Converge Technology Solutions Corp

TSX:CTS

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, everyone. Welcome to the Converge Technology Solutions Corp. Fourth Quarter and Fiscal Year 2022 Results Conference Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there'll be a question-and-answer session. [Operator Instructions]

Your main hosts today are Shaun Maine, Group CEO, and 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 statements 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 a conclusion, forecast or production in the forward-looking information. Certain material factors or assumptions are applied in drawing a conclusion or making a forecast or a projection as reflected in the forward-looking information.

Additional information about the material factors that could cause actual results to differ materially from the 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. Such statements only speak as of the date they are 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 have no standardized meaning. Please refer to the Converge's filing of Canadian Provincial Securities regulators for an explanation and reconciliation to IFRS measures.

I would now turn the meeting over to Shaun Maine, Group CEO. Mr. Maine, please go ahead.

[Shaun Maine, Group Chief Executive Officer]

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 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 UK. 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 roadmap for transitioning Converge and its acquisitions into a midmarket 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 of 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 its 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 the 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 have 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.

[Thomas Volk, Board Chairman]

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 midmarket 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 proved the value to our existing midmarket 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 their 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 targets by acquiring approximately $1.2 billion gross revenue and $68 million adjusted EBITDA throughout the fiscal year ‘22.

This exceptional growth in revenue and profits instills the confidence in the execution of our business to realize the vision of becoming a $5 billion company in the next three to four 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 at 2022 Triple Crown Award winner by CRN, earning a spot on each of the Solution Provider 500, the Fast Growth 150 in the Tech Elite 250. More recently, CRN named Converge to its 2023 Managed Service Provider 500 list in the Elite 500 and 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 Partners 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 the 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 with 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 a 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 Masters of Business Administration, Masters 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 these commitments with the official launch of our Converge Core Values. Our Core Values have been created as a commitment guideline and map to which we treat our customers, employees, partners and co-workers. 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 better together is evident in the unity we have created as part of our culture. We believe that the relationship built along with a 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 as our commitment for all employees to feel valued and appreciated 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 their very best while also attracting likeminded industry leaders. This mindset of excellence will remain an important threat 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 unifying devotion to being better together. While hybrid work models continue to lighten our ecological footprints, Converge remains committed to conducting operating business in a manner that reduces environmental impact while striving to conserve and protect through sound business practices. It remains a top priority to learn and advance from practices discovered through new acquisitions such as our first UK acquisition, Stone Group. They were the UK's largest privately owned IT hardware manufacturer displaying exemplary sustainability goals. Stone was the winner of the International CSR Excellence Award in 2022. This is reflecting companies that have recently received CSR Accreditation Silver Award for the company's many environmental efforts, including reduction in carbon impact, charitable 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 their strategies are clearly communicated to outline the company's intentions with respect to financial targets and redevelopment, trading and supply chain partners, environment and social development.

Now, let's turn our attention to the financial operation 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 chains challenges and general macroeconomic uncertainty that companies are facing, Converge continues to see robust demand for its product 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 period, 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 change is applied to the full year audited results with 2021 comparative numbers reclassified 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 transaction 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 zero dollar 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 detailed disclosure of the impact of adoption in our audited financials and the quarterly reclassification impact for ‘21 and ‘22 is presented within our eight 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 details. Matt?

[Matt Smith, Interim Chief Financial Officer]

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 per our preliminary release.

As with 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 and other services, which includes the net revenue from public cloud resale 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.

In 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 proportionally more hardware when we acquire them, but is expected to grow over time by leveraging cross-sell opportunities where acquired companies introduce Converge's, higher margin cloud and managed service offerings to their 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 better than expected net debt position of $260 million with a strong cash position of $159.9 million and $80 million in availability under a 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 calculated 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 one 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 at 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 according exercise we announced subsequent to Q4, the company also signed a definitive agreement to acquire the remaining 25% stake in Rednet ahead of the earliest scheduled call option for the original purchase agreement.

The purchase price is based on a multiple of German company's projected FY23 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.

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 to date.

