Climb Global Solutions, Inc. Q2 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 Second Quarter Ended June 30, 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 second 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 will open the call for your questions. I'd now like to turn the call over to Mr. Mansouri for introductory comments.

Thank you, Carmen. 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, adjusted net income to EPS 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. During the quarter, we continued to execute on our core initiatives to generate growth within our existing vendor base while adding new innovative vendors to our line card. This led to another period of double-digit growth to the top line in our ninth consecutive quarter of profitability improvement. In addition, throughout the quarter, we made strategic investments in our operating systems, new personnel, sales territory expansion and training and development programs to reinforce our foundation. With a clean and efficient infrastructure and continuous focus on strengthening our line card, we are well positioned to continue our plans for growth and profitability as we scale our global footprint. We are committed to a focused line card, which enables us to partner with the most strategic and cutting-edge technology vendors in the market. Out of the 38 brands we evaluated through the second quarter, we signed agreements with only four of them. Quickly touching on a few of our latest wins. First, we partnered with Jamf, a publicly traded company that provides end-to-end systems management and security solutions for an Apple-first environment that is enterprise secure, consumer simple and protects personal privacy. Next, we finalized our agreement with Offensive Security, a leading provider of professional workforce development training for cybersecurity. Offensive Security will be a viable cross-sell within our security offerings, which is one of our fastest-growing segments of our business. And finally, we signed GitLab to our line card, the most comprehensive AI-powered DevSecOps platform in the world. We look forward to building a prosperous relationship with each of these vendors as we take their products to market. In addition to our vendor wins in April, we entered into a strategic partnership with another distributor called Radius. This unique partnership enabled us to leverage the Radius line card for direct sales in other markets while providing them with an infrastructure plan to transact. In particular, Radius has a strong vendor relationship with Tanium, a cybersecurity and systems management company, which has been a consistent winner in the market with a commitment to selling through the distribution channel. Drew will expand on the mechanics of this partnership later in the call. In late May, we announced our inclusion into the Russell 3000 Index, which became effective on June 26. This achievement is a testament to the dedication and consistent execution of our entire global employee network as well as our outstanding customers and vendors. We celebrated this milestone by ringing in the new NASDAQ closing bell in Manhattan a few weeks ago. I couldn't be prouder of the team we've built and look forward to achieving even greater success in the years ahead. As we enter the back half of the year, we have a solid foundation in place to continue driving organic growth with existing vendors while adding new innovative vendors to our line card. We will also continue to evaluate M&A opportunities that can enhance our service and solutions as well as our geographic footprint. These initiatives, coupled with our robust balance sheet, will enable us to execute organic and inorganic growth and profitability objectives in 2023. With that, I will turn the call over to our CFO, Drew Clark, to take you through the financial results.

