021. We've seen this accounting change made recently amongst leading IT resellers, especially in Europe that report under IFRS and believe this will promote comparability and reporting standardization across companies that operate in this space. It's important to note that this accounting change is purely isolated to the presentation of net revenue and cost of sales and has $0 impact to gross revenue, gross profit, net income or adjusted EBITDA. For ease of readability and comparability where applicable, we've included the equivalent net revenue under the previous accounting rules throughout this earnings presentation. I also direct your attention to the included appendix of the earnings presentation for your reference, where we've presented a reconciliation of net product revenue and cost of sales, as previously reported, to the actual reported numbers, inclusive of this change. Additionally, we've also provided a detailed disclosure of the impact of adoption in our audited financials and the quarterly reclassification impact for '21 and '22, is presented within our 8 trailing quarters disclosure within our MD&A. This should provide full transparency on the impact of this IFRS-based accounting change, which doesn't reflect any business or operational performance changes. Now I'll turn over to Matt to walk through financials in more detail. Matt?

Thank you, Thomas. Expanding on revenues, the growth we achieved was generated across all of Converge's portfolio of products and services. Net revenue for Q4, consistent with prior period reporting treatment was $771.6 million and in line with expectations for our preliminary release. As of full year revenue, Q4 net revenue was impacted by the same net down of software revenue, resulting in reported revenue of $640.9 million, a difference of $130.6 million. Q4 product revenue, which includes hardware and software, increased 43% to $507.6 million from Q4 2021, and up 64% on a full year basis from $839.5 million last year. Q4 professional and other services, which includes a net revenue from public cloud resell and product support increased 43% to $99.9 million over last year and up 60% from $215.7 million to $344.3 million on a full year basis as we continue to invest in our key consulting practice areas, including analytics, cloud and cybersecurity. Q4 Managed Services revenue increased 49% to $33.3 million from Q4 last year, implying annual recurring revenue from managed services today of $133.4 million. Excluding all third-party maintenance and cloud services, our pure services business for 2022 was $383.9 million in revenue terms, and we are poised to continue displaying growth in this area heading into 2023 and beyond. Converge exited 2022 with a total of 10 acquisitions completed, but as mentioned, this M&A-led growth was complemented by annual organic gross revenue growth of 8.5%, meaning that an incremental $170.4 million of revenue has been generated by our existing portfolio of companies compared to 2021. Gross profit performance was strong again in Q4, growing by 46% from Q4 2021 and 59% on a full year basis. While our acquisition strategy was a clear driver of the reported GP growth, organic GP growth was a significant contributor with organic growth of 10.5% in 2022, meaning that our existing portfolio of companies has generated an incremental $36.2 million of GP compared to prior year. Excluding the impact of the software net down change for a moment, consistent with how we reported in prior periods, gross margin for Q4 was 21.9% compared to 22.9% in Q4 last year. Full year 2022 gross margin was 21.8% compared to 22.6% in 2021. Adjusting for the impact of the software net down, reported gross margin increases to 26.4% compared to adjusted margin of 26% in Q4 last year, and full year 2022 gross margin was 25.4% compared to adjusted margin of 26% in 2021. In the near term, gross margin reflects the impact of recent acquisitions that sell proportionately more hardware when we acquire them, but is expected to grow over time by leveraging cross-sell opportunities where acquired companies introduced Converge's higher-margin cloud and managed service offerings to the customer base. Adjusted EBITDA was 52% ahead of fiscal 2022 and 24% up on Q4 last year. Excluding the impact of the software net down change consistent with how we reported in prior periods, EBITDA margin as a percentage of net revenue for Q4 was 5.6% compared to 6.9% in Q4 last year, and full year 2022 adjusted EBITDA margin was 5.7% compared to 6.2% last year. Including the impact of the software net down in the current and prior periods, adjusted EBITDA as a percentage of reported net revenue was 6.7% in Q4 and 6.6% on a full year basis compared to 7.8% and 7.1% last year, respectively. EBITDA as a percentage of GP, which removes the noise of the accounting change, which we believe is a more meaningful measure of how effectively we turn gross profit into bottom line profit was 25.5% for Q4 and 25.9% for fiscal year 2022. Between Q4 and Q1 2023 year-to-date, we've carried out cost takeout that will result in approximately $15 million in annualized savings with the benefits to be realized beginning in Q1 onward. Looking at our balance sheet. We finished 2022 with a better-than-expected net debt position of $260 million with a strong cash position of $159.9 million and $80 million in availability under our revolving credit facility. Subsequent to Q4, in February, we announced the exercise of our accordion feature under existing credit terms, increasing our facility by $100 million for a total borrowing capacity of $600 million. In terms of cash flow, we generated cash from operations of $30.4 million in Q4, better than we reported in our preliminary results, and $41.6 million on a full year basis. This reflects improvements in Q4 in managing working capital and will be momentum that we carry into Q1. Adjusted free cash flow, which we calculate as adjusted EBITDA less recurring capital expenditures and payments of lease liabilities, was $36.7 million in Q4, representing free cash flow conversion of 85%, which was generally consistent with last year on a quarter and fiscal year basis. And finally, as announced previously, Converge obtained approval from the TSX to make a normal course issuer bid, NCIB, which launched on August 11 and will terminate 1 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 in common shares, representing 5% of the issued and outstanding common shares as of July 31, 2022. And as at December 31, 2022, 6.5 million shares have been purchased under the program, reducing our issued and outstanding shares to approximately 208.8 million. In addition to the $100 million accordion exercise we announced subsequent to Q4, the company also signed a definitive agreement to acquire the remaining 25% stake in REDNET ahead of the earlier scheduled call option for the original purchase agreement. Purchase price is based on a multiple of German companies projected FY '23 results, which is ahead of original budgets at the time of acquisition. The payout also includes early payment of the seller note and accrued interest through the payment date. The company since completed this transaction in Q1. And with that, I'll turn the call over to Greg Berard, our Global President and CEO, to provide some more color on the strength of Converge's global sales organization, which is a significant driver behind our financial successes today.

