Converge Technology Solutions Corp

TSX:CTS

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Converge Earnings Call for the Second Quarter of 2024. [Operator Instructions] I would now like to turn the conference over to Avji Kamboj, Converge Chief Financial Officer. Please go ahead.

[Avjitpal Kamboj, executive]

Thank you, and good morning, everyone. Before we begin, I would like to take a moment to acknowledge the passing of our dear friend and colleague, Lorne Gorber, our Investor Relations at Converge. Loren was a true legend in the PR profession, and we will miss his coming presence, great storytelling and wisdom. His teachings will forever remain with me. Our hearts go out to his family and friends. I would like to welcome and introduce Dennis Fong, who will be assisting me with the Investor Relations going forward. I will now turn the call over to Dennis.

[Dennis Fong, executive]

Thank you, Avji, and good morning. Also on the call today to discuss Converge's second quarter 2024 results are Shaun Maine, Group CEO; and Greg Berard, Converge's Chief Executive Officer. This call is being recorded live at 8 a.m. Eastern Time on August 8, 2024. The press release we issued earlier this morning is available for download, along with our Q2 MD&A, financial statements and accompany notes, all of which have been filed and are available on SEDAR plus. Please note that some statements made on this call may be forward looking. Actual events or results may differ materially from those expressed or implied and converge disclaims any intent or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The complete safe harbor statement is available on both our MD&A and press release as well as converge.com. We encourage our investors to read it in its entirety. We are reporting our financial results in accordance with International Financial Reporting Standards, or IFRS. As before, we will also discuss non-GAAP performance measures, which should be viewed as supplemental. The MD&A contains definitions of each one used in our reporting. All the dollar figures expressed in this call are Canadian unless otherwise noted. I'll now turn it over to Shaun to begin with opening remarks, then Greg will provide a high-level summary of our Q2 results and business overview for the quarter. Avji will dive further into the financial details of our Q2 results and provide an outlook for Q3 and the year before we wrap up to take your questions. So with that, over to you, Shaun.

[Shaun Maine, executive]

Thank you. Good morning and good afternoon to those of you joining from overseas. Welcome to our second quarter 2024 results call. Let me begin by saying how pleased I am to reflect on the significant growth Converge has achieved in the first half of 2024. It is always gratifying to witness the hard work and dedication of our team, continue to translate into record results and the impressive growth Converge continues to achieve. As recently announced, Converge fulfilled the criteria necessary for the deconsolidation of our majority-owned subsidiary, by Portage CyberTech. It was an important step for each company as it allows converge to remain a strong partner in Avoca for Portage's industry-leading products, while positioning Portage to continue on its own accelerated growth path, operating completely independent of Converge. With the conclusion of the Portage deconsolidation, there is no group anymore, and therefore, my role as Group CEO no longer serves its strategic value. As I said, at the end of 2024, I plan on stepping back from this role at which point Greg will assume all of my executive responsibilities. I will continue to serve Converge as in an advisory capacity while remaining as Chair of Portage. As mentioned over the past quarters, we have continued to put a pause on M&A with a focus on integration, cross-selling and cash generation under one Converge driven by Greg's leadership as CEO, and Avji as CFO. The company is on an incredible path that is set to continue with the leadership team we have had in place, and this transition is a natural progression on the road map to converge this next stage of growth. I want to highlight the exceptional job our CEO, Greg has gotten, to build these deep capabilities we have in our key practice areas, particularly around AI, setting the company up to uniquely take advantage of growth opportunities in the IT services marketplace. I look forward to supporting him and continuing this momentum and leveraging my experience to guide the company's strategic vision. With that said, I'll now turn the call over to Greg, Converge CEO, to provide a high-level summary on the quarter and dive into our valued partner relationships and operational highlights.

[Greg Berard, executive]