Thank you, Dale, and good morning, everyone. As we review our second quarter financial results, I would like to remind everyone that all comparisons and variance commentary refer to the prior year quarter unless otherwise specified. While we had another strong quarter, it was not quite as boring as the previous eight. So let's jump in. As reported in our earnings press release, adjusted gross billings or AGB, which is a non-GAAP measure, increased 14% to $274.7 million compared to $241.8 million in the year-ago quarter. In addition, net sales in the second quarter of 2023 increased 20% to $81.7 million compared to $67.9 million, which primarily reflects organic growth from new and existing vendors. As we have communicated before, we focus on AGB as the true metric of our growth as the calculation of net sales is influenced by product mix and the respective adjustment to convert AGB to net sales for financial reporting purposes under GAAP. In the second quarter, we had an increase in sales of products such as Tintri that included hardware and therefore, a lower adjustment from AGB to net sales. Gross profit in the second quarter increased 10% to $13.7 million compared to $12.5 million. Again, the increase was primarily driven by organic growth from new vendors as well as our existing top 20 vendors in North America and Europe. This growth was partially offset by customers taking advantage of early pay discounts at a greater level than in the prior year. Gross profit as a percentage of adjusted gross billings was 5% compared to 5.2%, and as a percentage of net sales was 16.8% compared to 18.4% in the prior year quarter. Both of those were impacted by the early pay discounts taken by the customers in 2023 compared to 2022. SG&A expenses in the second quarter were $11.6 million compared to $7.9 million for the same period in 2022. SG&A as a percentage of adjusted gross billings was 4.2% compared to 3.3% in the year-ago period. The increase was primarily attributed to the previously announced and well-deserved one-time $1.8 million grant of common stock to Dale in April 2023. As most investors are aware, the grant is a non-cash charge and has no impact on our adjusted EBITDA. In addition, SG&A increased as a result of investments made to improve our infrastructure, as Dale referenced earlier, including new personnel, ERP, and training and development costs. Commissions, which are variable expenses, increased over the prior year's quarter due to the growth in AGB. Altogether, our SG&A included approximately $0.4 million of expenses that are non-recurring in nature. For the second half of the year, we expect SG&A as a percentage of AGB will be more consistent with the most recent trends and decline in 2024 after we've implemented our new ERP and continue to scale our operations. It's important to note that our newly formed distribution partnership with Radius has a different economic profile than our typical vendor partnerships. The economics and mechanics are such that we recognize the total AGB generated by Radius. However, we pay Radius 70% of their GP through SG&A as they are effectively running their own sales operation while utilizing our infrastructure to transact business. Despite the different economic profile, this partnership is accretive to net income and adjusted EBITDA. And as Dale mentioned earlier, it offers direct cross-sell opportunities with their vendors in other geographies. Net income in the second quarter of 2023 was $1.4 million or $0.31 per diluted share compared to $2.8 million or $0.63 per diluted share for the comparable period in 2022. The decrease was primarily attributed to higher SG&A as well as increased early pay discounts. Adjusted net income, a non-GAAP measure, which excludes the one-time stock grant, increased 12% to $3.1 million or $0.72 per diluted share compared to $2.8 million or $0.63 per diluted share for the year-ago period. Adjusted EBITDA in the second quarter increased 4% to $4.7 million compared to $4.5 million. The increase was driven by organic growth from both new and existing vendors, partially offset by investments made in our infrastructure and costs associated with our acquisition of Spinnakar in August of 2022. Adjusted EBITDA as a percentage of gross profit or effective margin was 34.1% compared to 35.8% in the year-ago period. Our effective margin and drop-through were impacted by Radius and the aforementioned increase in customer early pay discounts. Before diving into our liquidity position, I'd like to touch on our new credit facility we closed with JPMorgan Chase in May. The five-year secured revolving credit facility has a borrowing capacity of up to $50 million and an accordion feature to increase the size of the facility up to $70 million. This facility replaced our previous $20 million secured line of credit with Citibank, which was set to expire in June of this year. Under the new agreement, the interest rate is based on adjusted term SOFR plus a 1.5% to 1.75% spread. We look forward to working with the JPMC team as we now have additional capital and flexibility to fund our growth and execute on our strategic initiatives in the years ahead. Turning to our balance sheet, cash and cash equivalents were $43.9 million on June 30, 2023, compared to $20.2 million on December 31, 2022, while working capital increased by $3.4 million during this period. The increase in cash was primarily attributed to the timing of receivable collections and vendor payments. As of June 30, 2023, we had $1.6 million of outstanding debt from the term loan that we closed in April of '22, for which the proceeds were used to fund certain capital expenditures. We had no borrowings outstanding under our new $50 million revolving credit facility with JPMC. Subsequent to quarter-end and consistent with prior quarters, our Board of Directors declared on August 1, 2023, a quarterly dividend of $0.017 per share of our common stock, payable on August 18, 2023, to shareholders of record as of August 14, 2023. To echo Dale's point earlier, we will continue to utilize our robust liquidity position to evaluate M&A opportunities both domestically and abroad to enhance our service and solutions offerings across existing and future geographies. We look forward to executing our organic and inorganic objectives and delivering another period of strong results in the back half of 2023 and beyond. In summary, we are proud of the effort of our global team to generate another quarter of double-digit growth in AGB and operating EPS, which excludes the one-time stock grant. This now concludes our prepared remarks. We'll open it up for questions from those participating in the call. Thank you, and now back to you, operator.

Our first question is from Vincent Colicchio with Barrington Research. Please proceed.

Yes. Good morning, guys. Dale, curious, are you seeing any changes in the demand backdrop from last quarter to the current period? In particular, are you seeing any pushback on pricing or any changes in sales cycles?

You're talking about from Q1 to Q2? Yes, from Q1 to Q2. So we haven't really seen that. We've seen some of our competitors that are more hardware-centric that have seen a little slowdown as people have stopped buying a lot of hardware, but we haven't really seen that. We haven't seen it from our vendors. We have seen some consolidation of vendors not going with as many distributors. So they're trimming that. And we've been fortunate enough to make it through those because they're looking for a broad line and something that is much more strategic, and we typically fit that. And there's not a lot of competition on the strategic side. So I haven't seen really a pullback.

And are you seeing strength in the same technology segments as the prior quarter? Any changes there?

We are. I mean we're seeing a little slowdown in the data center side, but we are focusing heavily on security. If you look at our marketing, we have six segments we focus on, security being one of the biggest ones. A lot of our vendors are all emphasizing security. And now we're starting to see the AI terms propagate into much of their marketing materials and what they're promoting, but haven't seen a slowdown. And we're continually looking for adjacent markets that are outside of our normal six categories to say, 'Hey, is this something we should really start diving into?' and we've got some opportunities that we'll probably announce in Q3 and Q4.

