Climb Global Solutions, Inc. Q3 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 Third Quarter Ended September 30, 2021. Joining us today are Wayside's CEO, Mr. Dale Foster; the company's CFO, Mr. Drew Clark; and the company's Investor Relations adviser, Mr. Sean Mansouri with Elevate IR. By now, everyone should have access to the third quarter 2021 earnings press release, which was issued yesterday afternoon at approximately 4:15 p.m. Eastern Time. The release is available in the Investor Relations section of Wayside Technology Group's Web site at waysidetechnology.com. This call will also be 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. Mansouri for introductory comments.

Thank you. Before I introduce Dale, I'd like to remind listeners that certain comments made on 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 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 are being made 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 and adjusted EBITDA 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 press release and Form 8-K we furnished to the SEC yesterday. I'll now turn the call over to Wayside's CEO, Dale Foster.

Thank you, Sean, and good morning, everyone. As you can see from our results in the earnings release, we had a very strong quarter. All of our teams are performing well, including our CDF team in the U.K. I spent time with them earlier this month and will add more color later in the call. We've seen a significant increase in the number of potential vendors approaching us to distribute their solutions, which continues to be encouraging. This has led us to be more selective in who we incrementally onboard with emerging brands, while our sales and marketing teams continue to drive sales with our complete line of strategic vendors. We signed several new emerging partners during the quarter. The more notable new partnerships include a new agreement with Mirantis in August. Mirantis is an open source cloud computing software company that produces leading edge container and cloud management products. Climb also entered into an agreement with Enable this past quarter to distribute their MSP solutions. Enable is a global provider of software that helps companies navigate the digital evolution. With a flexible technology platform and powerful integrations, Enable makes it easy for MSPs to monitor, manage and secure their environment. Our sales teams believe that both of these new partnerships will be significant growth drivers as we move forward. Following up on the acquisition of CDF in the U.K., we are now coming up on our one-year anniversary of the transaction. I traveled to meet the entire team last month in the U.K., and it was clear that we made the right choice in acquiring CDF. The Climb and Grey Matter teams mirror our energy and commitment to both vendors and customers, along with their focus on growing their prospective businesses. Overall, this past year, we have seen both teams sharing innovations, vendors, systems and our cloud marketplace offerings. One of the key vendors CDF has is Microsoft with agreements to sell both direct and indirect. Our Microsoft CSG business is up 26% in Q3 of 2021 versus Q3 in 2020. As for prospective M&A targets, we are in active discussions with multiple parties as we evaluate opportunities in the U.S. and abroad. As a reminder, we are focusing on companies that will be accretive to earnings and fit our strategic direction. The potential targets will fit into one or more of our defined categories: geographic reach, vendor perspective, or services and solutions. We have ample room on our balance sheet and debt capacity to execute both tuck-in transactions and acquisitions of size. The distribution landscape over the last quarter has seen additional consolidation with mergers and acquisitions being completed by Ingram Micro by Platinum Partners and Tech Data by Synnex. This leaves just three major broadline distributors worldwide, including Arrow as a third with combined revenues of over $130 billion. We think that this will have a positive impact on our business as these large competitors will be focused internally on integrating their corporate teams and systems with potential disruptions to their vendors and customer base. Larger, more established vendors are looking to have fewer distribution relationships, which provides us with more targets and fits into our value-added distribution go-to-market plays. During the third quarter, we unveiled our new Climb Expedition Cloud Marketplace. As we briefly discussed in August, our new cloud marketplace is designed for MSPs and hybrid VARs to explore and transact with vendors that are moving into a subscription-based model of software delivery. The initial launch of the Expedition Marketplace has received excellent feedback and more of our vendors have reached out to be part of it. With seven vendors launched to date, fourteen are in the pipeline at different stages, preparing to make their debut. As we look towards the future, our commitment remains focused on building a marketplace that highlights emerging technologies, while enabling our partners to transact however they would like to transact. With so many customers and vendors moving from perpetual licensing to a subscription-based model, the cloud marketplace will play a key role in the future of Climb's distribution strategy. Overall, our partners continue to recognize our unique ability to actively sell and market their products to channel customers. Spending on security, data center and cloud product lines are at all-time highs, and we plan to continue capitalizing on this market momentum by providing a streamlined and effective sales channel for our partners. With that, I will turn the call over to Drew to take you through the financial results. Drew?