[Greg Berard, Global President and Chief Executive Officer]

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 increase 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 get 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 remains resilient amongst our well diversified customer profiles. Today, we service a customer base consisting of 21% in healthcare, 21% in 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 one practice area and almost 50% of our clients are now leveraging our skills and expertise across more than four 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 [IP for G], 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 IP for G revenue. We also now have our IP for G solution available in the US, Germany and we just recently launched two 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 three 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 the practices to have solution specialists, pre sales 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 line 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 midmarket 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.

[Shaun Maine, Group Chief Executive Officer]

Thanks Greg. Throughout 2022, Converge completed 10 acquisitions, including three acquisitions in Europe, building out our advisory services, our implementation to key verticals like education and healthcare, and our managed services, being our total up to 35 acquisitions in a little over five years. Combined with 2021, this has added over $200 million in advisory services revenue, a key growth area and differentiator as Greg has been mentioning. In addition to these acquisitions, Converge purchased the 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 out a dedicated team to accelerate acquisition integration. In 2022, this team completed 41 integrations, including 9 CRM integrations, 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 Gaitneau on March 22 to celebrate this launch with their partners, employees, and 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.

[Thomas Volk, Board Chairman]

Thank you, Shaun. Let me now take the opportunity to write 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 is a development or conclusion to the process, we will communicate it widely and in a timely fashion, while in the meantime, we make 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 a full year contribution of the 10 acquisitions completed during FY22. 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 question and answer section.

With that, I turn it back to the operator.

[Operator]

[Operator Instructions]

Your first question comes from Christian Sgro with Eight Capital.

[Christian Sgro, Eight Capital]

Hi, good morning. 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.

[Thomas Volk, Board Chairman]

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 are 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 we need someone to operate and run them. So our managed services business is 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.

[Christian Sgro, Eight Capital]

Okay, that's helpful. And to 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.

[Shaun Maine, Group Chief Executive Officer]

How we can see the trend of hardware versus software.

[Thomas Volk, Board Chairman]

The trend of hardware versus software. As you see, the expectation these are 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.

[Operator]

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

[Rob Goff, Echelon]

Thank you and good morning. 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?

[Thomas Volk, Board Chairman]

Well, as we stated on the previous calls, Rob, we know that we have a very strong booking in Q1, that's we are 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.

[Rob Goff, Echelon]

Thank you. 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.

[Thomas Volk, Board Chairman]

Yes. Matt, is it okay if you answer that.

[Matt Smith, Interim Chief Financial Officer]

Yes, sure, Rob. Yes, I just pointed 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'd see in past years. That's largely as a result of the number of acquisitions, and more importantly, the size of acquisitions. Anytime 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, collections 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 a full year basis.

[Operator]

Your next question comes from Robert Young with Canaccord Genuity.

[Rob Young, Canaccord Genuity]

Hi. Good morning. I was hoping you can get 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 you could just give us a little more sense of the drivers behind Q1 seeing less seasonal decline.

[Thomas Volk, Board Chairman]

First of all, obviously the increase in the backlog of Q4 was a temporary issue, basically delayed business, which we now get into Q1. So that's one driver, the other drivers, as we said, highlight at the beginning of Q1, when you had a preliminary result, 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 three 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 a 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.

[Rob Young, Canaccord Genuity]

Okay, thank you. 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?

[Thomas Volk, Board Chairman]

Well, on the large deal front obviously, the customers are more diligent nowadays, and that's a phenomenon obviously 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, the issues they had with resource shortages, the issues they had with some analytics of their data, et cetera, are continued issues where they need to invest to 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.

[Rob Young, Canaccord Genuity]

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

[Thomas Volk, Board Chairman]

And as I said Robert, sorry to interrupt you, but 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 three, four 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 yes, 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 how to look at the business.

[Rob Young, Canaccord Genuity]

Great. Thank you for that. 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? And then I'll pass line.

[Thomas Volk, Board Chairman]

All right, Rob. I think to increase the debt facility, obviously, as we said earlier, will give us more flexibility. It is an opportunity which we had to address at a certain point in time. So I think 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.

[Operator]

Your next question comes from Stephanie Price with CIBC.

[Stephanie Price, CIBC]

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

[Thomas Volk, Board Chairman]

So now we are not entrenched into 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 in the IT. So it is not really affecting us from that perspective.

[Stephanie Price, CIBC]

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?