Thank you, Shaun, and good morning and afternoon to everyone. Before we get started talking about Q2, I wanted to personally thank Shaun for all his leadership and support over the years. Shaun had a vision when he founded Converge and has done a phenomenal job getting us to where we are today. His hard work and efforts have created a company that went from $0 in 2017 to over $4 billion today, an amazing accomplishment and testament to Shaun's leadership. So thank you, Shaun, for all you have done for Converge. I look forward to working closely with you during the transition. I also want to thank Thomas and the converged Board for all of their support in me and the executive team as we continue to take Converge to the next level in 2025 and beyond. Now let's talk about how we performed in Q2. I am pleased to report we have exceeded over $1 billion in gross sales for the fourth consecutive quarter. Over the past 12 months, we have achieved a new level of scale that demonstrates the breadth and depth of our solutions and partnerships while highlighting Converge's unique set of services offerings as a leading North American IT end-to-end solution provider. As you will see, we continue to outperform the market and prove the cross-sell and AMS strategy we have implemented will continue to help us grow organically and be the trusted adviser for our clients for all of their strategic IT initiatives. In Q2, we reported $1.06 billion in gross sales, representing an increase of over $106 million and gross sales organic growth increase of 11.1% year-over-year. Our gross profit increased by 2.1% to $179.3 million and our adjusted EBITDA of $45.1 million was up 8.6% from last year. We delivered a strong quarter, specifically around our strategic focus areas: analytics, AI, application modernization, cloud and cybersecurity. We continue to demonstrate strong cash generation, producing $52.4 million in cash from operating activities, a considerable increase of $62 million year-over-year. Our substantial cash generation continues to strengthen our robust balance sheet, closing the second quarter in 2024 with a net debt reduction of $194 million year-over-year and by $51.9 million compared to Q4 2023, bringing a net debt-to-EBITDA ratio of 0.9, a great improvement from 2.25 as of last June 2023. This steady cash flow allows us to continue to prioritize and provide additional returns for our shareholders, returning approximately $47.4 million in capital through NCIB share buybacks and our quarterly dividends in Q2 and $51.7 million year-to-date. We will continue to evaluate our capital allocation strategy and continue to focus on organic growth, reducing debt, returning value to our shareholders and focusing on strategic acquisitions. The year-to-date record results are supported by delivering over $2 billion of gross sales and an organic growth rate of 7.7%, highlighting the sustained demand for our comprehensive set of solutions. Our advise, implement and manage strategy continues to put us in a position to deliver end-to-end solutions and services and validates the strength of our organic growth strategy and our continued ability to outperform other regional providers. In North America, we continue to see the power of our practice areas as we accelerate discussions with our clients on driving the higher-value solutions. We are engaging in the right conversations with our clients around AI, cloud and cybersecurity initiatives, and this is positioning Converge for larger opportunities through our unique internal expertise and ever-expanding capabilities. As we maintain ongoing demand with our unique set of solutions and diverse customer matrix, Converge is proud to be recognized and awarded across the IT sector by top partners. In Q2, we furthered our reputation as a leading end-to-end solution provider within the IT space, earning continued recognition from our valued partners and top technology providers. We are pleased to be named to CRN's 2024 Solution Provider 500 list for the fourth consecutive year where we ranked #28 this year, increasing 22 spots from our initial ranking in 2020. This recognition highlights Converge's position as a top player in the IT industry and global technology supply chain. Additionally, this quarter, we received 3 Partner of the Year awards from some of our valued partners. Our cybersecurity team was recognized by Arctic Wolf as the 2024 large solution provider Partner of the Year, demonstrating the vast growth of our partnership while simultaneously proving, we are on track for greater collaboration with the Arctic Wolf team, while we continue to deliver the best-in-class cybersecurity solutions to our clients. Alteryx recognized Converge as 2024 America's Acceleration Partner of the Year, showcasing our analytics practice and our team's commitment to empowering organizations with cutting-edge analytics solutions that drive meaningful business outcomes. In today's data focused world, our partnership with Alteryx has played a crucial role in enabling us to help our clients navigate their data-driven paths with greater efficiency and impact. Through our partnership, we will be able to continue to push the boundaries of innovation within the analytics space. And most recently, Converge was named North America Storage Partner of the Year by HPE, honoring our commitment and success supporting customers' digital transformation journeys. HPE and Converge have a long-standing partnership that is highly valued within our team and the growing partner ecosystem, sharing the same end goal of delivering better outcomes to shared customers, supporting them to channel their growth potential. Converge takes great pride in our unique partner relationships that enable us to offer a world-class portfolio of solutions. The combination of our AIM strategy and the number of strategic partnerships is what makes us unique in the marketplace. The prestigious accolades achieved not only this past quarter but throughout 2024 are a true testament to the success we are seeing across all our practices. It is a combination of our technical expertise and trusted adviser status that gives us the ability to drive the right solutions and value with our clients. To elaborate on the value we are driving with our clients, we had a number of great wins in Q2 that showcase our status as a trusted adviser and continued execution of driving higher-value solutions. In one example, we worked with a large industrial client who is acquiring companies and needed help with their cybersecurity needs. Our cyber team came together and put together a solution that gave our clients flexibility to ensure they could keep up with the demanding needs of their business. We packaged up our penetration testing, vulnerability management, risk and compliance, and cloud security services to simplify our