Climb Global Solutions, Inc. Q1 FY2021 Earnings Call

Good morning everyone, and thank you for participating in today's conference call to discuss Wayside Technology Group's financial results for the first quarter ended March 31, 2021. Joining us today are Wayside's CEO, Mr. Dale Foster; the company's CFO, Mr. Michael Vesey; and the company's outside investor relations advisor, Cody Cree with Gateway Investor Relations. By now, everyone should have access to the first quarter 2021 earnings release, which went out yesterday afternoon at approximately 4:15 PM Eastern Time. The release is available in the Investor Relations section of Wayside Technology Group's website at waysidetechnology.com. This call is also available for webcast replay on the company's website. Following management remarks, we'll open the call for your questions. I'd now like to turn the call over to Mr. Cree for some introductory comments.

Thank you, James. Before I introduce Dale, I'd like to remind listeners that certain comments made in this conference call and webcast are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain known and unknown risks and uncertainties, as well as assumptions that could cause actual results to differ materially from those reflected in these forward-looking statements. These forward-looking statements are also subject generally to other risks and uncertainties that are described from time to time in the company's filings with the SEC. Do not place undue reliance on any forward-looking statements, which speak only as of the date of this call. Except as required by law, the company undertakes no obligation to revise or publicly release the results of any revision to any forward-looking statements. Our presentation also includes certain non-GAAP financial measures, including adjusted gross billings, adjusted EBITDA, net income excluding non-recurring costs, and non-GAAP earnings per share as supplemental measures of performance of our business. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You'll find reconciliation charts and other important information in the earnings release and Form 8-K we furnished to the SEC yesterday. I would now like to turn the call over to Wayside's CEO, Dale Foster.