[Thomas Volk, Board Chairman]

Well, I think that's an ongoing effort, so with us acquiring 35 companies. Obviously, that always provides 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 obviously 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

[Operator]

Your next question comes from David Kwan with TD Securities.

[David Kwan, TD Securities]

Good Morning, guys. I'm not sure if you can comment on this, but as you guys are going through the strategic process, are you contemplating refining your approach to M&A?

[Thomas Volk, Board Chairman]

Well, what we said at the end of last year is that we will definitely stop or 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.

[David Kwan, TD Securities]

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

[Thomas Volk, Board Chairman]

Yes, I think David 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. And however, in Europe, we will have to add more miles 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 as an acquisition.

[David Kwan, TD Securities]

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?

[Thomas Volk, Board Chairman]

Well, first of all, we have thousands of mid-market customers, right? So that is obviously something which prohibits us to basically even look at all of them and understand what they are doing. And since we have 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, speaking by Silicon Valley Bank, it's very hard to predict what is the next, which one is the next bank or what will happen. So that's impossible for us. But I think we obviously apply the proper diligence on our customers when engage with them in the business.

[Operator]

Your next question comes from Jerome Dubreuil with Desjardins.

[Jerome Dubreuil, Desjardins]

Yes, thanks for taking my questions. First one is on the hardware side. You mentioned in your preferred remarks that hardware sales can be cyclical. The perception is that we may not be yet in a recession. I know you referred to kind of industry consultants forecast but as of right now do you think we are seeing in your results some sort of a down trends in terms of hardware sales or its business as usual?

[Thomas Volk, Board Chairman]

Well, I would say what will see is a change in the mix of our business, right. Obviously, the growth which we saw in hardware before is obviously not as strong as more going forward, but at the same time we see more growth in software and services. So from that perspective, I think we are well set up to deal with the cyclical elements in the IT market and that's part of our business as we manage it, it has always been that way for the many years I'm in the IT market, the hardware business has been cyclical. As we know, the COVID period drove a lot of hardware and now a year later, or two years later, this hardware is still in place and we know that hardware will have to be replaced in another year or two years and then we'll see the other trend. But with us being able to address our customers not just at the product, but at the solution, and you will see that impact on us is very minimal.

[Jerome Dubreuil, Desjardins]

Okay, great. Thanks. And second one, as a Chairman in general, what is your view of operating a public company with somewhat limited visibility on the financials in the coming quarters due to supply chain? I understand it's not under your control, but how is this something you are comfortable with?

[Thomas Volk, Board Chairman]

Well, I think the issue you're describing in the IT industry, which has been always a very dynamic industry, and I have been CEO and Chairman of other companies, public companies in the space, is an issue which we are all familiar with. And obviously, I think our interaction with the management as a chair of the company as well as the board of the company, our regular interaction with the management, understanding where the opportunities are and what the management is doing to address those opportunities is essential as a board, also to understand how to operate as a board and also, since I'm an executive chair, also help the management in terms of executing the strategy.

[Operator]

Your next question comes from John Shao with National Bank.

[John Shao, National Bank of Canada]

Good morning, guys. I understand accounting change and your net revenue. So my question is, when I look at your past M&A, especially those that Converge gave their revenue EBITDA number. So how much haircut should I apply now? So your reported net revenue and those contribution from acquisition would be under the same scope.

[Thomas Volk, Board Chairman]

I think, so, first of all, it is going forward probably to be more of a formula rather than going into each acquisition and figuring out how that works. That's why we gave you all these eight quarters financials and the impact of the accounting change so that you can actually go back and see like in Q1, the impact typically is less because we do less software. And in Q2, we see most of the Q4 is a very strong software quarter. So that will give you feel on how you could model these things. And then on the way we actually buy companies and announce acquisitions, we have always announced gross revenue because the practice of these companies, how they net down is either not in place or it's not, quite often not done consistently. So, for us, reporting their net revenue treatment is inconsistent with the way we do it. So it wouldn't actually help you to come to any conclusion.

[John Shao, National Bank of Canada]

Okay, thanks. So, could you give us some quick comments on the current state of supply chain, given we've been getting conflict information so far, and also give us some outlook and how it's working for the year.