Great. Thank you, Matt. Let me begin by stating, as Thomas mentioned earlier, the company continues to operate under the unique macroeconomic conditions that have emerged in recent years including supply chain constraints, which are not unique to Converge and impacted our reported revenues in Q4. However, what has been unique has been our team's ability to create and seize opportunities for profitable growth. And while we did see backlog, in Q4 increased by $52 million to $556 million. It is important to evaluate this in its full context. In Q4, we cleared out 80% of the Q3 backlog. While so far in Q1, we have already seen 90% of the Q4 backlog gets shipped. What this shows is that we continue to be well positioned with our partners to deliver on our product backlog, and we don't view these metrics as lost revenue, rather simply deferred. And as we continue to shift our customers to high-value services, we expect to see the backlogs continue to soften and our organic growth continue to strengthen. Converge's strategy of acquiring clients through acquisitions and then generating demand and cross-selling is a proven process that we have become extremely comfortable and successful with here at Converge. We are pleased with the growth numbers Converge has displayed and more specifically, the demand for our IT capabilities remain resilient amongst our well-diversified customer profiles. Today, we service a customer base consisting of 21% health care, 21% technology, 18% government, 10% in finance and 30% within other, which ideally positions us for further growth into 2023. We continue to execute on our cross-sell strategy, and the numbers now show that close to 90% of our clients are buying more than 1 practice area and almost 50% of our clients are now leveraging our skills and expertise across more than 4 practice areas, which continues to showcase the success we are having across our North American client base. Our continued focus on driving higher-value solutions with our clients and expanding our footprint in our accounts is key to our continued success and organic growth. Our investments in solutions like IP4G, which we talked about and launched earlier in 2022 is another way for us to continue to drive high-value professional services, managed services and cloud recurring revenue above and beyond I 4G revenue. We also now have our IP4G solution available in the U.S., Germany, and we just recently launched 2 locations here in Canada. We also continue to invest heavily in aligning our managed services portfolio with all of our practices, and this is evident with our continued growth around our Managed Services business quarter-over-quarter. Another great example of how our acquisition strategy works is showcased here with this client example. As we have talked about before, our goal is to always do executive briefings with our top clients and drive campaigns and workshops in region with our strategic vendors to showcase our technical skills and capabilities. Our goal is to drive more cross-sell and organic growth across our Converge practice areas and increase our wallet share and value with our clients. This is a great example of turning a $3 million account to over $8 million in 3 years, but the key focus is the diversification of revenue. As we all know, digital infrastructure and hardware sales can be cyclical. So driving the growth in cloud and other high-value services, analytics and cybersecurity in this example helps provide consistent growth year-over-year and continues to increase the recurring revenue base in our accounts. Our continued focus on driving high-value services is key to our overall organic growth strategy. We have built all of our practice areas to focus on advisory services, implementation services and managed services. This is consistent across our analytics, application modernization, cloud, cybersecurity, digital infrastructure and digital workplace solution areas, so all of our clients have the same experience and access to our technical expertise. We have structured all of the practices to have solution specialists, presale solution architects and delivery resources to help support our acquisitions and clients across North America and to drive the cross-sell strategy across our diverse client base, and we will continue to build out a similar model across Europe. As a result, we have continued to see our professional services numbers grow every quarter. Having highlighted the skills and capabilities that Converge has built over the past few years, it's appropriate at this time to provide an example of one of our practices to showcase our technical depth and breadth across our portfolio. Converge has transitioned its companies to successfully cross-sell higher-value services into its diverse client base, supporting our organic growth rate of over 10% in 2022. A couple of key points I want to highlight within our advanced analytics practice are the vendor diversification with IBM, Microsoft, Snowflake, Tableau, UiPath and many others. And also the deep skills across artificial intelligence, data visualization, data integration and financial performance management. By leveraging our advanced analytics practice, a great client example took advantage of our data scientists to help them drive better forecasting abilities within their business and also reduce their overall inventory course. Our ability to drive this unique value with our client showcases our strategy to drive more software and services revenue for Converge at the same time. All of our practice areas have the depth and breadth similar to our advanced analytics practice with all of our technical resources having over 10-plus years of experience, and we continue to invest in the thought leadership and technical expertise to drive this type of value with our clients. This is a unique differentiator for us with our mid-market clients and allows us to be their go-to partner for their end-to-end technology needs across analytics, cloud, cybersecurity and managed services. We will continue to invest and grow in these solution areas, and we look forward to continuing to execute on this strategy across North America and expanding in Europe. At this point, I will turn the call back over to Shaun Maine.