ability to deliver all of our services into one contract for the client. Another example of Q2 of our teams working together across all our solutions is the work we did at a health care client. They were having challenges managing schedules, matching workers with the right patients and driving higher value of client service. We engaged our thought leaders across our AI practice, application modernization, cybersecurity and managed services teams to put together the right solution. We partnered with the client to design and build a new mobile application that the caregivers could leverage to easily access and manage their schedules, leveraging AI to optimize matching the right caregivers to patients, which resulted in a higher quality of care and improved communication. The last story I'll mention is another example of the team working with our clients to drive higher value solutions, leveraging AI and application modernization solutions. We had an automotive client that was looking to improve accuracy, minimize false positives and swiftly identify root causes to reduce network outages. Our teams work together to build a solution that leverages AI-driven analytics and/or automation to help them improve their IT operations and streamline processes. The solution helps the client better, drive anomaly detection and proactive alerting to boost efficiency, cut costs and strengthen business resilience. These are just a few examples that highlight our AIM strategy is working. As we just discussed with those examples, our organic growth has continued to outpace the market, and this momentum stems from the diversity of our vertically integrated set of solutions that touches all the client critical technology platforms that are strategic to our clients. In the second quarter, we added another 80 net new logos, maintaining our focus on driving organic growth through our cross-sell execution through existing clients, continuing to bring in net new logos through our marketing events and campaigns as well as rolling out new IP and solutions with our key strategic partners. I recently did a road trip to meet with over 10 of our CIOs and talked about their key initiatives and where we continue to invest and drive value with our clients. The discussion points included their focus on AI, application modernization, cloud, cybersecurity, and much more. Through these CIO meetings and so many other conversations, we continue to create increased awareness of our thought leadership and assist our clients with their most pressing investment priorities, helping them through the entire life cycle from advisory to implementation to managed services. Conversations like this confirm that we have the right platform, the right solutions and the strategic partnerships that continue to drive the growth and value we need with our clients. Last quarter, we spoke about our AI SWAT team that we formed to drive multi-practice AI solutions for our clients. We are now meeting on a biweekly basis and building advanced AI solutions that resonate and drive deeper value with our clients. This team of thought leaders continues to significantly expand our market reach. We are now engaging with large enterprises to build and manage their high-performance clusters that support their AI and heavy compute workloads. Our success can be attributed to the unparalleled skills of our engineering team and our deep understanding of the diverse expertise required to manage and optimize these environments. Converge's ability to own the end-to-end process of building, deploying and managing HPC environment sets us apart from our competition. Through this process, our technical thought leaders have become trusted advisers to our clients, enabling us to serve as a comprehensive end-to-end solution provider. Activity in AI has become incredibly pervasive across all our clients and practices, and we are capitalizing on this trend by delivering targeted solutions that address specific enterprise needs and demonstrate measurable ROI. As an example, in the second quarter, we launched Computacenter IQ, a comprehensive suite of enterprise grade, AI-powered solutions and frameworks built to transform customer interactions, boost agent productivity and optimize operational efficiency within contact centers, all built on IBM's Watsonx platform. The combination of our thought leadership in the AI space, combined with our strategic partnerships will allow us to change the game for our clients and the customer experience industry and enhance their decision-making, operational efficiency and customer satisfaction. We continue to see sustained momentum across all of our strategic investment areas. As all of you are aware, the CrowdStrike incident impacted many of our clients across the globe, and our teams are engaged right away to help them understand the impact and resolve issues quickly. This situation underscores the true power of Converge as an end-to-end solution provider. We quickly mobilized the response team from all our practice areas, assisting clients across the entire IT environments. We were able to leverage our experts across cloud, data center, networking and managed services. Our team worked for days and provided the outcome our clients were looking for. We have the expertise to support our clients' security needs. This incident showed how strong our portfolio is and the value of having a trusted adviser and partner for their comprehensive solution requirements. All of these examples continue to show that we have the right strategy, the right solutions and the right partnerships to continue to drive organic growth and higher value with our clients. I am confident we will continue to be the trusted adviser, an end-to-end solution provider for our clients for many years to come. Before I hand the call over to Avji to go through the financials in more detail, I wanted to give a quick update on the expansion of our Board. During our AGM this past quarter, we took the opportunity to expand the converged Board of Directors and had the pleasure of electing both Gayle Morris and Mary Hassett. Gayle brings over 30 years of experience as a corporate technology executive in high-tech computing, software and networking across top global companies, including Microsoft, Cisco, BEA, and Dell. Mary is a corporate executive with over 25 years of experience in human resource leadership roles currently holding the role of Senior Vice President and Chief of Human Resources at Lam Research and previously served as Vice President of Human Resources for HPE for the company's hybrid IT organization. The addition of both Gayle and Mary to the converged Board of Directors will be a major asset to the company and serve as a catalyst to the Board. I will now pass the line to Avji to review the details of our Q2 and half year financial performance.

