Climb Global Solutions, Inc. Q1 FY2023 Earnings Call

Good morning, everyone, and thank you for participating in today's Conference Call to discuss Climb Global Solutions' Financial Results for the First Quarter Ended March 31, 2023. Joining us today are Climb'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 first quarter 2023 earnings press release, which was issued yesterday afternoon at approximately 4:05 p.m. Eastern Time. The release is available in the Investor Relations section of Climb Global Solutions website at www.climbglobalsolutions.com. This call will also be available for webcast replay on the company's website. Following management's remarks, we'll open the call for your questions. I'd now like to turn the call over to Mr. Mansouri with 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, adjusted EBITDA, and effective margin 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 Climb's CEO, Dale Foster.

Thank you, Sean, and good morning, everyone. As you can see, our momentum from the record year in 2022 has carried into our first quarter with significant growth in all of our key financial metrics. Our performance was driven by continuing to execute on our core initiatives, generating organic growth with existing vendors while adding new vendors to our line card. In addition, we continue to drive growth and margin expansion from our integration of Spinnakar, which we acquired last August. Excluding Spinnakar, we generated double-digit growth on both the top and bottom line, demonstrating the strength of our core business as we continue to scale our line card in the U.S. and abroad. Of the 18 vendors that we evaluated throughout the quarter, we signed agreements with only four, demonstrating our commitment to a limited line card that focuses on the most innovative technology brands in the market. I'd like to highlight one of the latest partnerships that we launched in Q1 in North America. We partnered with LogicGate, a vendor that was first part of the Spinnakar portfolio. They are a leading provider of transformative risk and compliance solutions delivered on the Risk cloud platform. We look forward to growing our relationship with LogicGate, as we continue to scale our business globally. As many of you are aware, M&A will continue to be an important component of our growth strategy as we continue to evaluate potential targets that would extend our geographic reach and enhance our Climb team. We began this initiative in 2020 with the acquisition of Interwork Technologies, followed by the acquisition of CDF Group, a U.K. cloud software distributor and service provider. As I mentioned earlier, last August, we completed the acquisition of Spinnakar, another U.K.-based IT channel distributor focused in the EMEA region. These transactions have not only extended our geographic reach beyond the United States but have also enabled us to reap the benefits of cross-selling opportunities between each entity in each region. This was further reflected in our recent entry into the French market with Spinnakar's relationship with VAST Data. We expect additional cross-selling opportunities as we expand our reach across new regions. Quickly commenting on the macro environment, we do see a potential slowdown of IT spending across our regions, mainly in hardware sales, which could have a downstream effect on software sales. For example, less investment in hardware, such as laptops, computers, and servers, could lead to a reduction in various endpoint solutions. With the recent announcements from both large vendors and customers rightsizing their businesses, we will be paying close attention to where we can maintain our growth while being adaptive and agile to the needs of our customers. We believe the core segments of the market where we focus, which includes emerging technology companies operating in cybersecurity, storage, HCI, data management, network connectivity, and cloud, are somewhat insulated from the broader issues impacting other verticals, as these are key areas of investment for most companies. Looking towards the remainder of 2023, we expect to continue to drive organic growth and further improve our operating leverage as we scale our business. With a strong balance sheet and a pipeline of M&A targets, we continue to be selective as we pursue acquisitions that will not only be accretive to our business but will align with our culture and strategic goals. We expect the tone for 2023 to remain strong following a solid first quarter, and we look forward to delivering another year of exceptional growth and profitability. With that, I will turn the call over to our CFO, Drew Clark, who will take you through the financial results.