And did the growth of the top 20 vendors grow in line with the business? Any exceptions there?

It was very consistent in terms of the vendor mix in our top 20. We've got some new emerging vendors that are starting to chip away at the top 20. We expect that mix of top 20 will shift slightly as we get to the end of the year and move into 2024.

Vince, if you look at some of the vendors, many times you'll see a vendor that raised $20 million, $30 million. They have much in revenue. But now we have a couple of vendors we've signed; they're in the $300 million, $400 million range. And they're really accepting distribution as their go-to market. If you've seen many of the technology companies, just being a little cautious with the economy, they're trimming and just putting more leverage or expecting more from the channel, which is a good thing for us.

And lastly, on the acquisition side, have valuations continued to improve? And if so, does that make you feel better about getting something done here in the near term?

Yes. If you look at some of the targets, it varies because if it's overseas, the margins are typically higher, so the multiples are typically higher. I think some of those have softened a little bit, not drastically. I haven't seen a big change in that.

Next question comes from the line of Howard Root. Please proceed.

Good morning, Dale and Drew, can you hear me okay?

We sure can.

Sure. Great job on the quarter and continued progress. I have three questions this morning. One is for Drew regarding SG&A. The increase year-over-year was about $3.7 million, and I understand that $1.8 million of that was due to a one-time stock grant, which I hope the Board won't repeat. They should spread that out going forward to avoid similar issues. You mentioned another $400,000 in one-time professional service fees in the press release. That accounts for $2.2 million, but there’s still about another $1.5 million year-over-year increase. When looking at it sequentially, it rose from $10.3 million to $11.6 million, which is a $1.3 million increase that doesn’t even account for the stock grant. Can you provide some insight on what you expect for Q3 or a normalized number for Q2 in terms of SG&A dollars as we look ahead?

Yes. On a dollar amount, part of that delta between the prior year Q and this Q was a variable component, commissions. So if you looked at AGB compared to quarter-over-quarter, commissions were commensurately increased. So we had, again, a variable comp expense, but probably about $500,000 plus in incremental commission expense associated with Q2 of 2023. And then we had some payroll-related expense associated with Dale's grant that obviously will not reoccur in the subsequent quarter; that was about $150,000 give or take. So I think on a level-set basis, you'll see us pull back to a level that's probably closer to $10 million, $10.2 million.

Okay. Great. Yes. So if you take the $2.2 million off of the $11.6 million, that's what the SG&A would have been for that level of adjusted gross billings.

Howard, I want to add to that. We're going to be proactive. Sometimes I think of the whole Field of Dreams idea that if you build it, they will come. We sometimes need to build according to what the vendors request; if they want us to take over the renewals platform, we need to start investing in our team members to make that happen. We've established a separate renewals team and have had to expand it. We'll be flexible as they begin to delegate more responsibilities to us. Of course, we receive compensation for that, but there's usually a slight delay in realization. We intend to pursue this. I don't want to suggest it's going to be flawless, but in certain quarters, we've had two vendors come to us and say, 'We would like you to take care of this and that, and we want you to manage our incumbency program that we do not wish to handle and prefer not to assign to one of your competitors.' There will be some fluctuations, but not to the extent we saw last quarter.

Yes. And Howard, even though we don't provide granular guidance or detailed guidance on a quarterly basis, I can tell you that from an internal perspective, our operating expense was spot on with our internal expectations. Part of that is increased headcount, right? We acquired Spinnakar last year. We brought on some additional headcount that was not reflected in Q2 of 2022. So of the 10-plus Spinnakar employees, I think 7 or 8 of those folks remain with us, including obviously Gerard as the Chief Revenue Officer over in EMEA now and still running some significant vendor opportunities there. So we do have some built-in headcount increases that we expected and planned for. So that's part of the year-over-year change in SG&A as well.

Okay. Fair enough. I have a second question regarding adjusted gross billings. There was a nice year-over-year increase of $33 million or 14%. However, comparing quarter one to quarter two, there was a decrease of $32 million. This drop isn't typical for the quarter; I would have anticipated declines in Q4 or possibly Q1. Can you explain the sequential aspect of this drop in adjusted gross billings? What were you observing there, and what do you anticipate moving forward?