[Avjitpal Kamboj, executive]

Thank you, Greg. In my review of Q2 2024 financial results, I will refer to some measures that are non-GAAP, including gross sales, organic growth and adjusted EBITDA. For a detailed description and reconciliation of our GAAP to non-GAAP measures, please refer to our MD&A filed this morning. I'm happy to say the integration of our acquired businesses into one Converge is continuing to progress well, and we're well on our track with the operational milestones we've internally set for this year based on our principles of product and services discipline, operational discipline and financial discipline. And one of those milestones was deconsolidation of Portage, which happened at the end of Q2. I can't say enough about our team's focus and dedication in delivering double-digit top line organic growth despite a challenging macroeconomic backdrop and while executing our internal transformation and driving efficiencies. It's been an incredible effort across the organization. Delivering on our promise of providing additional transparency in our business, you might have noticed that we have now provided full segment disclosures by region being North America, Germany and the U.K., along with constant currency analysis in our MD&A. We will continue to strive to add additional disclosures over time and strive to provide more transparency based on what we deem to be appropriate measures of our business. Our cash generation and the conversion of cash from an adjusted EBITDA continues to be the highlight, and we are focused on balancing the investments we make to organically grow the business with the returnable capital for our shareholders to maximize shareholder value. As you've probably seen in the release, we took a significant noncash impairment charge against our German operations in Q2, and this drove our reported GAAP net loss this quarter. I will speak to this a little later. I would like to emphasize that this impairment impact was all noncash. Also note that our operating results in Q2 still include the consolidated results and negative adjusted EBITDA of Portage, which was deconsolidated to the end of the quarter on June 27. Starting this quarter, Q3, our financial results going forward will exclude financial results of Portage in gross sales, revenue, gross profit, SG&A and adjusted EBITDA. We will recognize our 51% share of Portage net loss through loss from investment in associates line in our income statement, and we will back out this loss from adjusted EBITDA calculation going forward. Let me begin with a review of Q2 top line results. Gross sales were approximately $1.06 billion for the quarter, representing 11.1% growth year-over-year, and this makes the fourth consecutive quarter with over $1 billion in gross sales. The growth is all organic, and it's remarkable given the economic volatility and uncertainty affecting customer spending and in a market environment where IT budgets continue to be scrutinized. We are outpacing the market and our peers by supporting our customers' most critical projects and technology investments as a trusted business partner. Including the 11.1% growth in gross sales between products, managed and professional services and maintenance support and cloud product growth sales, which includes hardware and software sales, grew by 12% this quarter and maintenance support and cloud growth was 29.6%, while professional and managed services gross sales declined by 17.6%. Product growth sales growth was all driven by strong software sales with over 50% growth in software sales year-over-year, while hardware sales were relatively flat. Growth in maintenance support and cloud was all driven by public cloud solutions such as AWS, Google Cloud and Microsoft Azure. We did experience a decline in our professional and managed services sales this quarter, driven by 3 key events: first, reduction in resale of some of these services as we laser-focus more on professional services delivered in-house. Secondly, executing on our products and services discipline, we moved away from certain noncore services. And lastly, conclusion of large talent or services contracts with 2 major clients as these clients transition to contractor spend to in-house spend. Despite the overall decrease, we did experience double-digit percentage growth in our focused practice areas of cloud platform, app modernization and cybersecurity where we continue to invest in for organic growth. I will quickly touch on revenue in accordance with IFRS for the quarter. As a reminder, revenue is not a primary KPI in our industry due to gross net accounting requirements or also known as netted down sales in our industry. Our revenue will fluctuate over time depending on the product mix of netted down sales. Most hardware sales are recognized on a growth basis, and most software maintenance cloud sales are netted down sales, meaning these are recognized on a net basis. Gross sales is the best measure for top line. We have added an additional slide to our deck to illustrate this gross net accounting and the impact on revenue and gross profit. IFRS revenue in Q2 was $651.8 million, a decrease of approximately 2% compared to Q2 in 2023. This represents an increase in gross net adjustment or netted down sales of approximately $120 million compared to Q2 2023. This increase in netted down sales was driven by the higher mix in sales where Converge acts as an agent. This is an indicator of higher software and public cloud sales for us. Our year-to-date growth sales picture looks similar, where organic growth of 7.7%, driven by 8.6% growth in product sales, 15.3% growth in maintenance support and cloud, partly offset by 8.3% decline in professional managed services. Our strong top line growth this year continues to be largely driven by innovative solutions to our customers, including high-performance compute for AI, app modernization, cloud solutions, and cybersecurity solutions and multiyear software licenses. We have not seen the end user device to refresh cycle yet, and it seems unlikely that it will happen in the second half of this year. Our internal focus continues to be on transforming our professional and managed services business where we are laser-focused on making the necessary changes to achieve our targeted growth. Now turning to our profitability. Gross profit in Q2 was $179.3 million, up 2.1% from Q2 last year. Gross profit margin for the quarter was 27.5%, an increase of 110 basis points compared to Q2 last year. The increase in gross profit is primarily driven by higher software sales and public cloud sales, resulting in higher netted down sales. Q2 adjusted EBITDA was $45.1 million, up 8.6% year-over-year. Excluding the $1.5 million negative adjusted EBITDA from Portage, adjusted EBITDA for the Converge business was $46.6 million in Q2, representing an increase of 9.2% year-over-year. Excluding Portage, adjusted EBITDA as a percentage of gross profit was 26.5% compared to 24.8% in Q2 of last year. Again, we expect that adjusted EBITDA as a percentage of GP to increase over time, driven by gross margin improvements and flexing their operating leverage from SG&A efficiencies. Our Phase 1 of the ERP program remains on track to go live in October. We are in the final stages of testing and training. The only key risk open at this point is training of all our sales operations and finance staff, which is always challenging during the summer months butifications. We have the right focus and almost daily evaluations, and our teams are fully dedicated and committed to the program, and I'm confident that I will deliver a positive news on our next earnings release. We also remain on