Thank you, Cody. And good morning everyone. We continue to drive our growth strategy during the first quarter, giving our business a solid foundation for 2021. Despite a tough comparable prior year period, our gross profit reached $10.8 million, which is a company record. And we continue our year-over-year growth across net sales and adjusted gross billings. While we continue to make strategic investments ahead of our growth objectives, the benefits of these investments have yet to fully flow through to our profitability. However, we expect to build onto this bottom-line growth over time, as we continue to work to expand our vendor network, and drive integration and synergies with our recent acquisitions. The three core growth drivers we laid out last quarter underscore our progress during Q1, and they will guide our work for the rest of this year. As a brief reminder, these initiatives are as follows: first, drive organic revenue growth from our business by deepening existing vendor relationships. Second, further enhance our vendor line card by adding new and emerging vendors with above-average long-term growth potential. And third, utilize our balance sheet and free cash flow to identify and make creative and strategic acquisitions while working to improve our overall profit margin. This strategic framework provides a useful structure for evaluating not only our quarter-to-quarter progress, but also the long-term operational and financial trajectory of our business. With that in mind, I'd like to review each of these core growth drivers in greater detail within the context of our Q1 performance. To begin, in deepening our vendor relationships we remain focused on helping our vendors navigate this current environment as their end customers work to enhance their IT infrastructures. With today's work landscapes becoming increasingly driven by hybrid solutions, including cloud-based and on-premise technologies, this has accelerated many businesses' technology adoption timelines. Customers' changing needs have shifted our product mix from quarter to quarter, making our expectations inherently choppy as we adapt to meet their needs. During Q1, security, data center, and cloud products garnered a greater portion of demand within our portfolio, replacing hardware as our top-selling product category from last quarter. We recognize these IT needs will continue to evolve even as the broader macro-economic recovery from the pandemic gradually advances, and we're working to optimally position and diversify our portfolio to support these needs. These recent spending trends on security, data center, and cloud product lines point to another concept that underlies our current strategy: the prevalence of the cloud. According to a recent guide published by IDC, spending on security products is expected to reach over $23 billion by the end of this year, driven by the rapid growth and adoption of cloud-driven markets and remote work solutions. In their current state, our portfolio and vendor line card already includes growing exposure to cloud and cloud-adjacent products. Our work to further support and diversify our network will help us continue to build on our platform as an incubator for emerging vendors—ones that are not only serving today's IT needs, but also preparing customers for their IT needs of tomorrow. Next, we're continuing to focus on developing emerging vendors with long-term growth potential to establish mutually beneficial partnerships. To discuss this in conjunction with our current line card, let me now turn to our second core growth driver and highlight some of the important vendor updates and wins from the quarter. In April, Climb Channel Solutions was awarded the title of Distributor of the Year by Tintri, a wholly owned subsidiary of DataDirect Networks. We have had a long-running distribution partnership with Tintri's intelligent infrastructure products, and we're honored to have received this recognition of our high-touch sales approach and expertise. As we collaborate among U.S., Canada, and EMEA sales teams, we're further expanding our global reach of our line card. This includes several new key wins from the relationships we're building through our recently acquired CDF network. For instance, carrying forward the momentum we generated with security products this quarter, one of our established vendors, Sophos, is launching its next-generation firewall product, and we've added this enhanced product to our distribution portfolio. In the U.K., we've also continued to drive growth with a digital transformation and enterprise software provider. Given the remarkable success we've had with Micro Focus over the past four quarters in North America, we're now turning our attention to Europe to do more of the same. One other key new product we've added to our distributed suite is Bing Mapping by Microsoft, which we've started distributing across our global footprint. This Microsoft mapping platform integrates with Office 365 functionality on key features and empowers developers and enterprises alike to build intelligent location-enabled capabilities. Having this product in our portfolio is a significant added resource to our offerings and will help us as we continue to expand and go deeper into the independent software vendor, or ISV, customer marketplace, where we currently sell Intel software-focused products. These incremental U.K. vendor and product additions dovetail into our progress on our third core driver, which is using our balance sheet liquidity to identify creative acquisitions and enhance our margin profiles. As we continue to develop our vendor network and advance the full integration of CDF, we're supported by a strong balance sheet, as well as the capabilities of our recent acquisitions added to our platform, particularly around cloud services. As I stated last quarter, being able to leverage the skill set of CDF's Cloud Know How team—our adoption and migration experts—allows us to provide customers with services ranging from everyday technical support to specialized consulting. This elevates our approach beyond our typical IT distribution function and offers us a new avenue to expand overall operating profit margin. Further, the cloud products and consultative services we offer through Sigma, Gray Matter, and Cloud Know How respectively have accelerated our long-running development of our internal cloud marketplace. This platform can be utilized by each of our subsidiary businesses across all geographies. We expect to launch the marketplace in full this month. The first vendors to be added to the marketplace are Kronos, Bitdefender, and Trend Micro, with many more in line to launch in short order. As we launch cloud-specific vendors, as well as vendors that are moving to subscription-based cloud models, we're taking the same high-touch approach to these relationships as we have historically done throughout our strong partner network. We're positioning ourselves to be the premier choice of emerging cloud vendors and products as we set them up on our platform, get them tapped into our expanding global distribution network, and enable them to grow and increase their brand profile within the IT distribution and solutions marketplace. To conclude, let me say we've made progress advancing our integration efforts, identifying cross-selling opportunities within the U.S., Canada, and EMEA, and working to update our vendor contracts for global coverage. One of the newest vendor brands, Wasabi Technologies, is an excellent example of that. Wasabi is a cloud storage company that delivers low-cost, fast, and reliable cloud storage. They have already partnered with five other brands on the line card. Additionally, Wasabi just announced they've received $112 million in Series C funding, which will help expand their global channel ecosystem and provide further value to our customers. Opportunities like these will be instrumental in driving growth as we continue to leverage our legacy and recently acquired expanded distribution network. To be sure, we still have considerable work to do in order to achieve the level of growth and profitability we believe our expanded platform is now capable of achieving. As we look out at the balance of 2021, we see plenty of growth opportunities to capture, with an often-winding road to get there as we meet our vendors' evolving needs. We look forward to making progress, reaching our short-term and long-term goals, and continuing our strong partnership with our current and future vendors. I will now turn the call over to Mike to discuss our financial results. Mike?