Yes, Howard, so again, we were on target with our own internal expectations. What happened in Q1 was a significant, vast transaction that landed in Q1 that we didn't expect. Q2 Spinnakar didn't quite perform at the same level. Vast opportunities got pushed out because of some data center delays over in Western Europe. Data center builds, both new construction and expansion slowed down due to the economic headwinds over Western Europe. Interest rates, obviously, have risen. So a lot of the data center owner-operators slowed down some of their process, which, therefore, slowed down some of the vast opportunities that we have with Spinnakar. Nothing's gone off the pipeline; they've just moved out into future quarters. And as we indicated previously, when we acquired Spinnakar and have made the comments each quarter, there is going to be some cyclicality or lumpiness to the Spinnakar acquisition. We're going to have some really strong quarters; we're going to have some ebbs and flows and some dips just because longer sales cycles for some of the vendor products like Deep Instinct and Vast, but they're much larger in size and much higher margins. So we believe that once we get into probably a normalized run rate into 2024 and beyond with some of those vendors, Vast, like as data center-related vendors, will get more consistency quarter after quarter, but there's going to be a little bit of lumpiness/roller-coaster over the next several quarters.

Okay. And then my last question kind of related there is on forward guidance. I know you don't give it, but at what point will you start at least giving next quarter guidance or some long-term targets? It's kind of the same question every call: what do you see, where are you in this market, where are you in the revenue ramp? Is this linear? Is this just starting? Is this starting to meet acquisitions to keep the growth going? It'd be just helpful to kind of get your take on it in this call and then going forward to get more guidance or at least long-term targets for you so we can kind of judge where this company is headed. So what can you say kind of where you are right now and some of these factors?

I think the best approach is that we won't provide detailed guidance at this moment because we don't feel comfortable doing so. However, I can discuss the industry in general and what we observe. Anyone who has been following for a while has likely noticed the consolidation in the North American distribution market through acquisitions. Our main target is the European market, which represents a significant opportunity for us. We see numerous acquisition targets there, almost as many as our CMO Charles Bass mentions regarding emerging vendors. It's important to consider our progress with the vendors we signed. Some of the names might be unfamiliar unless you are deeply involved in the technology space, but if you check Crunchbase or delve into their activities and growth, we believe that we should continue to grow organically in the 10% to 15% range, which is typical for emerging vendors. They tend to grow faster than GDP, unlike established vendors who typically grow at the GDP rate unless they are acquiring other companies. Our broadline competitors are growing at a rate of 3% to 4% or not growing at all. This is our focus as a team, and we aim to continue driving towards these emerging vendors. As we bring in more established vendors, we may experience some slowdown because they will constitute a larger share of our business. Their margins might decrease slightly, and their growth rate is slower, but we still categorize some of our top vendors as emerging since they remain below the $1 billion revenue mark.

Okay. Fair enough, every quarter, just the more you give guidance and perspective and whatever you can do, especially into next year, the more helpful it is for us to see what's going on and where we're headed. But nice quarter again, great job, continue good work, and hope things continue.

We have Vincent Colicchio with the follow-up from Barrington Research. Please proceed.

Yes, Dale, you just cited that 10% to 15% growth number for the type of client you work with. Would you say that's sort of the level they're on target for this year, best you can tell?

Yes, we analyze our individual vendors carefully. I don't want to commit to a global outlook, but regarding our vendor mix, that's our focus for growth. There are situations where we need to be flexible with expenses to meet our needs for a quarter, such as needing a specific team in place. But yes, that's our objective.

And Vincent, I would have stated this earlier as well, and I understand the market's need and investors' need for perhaps a little more guidance along the way. But we're in this for the long game. We're not focused on quarter-to-quarter. As Dale said, we're going to be opportunistic both in our organic growth and organic investments as well as our acquisition opportunities, which that pipeline is fairly robust. But I would say that we're comfortable that our adjusted gross billings will continue to have low double-digit growth. Quarter-to-quarter may be different, but overall, over the next several years, we're very confident that we'll grow this business at the same rate as our vendor population grows.

Okay. And then Dale, one last one. Should we continue to expect you to add approximately three vendors each quarter? Is that sort of the game plan?

Not really. It's what we actually see and when they're ready to go. Some of them, of course, we want to be a lot more excited about signing them as they are signing on or they're going and setting up their channel structure. But yes, I mean, sometimes it's going to be a couple; sometimes it might be five. We're trying to trim but we still continue to trend. We talk about who we add. We really don't talk about what we trim. So we push a lot of vendors over to Climb Elevate, which is now over 500 vendors that they actually transact, but it takes it out of the core client business, so it doesn't get marketing dollars spent on it. It doesn't get any real focus. So there's nothing there other than that being transactional and the systems connection to our customers. So we'll continue to do that. We've also launched Climb Elevate over in the U.K. So they're doing the same thing over there. We'll get more efficient, and then with our ERP coming online, we'll all be talking the exact same language, and it will make it a little easier for us across the pond.

Thank you all for your questions. I will pass it back to Dale Foster for final remarks.

Thank you, operator. Thank you to the shareholders, and thank you to the Climb team globally. We're going to continue to deliver on our core initiatives as a company, and we look forward to talking to you next quarter.

Thank you. And this does conclude the conference. You may all disconnect. Thank you.