track to deliver on our profitability margin target of 30% of adjusted EBITDA as a percentage of gross profit over the next 3 years. In Q2, we reported a net loss before taxes of $172.6 million. This was due to noncash impairment charge taken on Germany op segment of $176.1 million. Again, this is all noncash and is a result of the current run rate of our Germany business. I will go into more detail on our performance by segment. As I mentioned earlier, we have now provided a detailed breakdown of our financials by region. Breaking down our Q2 gross sales by segment, Converge North America business grew by approximately 13.1% during the quarter. North America business represents 87% of our overall gross sales. Gross sales in the U.K. declined by approximately 5.2% primarily impacted by the elections in the U.K. Germany business grew by approximately 3.5% in Q2. On a constant currency basis, North America gross sales grew by 11.2%, Germany increased by 2.8% and the U.K. declined by 7.7% for the quarter. Gross profit growth of 2.1% was all driven by growth in our North America business of 3.4%, offset by the challenging markets in U.K. and Germany, with the U.K. declining 3.2% and Germany gross profit declining by 8.4% year-over-year. Translating results from foreign currencies, predominantly USD, GBP and euros provided an approximate 180 basis points benefit to grow sales and gross profit. Adjusted EBITDA growth was also all driven by North America. North America's adjusted EBITDA increased double digit or by 11.8%, with the U.K. adjusted EBITDA being relatively flat and Germany adjusted EBITDA declining by approximately 22% for the quarter compared to last year. On a constant currency basis, North America adjusted EBITDA increased by 10.3%, U.K. declined by approximately 4% and Germany adjusted EBITDA declined by approximately 35%, resulting in consolidated constant currency adjusted EBITDA increase of 6.1% compared to Q2 of last year. Our team continues to work hard to get stability in our Germany business. There are some positive signs of stability, but it will take time, and we do not expect that Germany will recover in the second half of this year. We expect the performance in our Germany operations to be mostly consistent with the first half of this year. This significantly reduced run rate in Germany operating segment has led to the noncash impairment of goodwill and intangible assets in the quarter. I will again emphasize that the $176 million impairment charge is all noncash. Now moving to our cash flows, liquidity and balance sheet. Cash from operating activities in Q2 was $52.4 million, an improvement of $62 million from Q2 of last year. Cash from operations as a percentage of adjusted EBITDA was 116% for the quarter compared to our target of 75%. Free cash flow for the quarter, which is defined as cash from operations, less CapEx, less lease payments and interest payments, was $39.8 million or 88% of adjusted EBITDA for the quarter compared to negative $24.2 million quarter last year. We have continued to manage our working capital very, very effectively. Moving the positive cash from working capital and the cash taxes paid, we generated $40.2 million from cash from operations, representing approximately 97% of adjusted EBITDA. Cash conversion this quarter is in line with our previously provided guidance of converting approximately 75% of adjusted EBITDA to cash from operations from Q2 to Q4 of this year and our target of approximately 115% conversion of adjusted EBITDA to cash from operations for the full fiscal year 2024. Looking at our balance sheet. We finished Q2 with a solid financial position with a net debt of approximately $157.9 million. Our leverage ratio at the end of the quarter was 0.9x compared to 2.25x at the end of Q2 last year. As previously stated, our target leverage ratio is around 1x in a high interest rate environment, and we're very comfortable operating around this ratio. As a reminder, we calculate our leverage ratio as short-term and long-term borrowings less cash divided by LTM adjusted EBITDA. In line with our capital allocation strategy previously communicated, we continue to invest in organic growth and reducing debt and returning capital to our shareholders. For the first half of the year, we utilized cash consistent with our capital allocation priorities. We continue to invest in organic growth with the addition of new sales team members, continued investments in our capabilities and solutions for AI, application modernization, cloud and cybersecurity. Since the beginning of this year, we reduced our net debt by approximately $52 million and paid approximately $31 million in contingent and deferred consideration liabilities related to previous acquisitions for a total of $83 million reduction in net debt and acquisition of related liabilities. We also returned a total of approximately $52 million of capital back to shareholders in the form of share buybacks and dividends this year. In Q2 alone, we repurchased approximately 6.8 million shares for a total of 8.8 million shares repurchased for the year. The health of our business and balance sheet allows us to return capital back to our shareholders to maximize shareholder value while also ensuring our ability to reinvest back in our business to sustain organic growth, complete the integration of previous acquisitions to reduce debt and execute on future M&A. Our capital allocation priorities remain unchanged. We are excited about how the business model is shaping and thanks to the expertise and dedication of my colleagues were focused on continuing to deliver exceptional results. Now turning to our outlook. The uncertain market conditions we currently operate under are likely to persist throughout the remainder of 2024. Customer sentiment remains cautious. As I mentioned earlier, we do not expect to recover in Germany this year, but we do expect our U.K. business and North America businesses to perform relatively well compared to the market, but it is not where we had expected and forecasted. Given these market conditions for the full fiscal year 2024, we expect to grow low to single mid-digit which is again significantly higher than a market where most in our industry, including our peers, are expecting flat or a decline. Our relationship with the customers that our capabilities are allowing us to outpace the market. We also adjusted our guidance to exclude or tag results for the second half of this year, which were expected to be approximately $7 million in gross profit and negative $1.2 million in adjusted EBITDA for the second half of the year. We now expect for the full fiscal 2024 revenue to be between $2.6 billion and $2.7 billion, gross profit to be between $709 million and $721 million and adjusted EBITDA to be between $176 million and $184 million. This represents profitability growth of low to single mid digits. That being said, we have not included in our forecast a large AI, high-performance compute hardware deal that we're tracking. If that deal closes this year and if we are able to deliver it all within the year, and we will exceed the current expectations and we will likely be within our originally guidance range. For the third quarter Q3 2024, we expect revenue to be between $636 million and $658 million, gross profit to be between $172 million and $178 million and adjusted EBITDA to be between $43 million and $47 million. As a reminder, Q3 of 2023 last year was exceptionally strong, growing approximately 24% organically top line from the previous year. With that, I would like to thank you all for joining the call today, and I will now open the floor for questions. Operator?