Thanks, Dale. And good morning everyone. Net sales in the first quarter of 2021 increased slightly to $62.8 million compared to $62.6 million in the year-ago quarter. This modest growth reflects the positive impact of CDF and Interwork and was partially offset by a changing product mix within our existing vendor network relative to prior quarters, as Dale had mentioned earlier. It's also important to note the first quarter of 2020 had a substantial uptake in growth through a significant client win. Adjusted gross billings, a non-GAAP measure, increased 22% to $210.9 million in the first quarter of 2021 compared to $173.1 million in the year-ago quarter. Gross profit in the first quarter of 2021 increased 33% to a record $10.8 million compared to $8.2 million in the year-ago quarter. The increase was driven by the positive impact of CDF and Interwork during the quarter, with offsets from a variety of operational and strategic factors, including customers' early-pay discounts, reduced vendor rebates, and increased customer rebates, all of which were not incurred at the same elevated levels in the year-ago quarter. We're working with both vendors and customers to mitigate these factors in the future as we continue investing in our business and capture. SG&A expenses in the first quarter of 2021 were $8.8 million compared to $7.2 million in the year-ago quarter. As a percentage of net sales, SG&A was 14% compared to 11.5% in the year-ago quarter. The increase was primarily driven by incremental costs related to the operations of CDF and Interwork, as well as one-time severance expenses incurred during the quarter. On the whole, these elevated costs reflect investments we've made to support our base business that are recognized ahead of the profit benefit we expect to realize over time as we move forward with integrating CDF in support of this growth. We continue to expect our SG&A margin to gradually improve as we leverage the resources of our combined organizations. Net income in the first quarter of 2021 increased 82% to $1.5 million, or $0.35 per diluted share, compared to $0.8 million or $0.18 per diluted share in the year-ago quarter. Adjusted net income, which excludes non-recurring costs related to the unsolicited bid and the Interwork and CDF acquisitions, net of taxes, was $1.5 million or $0.35 per share compared to $2.2 million, or $0.50 per share in the year-ago quarter. In the first quarter of 2021, adjusted EBITDA was $2.6 million compared to $3.1 million in the year-ago quarter. The decrease resulted from the impact of severance expenses, early-pay discount programs, increased customer rebates, and decreased vendor rebates. As discussed on our expense line, we're working to mitigate these factors, creating better-aligned flow-through from our growth investments. Effective margin, defined as adjusted EBITDA as a percentage of gross profit, was 24.4% compared to 38.2% in the year-ago quarter. The decrease reflected the decline in adjusted EBITDA and the associated mitigating factors on our profitability. We've set out to improve our effective margin over time as we execute our growth objectives. Cash and cash equivalents increased $33.7 million as of March 31, 2021 compared to $29.3 million as of December 31, 2020. The increase was primarily the result of the timing of our vendor payments. We remain debt-free with no borrowings outstanding under our $20 million credit facility. Looking to the rest of the year, our strong liquidity position provides us with flexibility to execute on both our organic and acquisitive growth strategies. On May 4, our Board of Directors declared a quarterly dividend of $0.17 per share of common stock, payable on May 21 to shareholders of record on May 17, 2021. We continue to operate from a solid financial and operational foundation and make progress with our core growth drivers. We expect to expand profitability in the quarters ahead. This concludes our prepared remarks. Now we'll open it up for questions.

The conference call is now open for questions. Please follow the instructions to queue for questions.

Congratulations on the quarter. Definitely as businesses come back to normal work schedules as the pandemic ends, how do you see that affecting your business this year?

Yes, thanks Ed. And as Mike mentioned, it changes our product mix as a distributor. We have a hundred vendors across hardware, software, and services; it's just going to change that mix. What has not changed is how many vendors are still coming out of the startup phase, so we get to evaluate them and see how many customers are actually recovering and looking at different mixes in their product offerings to their end users. So it's all positive; I'm looking forward to actually getting more in front of the customers and vendors as regions open up and we're doing more travel. Other than that, yes, it's positive.

Great. And then my next question is on M&A—you mentioned that it's definitely a pillar of opportunity. What are you seeing out there in terms of opportunity and on valuations for some of these potential opportunities?

Yes, I'll let Mike talk on the valuation side. As far as the opportunities go, we've spoken about consolidation in North America distribution. We'll look at those markets, especially in the cloud, and also into MSPs. As we mentioned, Microsoft mapping—although it's not a big part of our business—getting it into the U.S. brings us into another category of customers and ISVs. We're selling to the Intel ISVs in Europe; we have Sigma in our media team over there, and then coming to the U.S., that product mix opens up new potential targets for us. We'll continue to look not only into the Europe market but other places for creative acquisitions.

Yes. In terms of reviewing prospects and valuation metrics, our view hasn't materially changed. We look at businesses that are profitable, are accretive to our business, fit strategically, and we think will provide an adequate return over a longer time horizon given some of the short-term investments we've made in the past. That being said, there's probably some general uplift in multiples for distribution companies, particularly larger ones, if you look at transactions like the Synnex-Tech Data merger over the past couple of years. So the environment might be one in which people are seeing the value in distribution and in this capital-light cash flow business model in general. But when we look to acquire a company, we're probably small enough relative to the larger players that our view of valuations and multiples hasn't changed that much.

Our next question comes from Howard Root.

Congratulations on continued progress, Dale and Michael. I have two quick questions and one more open-ended. One on the dividend: I know the new management team inherited this dividend, and it's been $0.17 for the last five years. Is the board still committed to the dividend at that level? Do you view this as a dividend-plus-growth story going forward, or are there any changes to that thought process on the dividend?