Thanks, Greg. Throughout 2022, Converge completed 10 acquisitions, including 3 acquisitions in Europe, building out our advisory services, our implementation to key verticals like education and health care, and our managed services, bringing our total up to 35 acquisitions in a little over 5 years. Combined with 2021, this has added over $200 million in advisory services revenue, a pre-growth area and differentiator as Greg has been mentioning. In addition to these acquisitions, Converge purchased remaining 25% of REDNET raising our ownership to 100%. Given this growth, the company is now focusing on integrating these companies to gain synergies and promote cross-sell. Converge has invested approximately $8 million in 2022 to build up a dedicated team to accelerate acquisition integration. In 2022, this team completed 41 integrations, including 9 CRM migrations, 8 ERP upgrades and migrations, 7 PSA migrations and 9 company consolidations. 22 of our 25 North American entities, excluding Portage, have been fully integrated with the rest scheduled to be completed by November of this year. Before I pass the call back to Thomas for closing remarks, I would like to provide an update on Portage CyberTech. Portage CyberTech is launching its new brand and celebrating the launch of its adaptable online services platform which has been successfully implemented for different provincial and municipal governments across Canada. This online services platform is now available for any government or organization that wishes to offer online services in a secure, unified way. Citizens and clients alike can access services with a unified experience while preserving their digital privacy. Portage CyberTech will be bringing together government, industry and academia during their Leaders Connect event in Gatineau on March 22 to celebrate this launch with their partners, employees in the public. Although included in the Converge financials, it is our plan to segment the Portage financials starting in the first quarter of 2023. I will now hand you back to Thomas.

Thank you, Shaun. Let me take the opportunity to provide a comment about the special committee that was formed in November 22. On behalf of the Board of Directors, I want to ensure investors know that the special committee is hard to work on their behalf. Rest assured, when there's a development or conclusion to the process, we will communicate it widely and in a timely fashion, while in the meantime, we made progress as expected. As Greg mentioned, over 90% of the Q4 backlog has been shipped to date in Q1, illustrating the short-term impact on our business in Q4 and bolstering the confidence for our Q1 performance being seasonally exceptionally strong. We expect that Q1 revenue and profits being very close to our Q4 performance. To conclude, we exited 2022 with strong run rate financials on a pro forma basis, which includes the full year contribution of the 10 acquisitions completed during FY '22. Our pro forma EBITDA is approximately $168 million. While the overall market is expected to remain flat in 2023, based on some independent research, we anticipate that we gain market share organically and that we will see improvements in our gross profit and adjusted EBITDA margins in 2023. So thank you again for your participation on today's earnings call. And with that, let me open the floor to questions. I will be your host for the questions-and-answer section. With that, I'll turn it back to the operator.

[Operator Instructions] the first question comes from Christian Sgro of Eight Capital.

For my first question, I wanted to ask about the Managed Services segment, which has been a focus for the business. I know with the macro uncertainty, but also with the backlog unwinding, I was wondering how the Managed Services opportunity has changed and how Converge's go-to-market has changed?