[Operator]

[Operator Instructions] The first question is from Robert Young from Canacord.

[Robert Young, analyst]

I just wanted to start on that last comment you made around the large incremental AI deal that's potentially in the pipeline. Can you just maybe give a little bit of context around that? Would that be a repeat deal or would it be an existing?

[Avjitpal Kamboj, executive]

Yes, Rob, as we've mentioned on previous calls, we worked on a number of large HPC deals with customers in the health care, financial services, automotive space, and it's with one of our clients that we continue to do business with.

[Robert Young, analyst]

So that's a potential repeat deal with an existing customer. It's not something that's new.

[Avjitpal Kamboj, executive]

It's a growth yield, correct.

[Robert Young, analyst]

And then second question for me to just be on good to hear that the ERP deployment is on track. Avji, maybe if you could just give us a quick summary of what the expected benefits. Maybe you give us a time line on how that might influence the financial performance and reporting. What benefits are you expecting to see come as a result of that through, I guess, 2025?

[Avjitpal Kamboj, executive]

Yes. So as we've talked about, we do not expect to receive any benefit for the remainder of this year. We will start having benefits from efficiencies within our operations starting Q2 of next year. And outside of the efficiencies, it will provide us more visibility into our business, allowing us to continue to operate on our disciplines of products and services discipline. We continue to do that today, but this will provide us more information and transparency into our business to be able to make the right decisions on what we sell and what we don't sell. And then also be able to make decisions on our operational and financial discipline based on where we need to make the investments in our business and where we can streamline our operations. We have not quantified the dollar impact of these. We will expect to do that once we've gone live.

[Robert Young, analyst]

Is there any way to maybe phase the benefit? Like you said, there is not likely to be a benefit until 2025. Would you see benefits early in 2025 or is it something that would phase through 2025? Maybe just some context around how investors may see the benefit.

[Avjitpal Kamboj, executive]

Majority of the benefit is expected to happen in the second half of 2025. That's when it will start. And it will be phased.

[Operator]

The next question will come from Christian Sgro from Eight Capital.

[Christian Sgro, analyst]

When you segment your customers either under the spectrum between large enterprise and SMB. Could you comment on the health of either of those 2 segments? And then I think last quarter, you were a little bit more focused on the enterprise market. Is that still the case maybe in the context of what you're seeing?

[Greg Berard, executive]

Yes, Chris, we'll continue to balance the business across both. We continue to see a large volume of transactions in the SMB space, but we continue to see more and more large enterprise transactions as well. So maintaining that balance both across customer base and obviously, the portfolio will continue to be a priority for us.

[Avjitpal Kamboj, executive]

And maybe just to add to that as well, Christian, our focus is not SMB, it's mid-market.

[Christian Sgro, analyst]

And maybe for the second question here, maybe the ones to poke at Portage and the strategy suppose to consolidation. Is there a refresh that you want to provide maybe on what the 12- to 24-month plan is, Converge's willingness to operate and run and support the business, but also what the plans are not that they're a little bit more separate?

[Greg Berard, executive]

Yes. So Portage is its key growth with the advent of the 3.0 release last September is U.S. expansion. And so that's their focus. Converge continues to be a good partner as a channel partner like we are with other ones, but key expansion. They've done a great job in Canada, both on the identity side and their portal business for municipalities, but really the key expansion is to the U.S.

[Operator]

Our next question will come from Stephanie Price from CIBC.

[Stephanie Price, analyst]

Just wanted to understand what's going on in the German business a little bit more. Thank you for the increased segmentation. It looks like revenue growth was okay, but profitability is maybe worse than the rest of the business. Just trying to understand a bit what's going on there and how much that drove the revision to the full year guidance.

[Avjitpal Kamboj, executive]

The way our German operations is all primarily in the education sector and public sector. And the way the public sector and education sector in Germany works is all predicated around framework agreements. And as those framework agreements come to conclusion, you're required to do full RFP and bit on those framework agreements. What you saw in top line growth and decline in margin was driven by the product mix. We had significantly our professional services and higher profitable hardware sales in the previous years compared to this year. You're starting to see some traction within the business where we're starting to win more and more framework agreements, especially around some end-user devices, but we have not been able to win our high-value businesses in Germany. And we're currently focused on investing in the business in terms of making sure we have the right sales team in place and the right operations in place. We have been expanding our teams, and we do expect to recover, but it's not going to happen quickly. This is not a commercial sector. This is government and public sector and recovery is generally slow as you bid on these framework agreements and slowly over time mine these framework agreements.

[Stephanie Price, analyst]

And then when you're thinking about the Q3 outlook and the revisions to the full year guidance, can you kind of talk about the buckets? I know maybe the demand environment has not improved to the extent that you were thinking and Germany, it sounds like it's a headwind there, too. But maybe just walk through how you're thinking about the rest of the year.