It might take on it: is the Board still committed to the dividend? You're right, it has been in place a long time. We talk about it at each board meeting. We inherited it, and the new board inherited it as well. If we look forward and say, 'Wait a second, we could really use those dollars better right now,' and we don't have a better use for it on the acquisition side given our free cash flow, I still think it stays in place until we have a better use for it.

Great. Second quick question: net sales year over year were essentially flat at $63 million, but adjusted gross billings increased 22% from $173 million a year ago to $210 million. That doesn't seem to track. Can you explain how adjusted gross billings goes up so much while net sales stay flat? Is there a beneficial effect we can expect going forward with that number increasing?

Yes. When we enter into a transaction and bill it, the accounting treatment differs depending on the product. If we sell a piece of hardware that is drop-shipped by a vendor, we report that as a gross sale. If we sell certain types of software, maintenance contracts, or security contracts that are recorded net, we report the net profit as net sales. To get a real indicator of the volume and how the business is tracking, adjusted gross billings is the number we look at internally. The reason for the shift this quarter—where adjusted gross billings grew over 20% while net sales were flattish—was product mix. Last year included a large hardware sale from one of our vendors. This year, our sales activity included more software and security and did not have a large outlier hardware sale. So it was strictly a function of product mix and GAAP accounting. The underlying economics are the same to us whether revenue is recorded net or gross. Internally, we focus on adjusted gross billings and gross profit as key indicators of business performance.

Yes. Howard, I look at it pragmatically. We had to collect $210 million this quarter versus $176 million a year ago—those are real dollars. It's the GAAP presentation that nets down based on accounting standards. But Mike's right: these gross billings are what we're collecting from customers and paying to vendors on margin. Watch us on the growth side and the gross profit piece.

Okay. And that ties into a more general question: your gross margins have improved markedly—from about 13% last year to roughly 17% in Q1. I assume that's due in part to the software shift. With the internal cloud marketplace, it feels like margins could continue to improve. Can you talk about how you see that playing out? I know you don't give guidance, but in general terms, should we expect gross margins and profitability to improve as you move into the internal cloud marketplace?

No, it's not that straightforward. Because of the way GAAP treats net versus gross sales, the margin percentages on GAAP net sales can be misleading quarter to quarter. You should look at gross profit dollars. Will those dollars increase? Yes, but not necessarily the GAAP percentage consistently, because one large hardware sale can change GAAP dynamics. Going into the cloud marketplace, margins for certain products are typically higher, so you'll see that, but we are in distribution and margins are slim overall. It's based on basis points where we can move the needle as we grow toward a billion-dollar company.

To add to that: there are two elements. When you look at gross profit relative to net sales, moving into more cloud services—which are recorded net—tends to make that percentage go up, though it will be up and down with mix. Over time, it would tend to increase. Also, an important indicator to look at is gross profit dollars relative to adjusted gross billings. You should consider both when measuring our progress.

Okay. It's a difficult business to look at from a GAAP perspective, and I wasn't as focused as I should be on adjusted gross billings, but a 22% increase is a really substantial increase for your business in Q1.

Yes, that shows the work we're getting done. We needed that to get to the bottom line.

Our next question comes from Walter Ramsley from Walrus Partners.

Congratulations. Good quarter. A couple of things: the two companies that the company purchased—how did they do in the quarter? Do you have a figure for what their contribution was and how that stacked up to what you were expecting?

I'll take that, Dale. We don't report separately on the companies we acquired. The main reason is that Interwork's and CDF's businesses are fully integrated into ours. The value of the cost savings from integrating the businesses was far superior to running them independently and reporting on them. That being said, we were pleased with the performance of the assets—meaning the vendor and account relationships, key management we picked up, and the performance and growth we got out of CDF for the quarter. We think both performed well; however, we don't report the numbers separately because the cost structures are so intermeshed it's difficult to do that.

Okay. And then the new cloud marketplace—could you take a minute and explain how that's going to work?

Yes. We're launching this month, and the platform is close to ready—we had a full demo recently. The way it will work is we'll take vendors that are moving to subscription-based models and new vendors that need that model. It will be a login platform or marketplace. Customers, once they have background checks, credit facilities, and so forth set up, will log in and start buying licenses and managing them online for their customers. We're working with resellers, so resellers will have their own instance to manage licenses across hundreds or thousands of end users. Vendors are moving in this direction because subscription models are popular—Microsoft is a prime example. On our reseller side, Gray Matter already has Microsoft direct and indirect contracts; we've taken what we've learned from them to the U.S., which is why the launch is quicker with CDF and Sigma in place.