Thank you, Dale, and good morning, everyone. Dale gets the exciting content, and I get the boring part. As we discuss our first quarter financial results, I'd like to remind everyone that all comparisons and variance commentary refer to the prior year quarter unless otherwise specified. So let's get started. Q1 results marked our eighth consecutive quarter of double-digit profitability improvement. As reported in our earnings press release, adjusted gross billings, which is a non-GAAP measure, increased 29% to $306.7 million compared to $238.7 million in the year-ago quarter. The increase was driven by organic growth from new and existing vendors as well as a contribution from our acquisition of Spinnakar, which closed in August. Additionally, net sales in the first quarter of 2023 increased 19% to $85 million compared to $71.3 million, reflecting double-digit organic growth from new and existing vendors as well as a contribution from Spinnakar, offset by a slight reduction due to the impact of foreign exchange. Gross profit in the first quarter increased 27% to $15.2 million compared to $12.0 million. The increase was primarily attributable to 20% growth from new vendors and our existing top 20 vendors in both North America and Europe, as well as a contribution from Spinnakar less the FX impact of our international business. Gross profit as a percentage of adjusted gross billings remained flat at 5.0%, and as a percentage of net sales increased 110 basis points to 17.9% compared to 16.8% in the prior year quarter. SG&A expenses in the first quarter were $10.3 million compared to $8.2 million for the same period in 2022. SG&A as a percentage of adjusted gross billings decreased to 3.3% compared to 3.5%. Net income in the first quarter of 2023 increased 23% to $3.3 million or $0.74 per diluted share compared to $2.7 million or $0.61 per diluted share for the comparable period in 2022. Adjusted EBITDA in the first quarter increased 33% to $5.7 million compared to $4.2 million in the prior year period. Again, this increase was driven by organic growth from both new and existing vendors as well as a contribution from Spinnakar. Adjusted EBITDA as a percentage of gross profit or effective margin increased 170 basis points to 37.2% compared to 35.5% in the year-ago period as we continue to see operating leverage in our business. Turning to our balance sheet, cash and cash equivalents were $61.7 million on March 31, 2023 compared to $20.2 million on December 31, 2022, while working capital increased by $3 million during this period. The increase in cash was primarily attributed to the timing of receivable collections and payables. We expect cash and cash equivalents to return to normalized levels moving forward. As of March 31, 2023, we had $1.7 million of outstanding debt from the term loan that closed in April 2022, for which the proceeds were used for certain capital expenditures. We had no borrowings outstanding under either our $20 million or GBP 8 million in credit facilities. Subsequent to the quarter end and consistent with prior quarters, our Board of Directors on May 2, 2023, declared a quarterly dividend of $0.17 per share of our common stock payable on May 19, 2023, to shareholders of record on May 15, 2023. As I mentioned in our last conference call, I'd like to reiterate the recurring nature of our business. As an IT distribution and solutions company, we do not generate recurring revenue in the traditional sense of a SaaS model. However, we do generate recurring revenue as we continue to average roughly 85% of renewal rates with our customers every year. While the macro environment remains uncertain, we have not experienced any impact on our renewals up to this point and continue to carry this expectation moving forward. Looking ahead, our strong liquidity position continues to provide us with the flexibility to execute on both organic and inorganic growth initiatives while our scale enables us to expand our relationships with vendor networks and customers across the globe. Regarding our M&A efforts, as Dale referred to, we will continue to evaluate targets that we can enhance our geographic footprint in addition to our service and solution offerings. We look forward to delivering another year of growth and profitability in the year ahead. This concludes our prepared remarks. We'll now open it up for questions from those participating in the call. Operator, back to you.

Our first question comes from Vincent Colicchio with Barrington Research.

Yes. Nice quarter. So in terms of your commentary related to the economy, you had mentioned no issues for renewals as of yet. I'm curious if there are any signs of economic impacts such as pushbacks on pricing, any changes in sales cycles, or if any of your vendor categories are slowing a bit. Any response to that would be helpful.

Yes. Thanks, Vince. Some of the comments come from our partner advisor council last week. We have both big customers and small customers, and our top 20 vendors were all present. It's noise in the marketplace. Like I mentioned in the commentary, there was rightsizing at some of these companies, both on the vendor side and the customer side. So there may be a little softness on that piece. However, we feel pretty insulated because of the essential nature of the software we provide. We don't have to deal with the logistics side, and the product mix we sell is critical infrastructure. Many of our clients are not going to forego protection under the network, whether it's endpoint security or firewall. So a lot of the software we cover across our portfolio is vital for their operations. We're going to keep an eye on market conditions, but we feel confident about our position.

So are security and data management your fastest-growing categories? I assume you expect that to continue, if they are.

Yes. They are our fastest-growing areas, and they are also quite large markets. When you look at the security piece, cybersecurity is a huge market for security solutions, including endpoint security to protect from ransomware. We are also seeing strong growth in the data center space as more companies look to manage and move data effectively in the cloud. Additionally, we focus significantly on data movement and management products, especially as businesses realize they need to maintain some critical infrastructure on-premise alongside their cloud solutions. These are definitely our fastest-growing categories. We also have excellent connections in the DevOps space, which offers unique product opportunities with potentially better margins. We continue to explore and add adjacent products to our portfolio as we see fit.

Drew, you had a nice year-over-year improvement in adjusted EBITDA margins. Assuming your sales momentum continues, can we expect similar year-over-year improvements going forward?

Yes, Vince, I think as you know, we don't provide quarterly guidance, but I would say that we're cautiously optimistic that the trend we've had of sequential year-over-year improvement will continue. To Dale's point, we have a high renewal rate. Customers are not likely to discontinue renewing security applications that protect their endpoints and data centers. While we expect some potential slowdown, we remain confident that we'll continue to see same level of growth we've experienced over the past several quarters.