[Thomas Volk, Board Chairman]

I think we said this in the call, and Greg said this as well. We have a very dynamic supply chain. Like in Q4, we were able to ship 80% of the backlog of Q3. Now, in Q1, we are able to ship already over 90% of the backlog of Q4. So that means that the issues we had in a year ago, where the supply chain was staggering, we had to wait six to nine months to get clear. That issue is resolved, but it's still not stable enough that we can actually predict exactly in which week things will be delivered. So when we look at the supply chain now, from perspective of a six to eight week window, we are pretty comfortable that we can deliver everything within six to eight weeks. But I know we cannot and this is why I said be careful by the end of the quarter, we have a strong booking month in March. We cannot predict how much we actually will ship in March and how much will slip into April. And that's the challenge we have. That's why we are quite cautious.

[John Shao, National Bank of Canada]

Okay, my last question is I noted both the receivable and payable went up quite a bit over the last quarter. So any changes to a payment term or just a timing issue?

[Thomas Volk, Board Chairman]

I'll let Matt answer that question.

[Matt Smith, Interim Chief Financial Officer]

Yes, certainly. And yes, I mentioned a little bit in response to Rob's question, but certainly no underlying operational or changes to credit terms with customers. It really is just timing. And as I mentioned, we saw tangible improvements in accounts receivable collection in December and should show improvement in that area heading into Q1. So certainly no concerns from a business standpoint.

[Operator]

Your next question comes from Rini Sharma with BMO Capital Markets.

[Rini Sharma, BMO Capital Markets]

Good morning. My question actually is about the cross-sell synergies that you spoke about. Just wondering if there are any specific practice areas that you're seeing more opportunities to cross sell between or seeing more inbound demand from customers.

[Thomas Volk, Board Chairman]

I’ll let Greg answer that question.

[Greg Berard, Global President and Chief Executive Officer]

Yes. The good news for us is we've diversified across a number of key strategic areas, right. And as you've seen since COVID happened, I would say we saw a big uptick early on with our cloud and our cybersecurity practice, and now that COVID has kind of settled down a bit, we're seeing the uptick in our analytics practice as well. So really, it's across all the practice areas. We're seeing demand from analytics, cloud, cybersecurity, and then managed services as well. So there's really not one that jumps out. We're really seeing good pipeline and good demand across all our strategic areas.

[Operator]

Your next question comes from Daniel Rosenberg with Paradigm Capital.

[Daniel Rosenberg, Paradigm Capital]

Hi, good morning. I wanted to ask around the product and IP portfolio that's under Converge and Portage. So we've seen in the past kind of use M&A to acquire some interesting talent, but we've also seen you build it internally. So I was just curious about your thoughts on R&D and developing IP. Whether it be developed internally or you'd use M&A to further expand the portfolio.

[Thomas Volk, Board Chairman]

Well, Dan, I think we will continue to do both. I think we showed the capability, like with Portage, that we were able to do a lot of it by ourselves. But like in all the IP world nowadays, if you want to grow, it's also a good practice to acquire IP. And I think you will see us continue to do both.

[Daniel Rosenberg, Paradigm Capital]

And then just switching gears to cash generation. So it's nice to see cash generation kind of show in this quarter. As we think about quarters going forward and Matt touched on some of the working capital changes, just how should we baseline the company versus 2021 and 2022 was kind of this anomaly. So just any clarity you could give on the cash generation front.

[Thomas Volk, Board Chairman]

Yes, as I mentioned, I think 2021 is more telling of kind of our typical cash flow profile. I think if you look at 2021 cash flow from operations as a conversion of EBITDA, that's probably a safe baseline in terms of how you might model 2022. But as I mentioned, we have some good momentum on the collections front heading to Q1, and we expect more of a normalized working capital picture in 2023.

[Daniel Rosenberg, Paradigm Capital]

Okay. And then lastly for me, just on the leadership announcements, as you think of aligning the company and just leadership in general as you go forward, I was just wondering if maybe Shaun could comment on Greg's strengths and where he sees his talent will be more most constructive as you work on European expansion.