[Avjitpal Kamboj, executive]

Yes. So the first big bucket was deconsolidation of Portage that led to gross profit reduction of $7 million for the second half of the year and increasing our adjusted EBITDA by $1.2 million for the second half of the year, given that Portage has negative adjusted EBITDA. The second item we looked at was end-user device through a fresh cycle. And that significantly reduced our outlook for the second half of the year. And lastly was, I think I mentioned on the last quarterly call, we were expecting Germany to recover in the second half of this year, but we do not see that recovery at all. And lastly, is just the market sentiment. I think you're seeing this across the board, whether our peers or industry competitors, they're all either declining or seeing relatively flat while we're continuing to grow, but the growth is not what we had expected at the beginning of the year. So we're in line with what the market is expecting and what the sentiment seems to be, we're revising the guidance for that. That being said, as I talked about on the call, there's this large AI deal that we're currently continuing to track. As you know, our growth last year in Q3 was actually pretty much all driven by high-performance compute. This is a similar type deal. If that deal comes in, we will actually be in our originally provided guidance.

[Operator]

Our next question will come from Jerome Dubreuil from Desjardins.

[Jerome Dubreuil, analyst]

The first one is on the managed services segment that you've reported a decline and you've been transparent with what happened there. Wondering what percentage of this segment in terms of revenues that is in your focus areas where you have seen double-digit growth phase?

[Avjitpal Kamboj, executive]

So our double-digit growth that you saw was all coming from the high practices that we're focusing on. And that's the trend in the market as well, whether it's AI, cloud compute. So helping our our midsized customers move to the cloud and providing professional services and software around the cloud migration. And then also cybersecurity, which is one of the biggest topics today. So that's where we're seeing the growth in those practice areas. But where you're seeing the decline offset this growth is in our traditional, what we call digital infrastructure and device business.

[Jerome Dubreuil, analyst]

With regards to the CEO, I guess, kind of transition, I wouldn't expect too much change in the strategy, but still asking, is there any strategy tweaks related to that transition?

[Shaun Maine, executive]

So no, again, with Portage being deconsolidated, a group CEO of one company doesn't make sense. Greg's been operating Converge already. So it's more of the same. We've received feedback from our shareholders that it was confusing the 2 roles. So I would say it's going to continue to do what he's always in.

[Jerome Dubreuil, analyst]

And finally, on the potential large contract, would the margins on that contract be similar to what you would expect in the rest of that business?

[Shaun Maine, executive]

It would be consistent with the margins within our product sales categories, but we do not split out our margins based on individual deals.

[Operator]

The next question will come from Divya Goyal from Sofia Bank.

[Divya Goyal, analyst]

So I wanted to get a little bit more color on this revenue mix details that you provided. So you noted that there was a pickup in the software sales and the public cloud sales versus the services, which saw a decent enough decline. What can we expect to see? Or what exactly is in your pipeline for the remainder of the year? And just to add on to this question, are these software sales potentially longer-term contracts or shorter term? And if they are shorter term, how do you expect to continue to strengthen your pipeline?

[Avjitpal Kamboj, executive]

Yes. So the product mix will continue to shape our profitability as we focus more on professional services and managed services. As I mentioned in my remarks, maybe I'll address the professional services and managed services decline, part of it was intentional and a part of it was circumstances driven. So a big portion when is intentional, it was really related to us making conscious decision on our operational and our product and services discipline that we will not provide these resale services anymore and focus on our in-house services. That was number one. Number two, there were certain professional services that we were providing that were noncore and utilizing a significant number of our resources internally. So we decided to cut back on those services and focus on our 4 practice areas that I mentioned that are growing double digit. And then the unintentional part that happened as part of market events was 2 of our large clients that were using staff augmentation services that we provide. So it's not really internal services we're providing. We are effectively providing people as a staff augmentation basis. And those 2 contracts came to conclusion as those customers move all the spend in-house. So that's on the professional services side. We do expect our professional and managed services to continue to grow. If I split out between professional services and managed services, managed services, which includes our IP 4G continues to grow at a rate that they were acceptable internally. It was a professional services on the resale side that we saw a decline. But in Q3 and onwards, we are currently expecting and forecasting to have an increase in that business. And within software and hardware, given this it is a cyclical industry, and as we talked about, generally, Q2 and Q4 are higher software sales quarters. So that's where you saw the double-digit growth on software. What we are seeing, I think we had talked about right outside of the cohort or maybe earlier last year, customers were tending to sign more shorter-term software deals. We're seeing that trend reverse now where customers are more open to signing multiyear software deals. So when I look at our software sales this quarter and our cloud, these are all multiyear software deals.

[Divya Goyal, analyst]

So my second question on the capital allocation strategy. You did mention that you're making significant internal reinvestments, including the sales force. What exactly is your target sales force addition? Like are you looking to add more software-related account executives, hardware-related? Or is it going to be a broad mix? And then just to tag on to that, I understand that the focus is on organic, but could there be a potential M&A, say, 25 onwards even if it's a tuck-in? And that's also my question.