Thank you, Dale. And good morning, everyone. Jumping right into our results, all comparisons and variance commentary refer to the year-ago quarter, unless otherwise specified. As reported in our earnings press release, net sales in the third quarter of 2021 increased 13% to $68.9 million compared to $60.9 million. This reflects both continued organic growth and the impact from the acquisition of CDF. Excluding the acquisition, we increased net sales by $1.2 million year-over-year with CDF contributing an estimated $6.8 million. However, the more indicative number of our sales growth is, of course, adjusted gross billings, a non-GAAP measure, which increased 33% to $226.9 million compared to $171.0 million in the year-ago quarter. We generated strong organic growth of 20% or $35.4 million with incremental contributions of $21.4 million from CDF. Gross profit in the third quarter of 2021 increased 56% to a record $11.3 million compared to $7.2 million in the prior period. Our gross profit grew to 16.4% of net sales compared to 11.9%, and as a percentage of adjusted gross billings, the increase was 5.0% versus 4.2%. Again, the increase was driven by organic growth and the addition of $2.4 million from our CDF acquisition. SG&A expenses in the third quarter were $8.1 million compared to $6.4 million, with the increase primarily related to the incremental costs from the operations of CDF as well as costs related to investments in our business that we expect will drive continued growth in the quarters and years ahead. SG&A expense as a percentage of adjusted gross billings decreased to 3.6% during the third quarter compared to 3.8% in Q3 of 2020. Net income in the third quarter of 2021 increased more than four times to $2.4 million or $0.55 per diluted share compared to $0.5 million or $0.13 per diluted share. Adjusted EBITDA in the third quarter increased 128% to $4.2 million compared to $1.9 million. This increase was driven by operating leverage and the aforementioned organic growth and acquisition benefits. Effective margin, defined as adjusted EBITDA as a percentage of gross profit, increased significantly to 37.4% in the third quarter of 2021 compared to 25.6% in the prior year quarter. This is a great indication of our ability to leverage our core operations and to successfully integrate our acquisitions. On to the balance sheet. Cash and cash equivalents were $29.9 million as of September 30, 2021, compared to $29.3 million as of year-end December 31, 2020. We remain debt-free with no borrowings outstanding under either our USD 20 million or GBP 8 million U.K. credit facilities with Citi Group. On November 2, our Board of Directors declared a quarterly dividend of $0.17 per share of common stock payable on November 19 to shareholders of record on November 15. Looking to the end of 2021 and into next year, our strong liquidity position and operating cash flow continues to provide us with the flexibility to execute on both our organic and acquisition growth strategies. This concludes our prepared remarks. We'll now open it up for questions.

Our first question or comment comes from the line of Ed Woo from Ascendiant Capital.

My question is on the outlook for 2022 as we're heading into the end of the year. How do your enterprise customers feel about our business next year?

We don't give guidance, as you know. But as far as just the actual underlying feeling, I think I said it before, it's pretty optimistic. When we thought that projects were canceled during the whole COVID times, they actually just got pushed back, and we're seeing some of those come in and we experienced that in the third quarter. And we just feel like we have a lot of that business building up as well. As I mentioned before, the vendors, same optimism. They're out there hiring as fast as they can to build up their sales team. So I don't see a downside going into 2022 as we're focused right in this quarter already with one month behind us.

Have you seen sales cycles return back to normal? Or are they still a little bit extended?

It depends on the product mix, right? So if we're dealing with anything that's hardware, we all hear about the supply chain issues. If it's going to the data center, something coming from overseas is going to take longer; yes, we see those pushed out. We see it in a couple of our solutions business lines where we're waiting and it's going to be something that plays out from Q4 into Q1 of 2022. But other than that, 90% of our business is software delivery licensing. So we don't see any disruption there.

And my last question is, is there any real differences between the business environment in Europe and North America or are they both pretty strong?