Okay. Will that create a recurring revenue stream for Wayside, or is there a different pricing model?

Exactly. Instead of selling a license or renewal once a year, it becomes a subscription, which could be monthly, quarterly, or yearly depending on the vendor's go-to-market preference. We'll manage the subscription and updates. Yes, you'll see recurring revenue, and that's what we're building both in the platform and as a company. We are still mostly a software company with some appliances to facilitate vendor products, but this will be subscription-based.

As you build up this operation, will that temporarily slow down earnings while you build it up, or won't it really be a factor?

That depends on the vendor. For vendors that move drastically from hardware to cloud, you'll see significant changes. For us, with a diversified portfolio of around 100 vendors, the transition will be slower. Vendors we incubate typically take time to ramp on the platform unless they were born in the cloud. So you won't see the dramatic swings in our business that you might see from a single vendor switching models.

Our next question comes from Peter Luxe.

I'm perhaps the longest-standing stockholder in this company going back more time than I care to think of. Is it possible—this question I've brought up before—given the nature of the business and its quarter-to-quarter variability, and the somewhat illiquidity of your shares, have you thought about whether this would be better as a private company?

Let me start with the quarter-to-quarter variability: one quarter doesn't make a trend. We're dealing with two acquisitions—one fully integrated, the other in process—and with CDF we have things moving across both our distribution and our solutions businesses. That can create some quarter-to-quarter variability, but profitability trends depend on vendor mix and driving costs out through integration. We are still looking at creative acquisitions in different market segments. If it's purely an MSP cloud play, for example, it would be all software and services and little to no hardware. So the business mix can change depending on targets. As to being private, we get different perspectives from shareholders. Some say keep the dividend and public structure; others say redeploy cash for growth. Our board is independent with differing views. We'll collectively make calls; for the rest of this year, I don't see the dividend changing while we evaluate opportunities. If we find a better use of funds that returns greater value to shareholders, we would act.

As vision tends to be opening up, do you intend to bring employees back to the office as a group, or continue to do business remotely?

Good question. We transitioned to remote quickly because our teams were already remote a couple of days a week. We now have a Denver office that we didn't have before, and it's open. We're following local government guidelines—New Jersey has been tighter but is opening up to 25%-50%. We'll mix teams back into the office and eventually get back to more in-person work, although perhaps not as hardcore as pre-pandemic. Sales teams are traveling where comfortable and allowed. It's still tough to travel to the U.K. and Canada at the moment, but Mike and I plan to travel as soon as practical. In-person is more productive, so as authorities let us, we'll be back in person.

A previous caller questioned your dividend policy. As a long-term shareholder, one thing that has always backboned this company in good times and bad was a solid dividend. Considering eliminating it to use the money elsewhere might seem like a good idea at the time but probably isn't. I'm not sure if the Board would agree, but I'm sure many shareholders would favor keeping it.

We hear different takes from stockholders. Some ask why pay a dividend if we could invest for growth; others prefer the steady dividend. Our independent board has differing mindsets, and as a collective group we'll make the right call. For the rest of this year, I don't expect a change to the dividend while we evaluate targets. If we find a better use of cash that we believe will provide greater value to shareholders, we'll act.

Finally—and I've asked this in more than one conference call—in every quarter you say you've finished with the one-offs, yet we still see one-offs like charge-backs and severances. I thought that trend was over.

I have said in the past that we're through some one-offs, and in many cases that has been true. However, when you make acquisitions you discover additional opportunities to improve profitability and go-to-market effectiveness. That can result in restructuring or severance to align teams and costs. So you'll see some of those items from time to time, especially around acquisitions.

That concludes the question-and-answer session. I'll now turn the call back over to Dale Foster for final remarks.

Thank you, Adrian. I appreciate it. I'd like to start by apologizing to everyone—time is valuable and we messed up kicking off the call. We did a recording this time, and the wrong recording was loaded, so my apologies. Thanks to everyone on the call today who listened in—our vendors, our customers, and the Wayside employee family. I hope to see many of you in person soon. I look forward to driving continued growth in the company. We're still looking for acquisition targets that make sense for us and expanding our customer reach. We don't discuss specific numbers regarding customer reach, but this is the value of our reseller network; we continue to expand it. We took advantage of opportunities while some companies 'turtled up' over the last 12 months, and we expanded. We'll continue to be disruptive in the marketplace. Thank you to everybody, and I appreciate your support.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.