[Greg Berard, executive]

So in terms of targets, we've stated we want to grow our sales force by 10%. Our goal is to bring in a mix of sellers, experienced sellers that bring accounts with them as well as an understanding of the portfolio we have. So we are bringing in a mix of sellers that have professional and managed services experience so we can hit the ground running and drive some of those higher-value solutions. But we set a target at growing our North American sales force by 10%, and we're confident we'll hit that number here in 2024. And we've also, from an organic perspective and continue to invest in thought leaders in the industry around AI and cyber, et cetera, so we can continue to grow the portfolio that we're investing in. On the latter part question around M&A, we are absolutely looking to continue strategic acquisitions. We're building a pipeline now, and we continue to have active conversations.

[Operator]

The next question will come from John Shao of National Bank.

[Meng Shao, analyst]

I just wanted to get more color on the 2 contracts that the customers move in-house. Should we see them as an isolated case?

[Avjitpal Kamboj, executive]

Yes. These were 2 isolated cases. These are, call it, on a large projects that the customers were working on. And as these projects came to conclusion, part of it was to bring a portion of that spend in house and then a conclusion of those contracts effectively resulted in us declining our talent services. But these are one-offs.

[Meng Shao, analyst]

You also talk about hardware reflection cycle and recovery of the German business, are the same in terms of the timing and the trajectory of the recoveries?

[Avjitpal Kamboj, executive]

No, they're not. When I talk about end user device cycle, that is a global statement I'm making. That includes North America, U.K. and Germany operations that we do not expect to have the refresh cycle happen in the second half of this year. It's not a matter of if the refresh cycle will happen, it's a matter of when. And part of that, I think what you're seeing is decision-making around refresh cycle is customers are looking at, including AI, you're seeing all these AI PCs come out. And I think the decision makers are having to make a decision whether to refresh now or wait for new devices as they come out. That's one. Two, and just being cautious in the market, we do live in an uncertain market right now, and customers are pushing out some of these decisions. So if it doesn't happen this year, then it will likely happen next year. On the Germany side, the recovery is much slower. As I mentioned, these are large framework agreements, multiyear agreements that you have to bid on and win and then deliver over a period of time. So we do not expect the recovery, I'm going to say, call it, at least over the next 12 to 18 months in Germany.

[Operator]

The next question will come from David Kwan from TD Cowen.

[David Kwan, analyst]

First question for Avji. Avji, can you talk about what kind of training is involved in the Phase 1 of the ERP migration you were talking about? Like how much time will employees have to spend getting trained and anything related to that?

[Avjitpal Kamboj, executive]

Yes. So we've actually taken a much, much deeper training approach. Generally, what you'll see is a lot of companies when they're training their staff, whether it's virtual meetings or in personal classroom trainings. We're actually doing, I'm going to call it, on-the-job training. We're having most of our employees within sales, operations and finance team spend whatever they do on a day-to-day basis and the existing ERP have similar subset number of those transactions be performed in our new European environment. And that's our approach to training. And we're monitoring that almost on a daily basis and a weekly basis and addressing any gaps in that training as we go along.

[David Kwan, analyst]

And just one more, maybe this one for Greg. Greg, can you talk about what the sales cycle for AI projects is looking like right now? Are customers still hesitant? Are they still in the training and learning phase? Or are you seeing a little bit more willingness on their behalf to start spending dollars on the projects more quickly?

[Greg Berard, executive]

Yes. What we're seeing is a combination of a couple of things. We continue to see the larger enterprises spend on building up their clusters to support the AI workloads they want to run over the next couple of years. In parallel, we're seeing more and more conversations around how they can leverage AI and do design-thinking workshops. So we're putting our teams on site and doing workshops with our clients. And the third piece I'll talk about is just more on the solution side. So leveraging AI to build more solutions, specifically in the automation space. We're having a lot of conversations around automating their environment and driving efficiencies. And that's where you're seeing more and more spend right now. So you'll see us continue to focus and roll out solutions that help our customers drive the operational efficiencies and automation in their environments.

[Operator]

We have one more question, and it will be coming from Rob too.

[Rob Goff, analyst]

In fact, would the question there be more about timing or competitive dynamics or some mix of the 2.

[Greg Berard, executive]

Sorry, Rob, you cut off in the beginning. Can you please repeat your question?

[Rob Goff, analyst]

With respect to the large AI contract that's outstanding, would your uncertainty be about the timing of determination or it's a competitive situation?

[Greg Berard, executive]

Yes. So for us, Rob, it's a timing on a '24, '25 kind of conversation. They continue to invest heavily in the AI space, and we've been their partner of choice. So for us, it's a timing conversation.

[Rob Goff, analyst]

And my next question would be for Avji. With respect to your free cash flow, can you talk a little bit more about the leverage you have in front of you? And are they fully pulled with respect to things like accounts payable, accounts receivable, inventory, sales commissions?

[Avjitpal Kamboj, executive]

Yes. I would say our working capital is pretty much normalized now. It's not the one-off levers that we had pulled in Q3, Q4 and Q1 of this year. Now this is just maintaining and managing our working capital effectively. But we do have the levers, obviously, in making sure I would say, inventory, AR and AP are 3 items that go hand in hand.

[Operator]

This concludes today's conference call. We thank you for participating and ask that you please disconnect your lines.