Regarding the acquisition market, Dale, have valuations improved? And if we see the economy weaken here, do you think it may make you a bit more cautious? Or do you think you'll take advantage of better pricing?

We're opportunistic. We hope to take advantage of better prices that are available in the market. Our targets include North America and Western Europe, but there are still opportunities in the U.S. We haven't seen much change in valuations, and I think companies are primarily focusing on their internal businesses right now. We continue to have multiple discussions and evaluate prospects, but we would be looking for potential discounts. However, we will proceed very strategically, as we always have.

Our next question comes from Howard Root, Individual Investor.

Congrats, Dale and Drew. This was simply an outstanding quarter. Can you hear me okay?

Yes. Howard, don't tell us we're boring. We know we're boring.

Drew gets the award for the funniest CFO, but that's a very shallow pool. So I have two questions today: one housekeeping and one bigger picture. The housekeeping is about the stock grant you announced to Dale a week or two ago with 35,000 shares. My question isn't about the amount; I don't consider that disproportionate, but it's about the immediate vesting. I see that it’s about a $1.3 million expense which will all hit in Q2. Without the vesting, it's a one-time grant and doesn't have the golden handcuffs for a few years to keep Dale in the CEO role. Can you explain why it happened and if this is unusual?

Yes. I'll address that, and Drew can add as well. It's more of a one-off deal, and it's really a timing issue. A few years ago, the company had a different slate of board members, and we've worked hard on improving governance. We've created committees, and one improvement we made in 2022 was forming a compensation committee. We brought in consultants to assist with that process. So this was a timing catch-up piece. It's not ideal, but we’ll manage it, and you won't see something like this again. It will be approached more systematically in the future.

Yes, Howard, I would add that, concurrently with that, the Board engaged an external compensation consultant who helped in creating a new salary, bonus, and long-term incentive plan. We also engaged legal counsel to harmonize executive compensation agreements. There were adjustments made to Dale's employment agreement where he gave things back to the company. We think there's plenty of incentives for both of us to stay here and drive shareholder value for the next several years.

Great. Just a follow-up on that. Is it correct that it's about a $1.3 million expense that will show up in Q2 due to that grant?

Correct. That will be an operating expense reflecting on the income statement. Yes, it will reduce EPS, but we usually add back share-based compensation for adjusted EBITDA, and this will not be recurring. So could we have opted for multiyear vesting? Possibly. But the compensation committee felt this was the right choice, and Dale was satisfied with the result.

Now, for the bigger picture. A year ago, we discussed you crossing the $1 billion in adjusted gross billings, and now you're annualizing at $1.2 billion with 20% growth. I’ve often heard that trees don’t grow to the sky. Can you give me an idea of where you see your market potential? That $1.2 billion sounds significant, but you're operating in a massive industry. In general terms, can you say if you're in the early, middle, or later innings of organic growth without acquisitions? Given your approach and the addition of four focused new product offerings each quarter, do you think it’s sustainable to expect this 20% growth over the next couple of years?

Yes, Howard, here’s my perspective. If you look at our three main competitors, the smallest one has about $40 billion in sales. The gap between where they operate and where we stand allows us the potential to double in size without drawing much attention, especially among vendors emerging from startup phases. I never dictate how manufacturers should market their products, but if they decide to go through us, we commit our resources to ensure that success. Yes, doubling or tripling in size is possible. We see numerous vendors entering the market, and we consistently receive inquiries from new vendors looking to partner with us. Our team has built a solid reputation and our recent events, like our Pat summit, have significantly strengthened our brand presence. We also find that many professionals in the IT markets switch jobs frequently, meaning we can cultivate relationships based on referrals and past experiences. We’re getting first looks at opportunities instead of just second chances like we used to.

Yes, Howard, I would add that we have included total addressable market indicators in our investor presentation deck available on the corporate website. The TAM for our sector is roughly $20 billion, and our current annualization at $1.2 billion reflects a significant opportunity for growth. If we capture more market share and introduce new products as Dale mentioned, we remain confident in our potential to double or triple our revenue in the next five years.

That’s great. Very helpful. And yes, I did buy when Dale came in, so I am very happy. Thank you for your performance, and please keep up the great work.

And I'm showing no further questions at this time. I would now like to turn the conference back to Dale Foster for closing remarks.

Thank you, operator, and thank you to all of our shareholders and team members who make up our Climb family. We are dedicated to our growth and performance. We look forward to providing an update after Q2. Thank you.

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