[Shaun Maine, Group Chief Executive Officer]

Sure. Greg did a phenomenal job as North American CEO. We've expanded that to do that globally. And again, I couldn't be happier as we've grown. This company didn't exist six years ago. I'm thrilled by the talent. And I look around the table here, and you've got Thomas Volk speaking with a German accent, and we were running around the street. five years ago, I wouldn't have expected to have my German Chair, a former CEO of Cancom, or John Teltsch, who came one of the senior executives from IBM. And so the team we've collected is I'm so proud of, and we become a very, very large company. When you look at the size of it. And Greg, I'm very good at that whole buying the companies, the cross sell, the way that Greg has had the practice areas. That's all Greg and just done a phenomenal job with our teams, the practice areas, and now having that expand to Europe as well. Greg's doing a phenomenal job. And really the people we've added as well, I will also highlight John Teltsch to have these kind of executives and Thomas around the company. I'm incredibly proud of the collection of individuals we have on this management team.

[Operator]

Your next question comes from Divya Goyal with Scotia Bank.

[Divya Goyal, Scotia Capital Inc.]

Good morning, guys. I just wanted to get some color on the savings that Matt talked about. The $15 million in savings is good, but I was just wondering what the temporary integration team that you created recently? Is that something that will continue to stay, or would that eventually come off and would that be an additional saving during the year?

[Thomas Volk, Board Chairman]

No, I think, Divya, and we talked about this before, you need to look at it the other way around. I think the integration team continues to help us to drive synergies. And as Shaun indicated, we have until November this year, really a roadmap laid out to integrate all the outstanding integration companies around the core systems. And that means there are synergies there. And by then we will have started to buy new companies again. So we will need that expertise. And this team is getting really good at integration. And the skill of integration is one of differentiator at our company. So I would assume for the years to come, while we grow inorganically, that team will be in place. And we are very proud of that team, because if you look at the market, this is one unique plus of Converge. Nobody else has done as well as we did in the recent years. So that team is phenomenal.

[Divya Goyal, Scotia Capital Inc.]

That's helpful. So, just on that front, I wanted to understand, what are the company's capital allocation priorities going forward? I know you mentioned that M&A is not going to come during the first few quarters, but throughout the year, how can we expect the capital getting allocated across the business?

[Thomas Volk, Board Chairman]

Well, as we said, we are planning acquisitions in the second half. We have now allocated to buy the 25% of Rednet. And then we will make decisions on what we will do when we actually at the point when we have to make some decisions on capital allocation in terms of how we manage our shares, how we manage our shareholder commitments, as well as how we manage our market commitment.

[Divya Goyal, Scotia Capital Inc.]

Thanks for that. Just the last question on Portage. Would at some point in time going forward, we start to get a little bit more sort of separate revenue generation from Portage and get to understand how that business growing on the side, given CTS' ownership and the outside ownership in that company?

[Thomas Volk, Board Chairman]

I'll let Shaun answer that one.

[Shaun Maine, Group Chief Executive Officer]

Great. Yes, we will be providing segmented financials as of Q1 for Portage as well. So although they'll be in the consolidated numbers, there'll be a segmentation for Portage, so you can see their broken down financials as well. So that'll happen as of Q1.

[Operator]

Your next question comes from [inaudible] with Laurentian Bank Securities.

[Unidentified Analyst]

Hi, good morning. I just had one quick follow up on Rednet. So looking at the timing of this deal on bringing the rest of the 25% of the entity, is that somehow like tied to the strategic review that's going on? And a follow up on that is you mentioned about the strategic review and the timely, like, the announcement in timely manner, but is there a definitive timeline to when that will conclude. that's it?

[Thomas Volk, Board Chairman]

All right, so, first of all, the Rednet decision was a mutual decision, which obviously had clarity also for the strategic review process, also for the shareholders of Rednet. So I think that obviously has been considered as a positive from that perspective. And again, like I said before, on the timing of the strategic review process, we are making progress as expected, but the timing will depend on the companies who are interested in terms of how will they quickly, they be able to line up everything they need to come to a conclusion.

There are no further questions at this time. Mr. Volk, over to you.

[Thomas Volk, Board Chairman]

Well, thank you. Thanks for everybody attending the session today. Thanks for all the questions, and we are looking forward to speaking to you again in the future. So thank you very much.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank your participating. And ask that you please disconnect your lines. Have a great day.