Well, I think on the Managed Services front, the opportunity for us actually is improving, knowing that we acquired a lot of business last year, which is based with customers on a product basis. And eventually, we're advancing these customers more and more into professional services solutions and eventually into managed services. So what we see is that our managed services platform, which is now integrated across all the company, is now set up to actually provide to these customers the full set of capabilities we need to manage their IT infrastructure. And based on that, we obviously see more and more opportunities arising for us for customers who don't have the internal means to manage their IT or who have adopted new technologies and concepts which we implemented with them when they needed someone to operate and run them. So our Managed Services business actually at the point where, like last year, we grew most of it organically, where we see organic growth which will outgrow the expected market growth of 10% to 15% in 2023.

Okay. That's helpful. And for my second question, I'll switch gears to the product segment. If there's just any color you could provide on the mix of hardware and software that you're seeing today and how you think that will trend through the year?

The trend of hardware versus software. As you see, the expectation is our independent large global research companies is that in 2023, the hardware market will actually shrink between 5% and 7%, while the software market will grow low single digits. So obviously, there is a shift more and more to software, and at least in the short term. And that's obviously reflected also in our plan in '23, which is actually a great basis for us because software typically also drives more services and more implementation, and that means that we are becoming more relevant to our customers.

Your next question comes from Rob Goff with Echelon Wall Partners.

My first question would be on the inventory. Thank you for letting us know that 90% of Q4 was run through in Q1. Could you give us some sort of feel for where Q1 backlog might end up like directionally?

Well, as we stated in the previous calls, Rob, we know that we have a very strong booking in Q1 that were also bolstering our statement that we will have an exceptionally strong Q1. But that said, we are very careful about making statements about improving the backlog in Q1 versus Q4, since we have seen in Q4 some behavior in the supply chain, which was not predictable. And we don't have today the certainty in our hands from our OEMs and partners that this will be different end of Q1. So basically, my expectation, and this is what we recommend to look at, is that you should look at the backlog to be probably not growing, but I don't think that we will have substantial improvement unless there's really supply chain stability, which we haven't seen that yet today.

Great. And as a follow-up, in your MD&A, you talked to working capital as a potential source of cash this year. Perhaps if you could elaborate a bit on that.

Rob, yes, I'd just point to the fact that if you look at our cash flow from operations on a full year basis for 2022, it's kind of atypical from what we've seen in past years. That's largely as a result of the number of acquisitions and more importantly, the size of acquisitions. Any time you acquire that many companies and integrate that many companies, there is some disruption in the short term to kind of our typical, let's say, collection cadence. We saw that improve tangibly in December, and we kind of carried that momentum into Q1. So I expect beginning in Q1, you'll see working capital as a source of cash, and that should continue on for the -- on a full year basis.

Your next question comes from Robert Young with Canaccord Genuity.

I was hoping you could give a little more color on your comments around the quarter-over-quarter strength in Q1. I think you said it's similar to Q4. Are you drawing those comments from the strong bookings environment? Or is it related to the deals which were slipped out of Q4 into Q1? Or maybe if you could just give us a little more sense of the drivers behind Q1 seeing less seasonal decline?

So first of all, obviously, the increase in the backlog of Q4 was a temporary issue with the delayed business, which we now get into Q1. So that's one driver. The other drivers, as we said, right at the beginning of Q1, when we made our preliminary results that we continue to see strong demand in the mid-market. So our strategy is working very well. So we continue to see that up-to-date and in our forecast. So that drives also our confidence in Q1. In addition, out of the 3 large deals, which slipped out Q4, one has already closed, the other one is closing now, and the third one will close in Q2. So that's also driving our confidence that Q1 will be seasonally exceptionally strong. So rather than I have the 20%, 25% lower Q1 than Q4, which is a typical seasonal result, we see Q1 to be very close -- maybe a little smaller, but very close to Q4.

And then you partly answered my second question, but the behavior in your customers, are you seeing any changes? The deals that slipped out of Q4, are you seeing any additional delays or reluctance to sign large deals?

Well, on the large deal front, obviously, customers are more diligent nowadays, and that's a phenomenon we see everywhere. But with us being focused on the mid-market, the core of our business continues to thrive, and we see that on an ongoing basis. And our mid-market customers have obviously understood that the issues they had with their own supply chain, issues they had with resource shortages, the issues they had with some analytics of the data, et cetera, are continued issues where they need to invest and improve their own business performance. And they are very agile doing that, and that's what we see to continue, and that gives us confidence that we will have a good start into the year.