Yes, the same thing that I think the energy is ahead of us in Europe, at least in our business—80% of our business in Europe is in the U.K.—and being there for a week, I just feel like they're ahead of us as far as—not to say recovery, but just opening up in certain areas. Where we have some areas here that are kind of tight, it's just wide open over there. Everybody has been traveling, they've opened up the EU between all the countries there. So I think maybe, similar to the pandemic when it hit, they were ahead of us as far as what we see; they already went through it. So we're on the opposite side.

Our next question or comment comes from the line of Bob Sales from LMK Capital Management.

Congrats on the quarter. Can you expand a little bit on the marketplace offering you have? And maybe just sort of two facets: one is how do you see this positioning relative to the other players that are exclusively focused on it? And two, maybe guide our expectations in terms of what you hope to achieve in fiscal '22 as a percentage of revenue or some other metric that we could just understand?

So looking at it two different ways. We have competitors that are traditional distributors that are getting into the cloud delivery system basically. And then you have ones that are born in the cloud like a Pax8 or Avant that already have that cloud offering that they started with. So there are two sides of it. We fit in with the traditional distribution model that is moving into subscription-based delivery, whether it's monthly, quarterly, yearly on that side. So what we're seeing is that we haven't parsed between the two because it's the way our vendors want to go to market or basically their capabilities that determine how they go to market. Right now, if they're doing perpetual licenses, they all want to switch to some type of cloud-based delivery subscription, whether that subscription is monthly or consumption-based. So you'll see our business internally shift from one model to the other. And then, of course, we hope to grow in both places. But we're not going to see just this huge cloud piece take off without some of the slowdown in the perpetual side. So it's just the way they're going to go to market, and we just want to make sure we're ready for that. We thought we were way behind, but we realized that it's really our vendors that we're waiting on. Our first entry is our cloud marketplace called Expedition. We're pushing that every day. We are growing quickly with companies like Wasabi that are also consumption-based. Once we get our two platforms to sit together, it becomes more efficient that way. But it's hard to really monetize it right now because it's just early stage, and our vendors are early in their ability to deliver through a platform.

The second question—I actually have two more questions. I don't think there's going to be a ton of traffic question-wise, so I'll shoot both if that's okay. Did you see any signs—there have been clear signs in the broader IT space of a spending slowdown—can you talk a little bit about whether or not you saw any of that trickle through the leading edge stuff, maybe whether it was a little lighter to the upside than you hoped for in the quarter? Anything to give us a sense of the impact on the leading-edge business that you serve within the context of the slowing broader market?

We track the broader markets because they do show trends for us. But if you look at the vendors that we actually service and sell—these are emerging vendors—so they are just coming out of the startup phase. It depends on where they are in their life cycle: where they're spending, what's their next tranche of funding, what series they're in and whether they're expanding. So we don't see the same kind of broad slowdown reflected in the emerging vendors. When the overall IT market is growing at 4%–5%, we should be in the high single digits to low double digits, because these are new players potentially competing against a Cisco or one of the big Tier 1s. We just don't see the broader slowdown as much in our space. We track the data and see some trends, but our focus is whether the vendor we pick up is disruptive and where they are in their lifecycle. If you look at our top two vendors, Sophos and SolarWinds, they give some key indicators: SolarWinds has been recovering and Sophos, with a lot of new product mix and their commitment to the channel, has been strong. We take those signals when we can.

And then the last question for me is when you think about the next acquisition desire—your last one took you overseas where you got a toehold in Europe—when you look at what is in your mind or what will motivate you in the next acquisition or two, what can you share about your thinking with us?

The thinking is, and we have a strategic plan that we follow, and I talked about it as far as is it geography? Is it a vendor similar to when we acquired Interwork and we got the Trend Micro relationship? So we look at probably four factors as to whether it's a good target. The other one is services. Can we add more technical services and start to do that swing in the company? It will be tough to move the needle, but gross profit margins on services are much higher. So we're looking at that space as well. Yes, there are still some targets in the U.S., not specifically a perfect fit for us in distribution, but more on the services and solutions side that we're talking to. We're also bringing solutions capabilities from the U.K. into the U.S., so you'll see more announcements to that effect, probably in Q1. We've signed multiple NDAs and are talking to some good targets, and it has to be a cultural fit with our management team and their management team and, of course, fit with the greater sales and marketing teams.