Okay. And that's the big wild card in Rob Goff's question, the directionality of the backlog. That's a big wild card in where the backlog ends up at the back end of Q1, which...

And as I said, Robert -- sorry to interrupt but you. As I said, honestly, we know that a normalized backlog would be a few hundred million lower than it is right now. But we just assume that this backlog stays where it is at this point. Because going back 3, 4 years, we had, had supply issues in the IT industry now for many years, starting 2018 with the Intel chip shortage. And assuming now that this will not happen this year with all the macroeconomic environment, with all the tension in the world and the uncertainties, is probably something which I would not recommend we should do. So just assume we stay where we are. And if it gets better, then we are on the positive side rather than being at the negative side, again, if we think things will get much better and then it doesn't. So that's kind of our recommendation of how to look at the business.

Great. Last one, just a short one. Maybe you can give us a little more color around the decision to expand the debt facility and acquire that remaining 25% of REDNET. Like what were the reasons for doing that earlier?

All right, Robert. I think to increase the debt facility, obviously, as we said earlier, it will give us more flexibility. It is an opportunity, which we had to address at a certain point in time. So I think it was a very good management practice to close that opportunity and secure it. On the other side, it also gave us the flexibility to actually act on buying back the remaining 25 shares of REDNET, which now gives everybody clarity about that we own the whole business there. And it's also at this point, I think, a decision which was done mutually between both parties, which makes it clear also in terms of going forward, who has the ownership of the company.

Your next question comes from Stephanie Price with CIBC.

Just curious about what you're seeing from the tech vertical, just given all the news reports around budget tightening and headcount reductions. So I think Greg mentioned in his prepared remarks, it was about 21% of revenue.

So now we are not entrenched in the large tech businesses like Microsoft or SAP or salesforce.com. We are entrenched in the technology companies which are mid-market companies, which today, like us, actually still struggle with some resource constraints, skill constraints. So we are used by many of them to complement their internal IT and help them to basically further their own growth and their needs and their IT. So it is not really affecting us from that perspective.

Okay. Great to hear. And then Matt also mentioned restructuring in Q4 that resulted in $15 million in annualized savings. Can you talk a bit about the cost structure here and if you see additional areas for cost reduction as you look into 2023?

Well, I think that's an ongoing effort. So with us acquiring 35 companies, obviously, there's always a bright opportunity for synergies. And as we said and as Shaun said earlier on, we continue to further integration during the course of this year, and that offers opportunity for synergies and cost reductions in some areas. So yes, this is an ongoing effort, which, by the way, in our company, we have been doing it regularly. But at the end of last year, we undertook a special effort to actually start this year with a basis which will reduce SG&A.

Your next question comes from David Kwan with TD Securities.

I'm not sure if you can comment on this. But I guess you guys are going through the strategic process. Are you contemplating refining your approach to M&A?

Well, what we said at the end of last year is that we will definitely stop our -- pause M&A in the first half of this year, but we will continue M&A in the second half. And as I illustrated in some calls, M&A is essential to expand our footprint in Europe and also to further our growth in several practice areas in North America, we will need more skills and resources. So that will also drive some M&A activities in the second half.

Well, that's helpful, Thomas. I guess, obviously, you had a really big year last year, acquired comfortably over $1 billion revenue. Could we see a more moderate pace from what we saw at least relative to the last year and especially maybe this year, you've got this pause on the M&A front at least through the first half of this year?

Yes. I think, David, the major difference is last year, we had both in Europe and North America, acquired companies to basically increase our reach, which basically meant that we bought a lot of customers through acquisitions and the revenue associated with that. Now as I said, this year, obviously, in North America, if we buy more skill-based businesses, that's far less revenue, right? And however, in Europe, we will have to add more bars as well to grow our footprint. But the mix will actually show that the $1.2 billion revenue we did last year is not something we see happening this year in the near term, in acquisition.

That's helpful, Thomas. Last question. just given what happened with Silicon Valley Bank here, could you talk about maybe any changes that you might be looking to make as it relates to risk management strategies, including maybe doing some more due diligence on the banking relationships of at least maybe some of your largest customers?

Well, first of all, we have thousands of mid-market customers, right? So that is obviously something which prohibits us to basically even look all of them understand what they are doing. And since we don't, we have a very diversified customer base that is obviously something which you cannot easily do. I think we have our controls and processes in place when we work with customers in terms of their financial stability, and we will continue to execute on them. And beyond that, it's -- like speaking about Silicon Valley Bank, it's very hard to predict what is the -- which one is the next bank of what will happen. So that's impossible for us, but I think we obviously apply the proper diligence on our customers when we engage with them in the business.