And just from an investor standpoint, obviously the stock thing is what concerns me—if acquisitions are done with stock it raises dilution concerns. From a cash and debt perspective, you've done a wonderful job with that, but as soon as you start doing stock acquisitions, it raises financial issues. So congrats again on a great quarter.

Our next question or comment comes from the line of Howard Root.

And really building on the success in the first two quarters of the year, it's outstanding progress. I have two questions. One on the subscription model and the shift or the growth in cloud-based distribution and subscription: does that change, if at all, your financial model? In particular, I'm looking at adjusted gross billings getting about a 5% gross margin and then SG&A being somewhere around 3.5%. SG&A is more of a fixed expense and goes up incrementally with growth based on acquisitions. The 5% gross margin is basically off of the adjusted gross billings line. Do you see that changing when you go more subscription or cloud-based? Or is that more a continuation of what you have now? My second question is on acquisitions—thanks for laying out the overall strategy that you have. You've had great results with Interwork and CDF. When you consider financial parameters for acquisitions, how do you measure accretion and what mix of cash versus stock or debt might you consider?

You're right on target, Howard, and that is the efficiency model of doing cloud where an MSP or a hybrid VAR can actually log in and manage their subscriptions. It doesn't involve as much heavy lift on our side. Of course, we want to move in that direction because our SG&A costs will go down as we deliver that. We're waiting, as I said, on the vendors. I'll pick two vendors and talk about Wasabi. Wasabi consumption-based offerings with leading distributors in the world today—they're not off the charts but it's ARR. So it's recurring revenue that won't stop. When that happens, and the numbers are smaller per month per consumption, there's more margin to be had there. We're noticing that and want it to be a bigger part of our business, which will keep driving that. For a company like Sophos, which is subscription-based and also has firewalls with hardware, the goal—and Sophos has done a good job—is they'll ship the firewalls and then the subscriptions that add capabilities to the firewalls will be cloud-based platforms where customers download and the billing happens automatically. It's really important for us to get the efficiency we do not have with manual touches when customers want to transact that way. Are we there? I would say we're less than 10% overall into that space right now. This time next year, I'd say the number is probably 30% that we'll be delivering that way, and that's really dependent on how fast our vendors can get there.

Howard, I think from our perspective there are industry-standard financial metrics that we'll be measuring and valuing a business around, such as the adjusted EBITDA that it contributes. We also need to factor in, as Dale referenced, what type of increased product opportunities we have with vendors that we may not have access to today and the cross-sell opportunities across the globe where we can get global contracts in place instead of just, say, a North American contract with a particular vendor. We'll value transactions based on traditional multiples off of metrics such as adjusted EBITDA and will consider premium aspects of a business that may justify an increase in valuation. If transactions are of the size such as CDF or Interwork, we have plenty of liquidity and working capital on our balance sheet to consummate those transactions. We will consider adding leverage because the balance sheet is leverage-free today and the cost of funds is relatively inexpensive historically speaking. So for a larger transaction, we would likely look to a combination of perhaps some cash, some debt financing in terms of the term piece and perhaps some equity as well. But again, those are to be determined on a deal-by-deal basis.

And Howard, just to be transparent, when we're looking at acquisitions—especially in the emerging space where we play the most—a lot of the emerging companies want to get successful in the U.S. and then grow to the rest of the world. With many targets overseas, they have problems acquiring new vendors quickly. The U.S. typically becomes 60% to 70% of the overall world market and then they grow into Western Europe or Asia Pacific. We think we're good at onboarding new vendors and then moving them to Western Europe. We can move it much quicker than a six- to eighteen-month cycle for a vendor to get to our U.K. team. We can ensure in that cycle, with systems and our sales and marketing teams working to deliver that product ahead of our competitors, that the vendor will be onboarded more quickly.

And just from an investor standpoint, obviously the stock thing is what concerns me. If acquisitions are done in that way—using stock—that raises financial issues. Congrats again on a great quarter.

I'm showing no additional questions in the queue at this time. I'd like to turn the call back over to management for any closing remarks.

Thanks, operator. Thanks to our employee base. A lot of things were moving over this last year between everybody getting back into the offices, people back on travel and everybody has been super supportive to our vendors and to our customers—just overall team effort. So I appreciate it. Thanks for joining the call today.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.