Earnings Call Transcript - CLMB Q3 2023

Operator, Operator

Good morning, everyone, and thank you for participating in today's conference call to discuss Climb Global Solutions financial results for the third quarter ended September 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 third 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.climbgobalsolutions.com. This call will also be available for webcast replay on the company's website. Following management remarks, we'll open up the call for your questions. I'd now like to turn the call over to Mr. Mansouri for introductory comments.

Sean Mansouri, Investor Relations Adviser

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, adjusted net income and EPS, as well as 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.

Dale Foster, CEO

Thank you, Sean. And good morning, everyone. We made steady progress on our core initiatives during the quarter, as reflected by another period of organic growth and profitability alongside our recent acquisition of DataSolutions. At a high level, this acquisition enables us to deepen our line card and efficiently grow market share in Europe. I'd like to publicly welcome the DataSolutions team to the Climb family and look forward to working with the new team in the months ahead. As we previously mentioned, our commitment is to have a focused vendor line card by selecting the most innovative technology companies in the market. Out of our 29 brands evaluated in the third quarter, we signed agreements with only 3 of them. I'd like to quickly highlight a couple of these wins. First, we partnered with GigaIO, a pioneer in artificial intelligence and high-performance data center solutions. This collaboration represents another step forward in our data center product line and will enable us to deliver additional cutting-edge solutions to the channel to optimize data center operations. Next, we initiated a relationship with Security Compass, a leading provider of cybersecurity solutions that integrates directly with existing DevSecOps tools and workflows, allowing organizations to release secure and compliant software to the market quickly and cost-effectively. We are excited to collaborate with each of these vendors and bring their products to market, building a mutually beneficial relationship along the way. In early October, we closed the acquisition of DataSolutions, headquartered in Dublin, Ireland, a leading specialty distributor of cloud and security solutions with sales in both Ireland and the U.K. DataSolutions brings a deep network of relationships to Climb, including 14 focused vendor partnerships such as Check Point, Citrix, and Neustar, to name a few. In addition to their strong vendor relationships, DataSolutions carries a robust recurring revenue base, with more than 90% of their fiscal 2023 revenue coming from existing partners. We expect this acquisition to be immediately accretive to earnings and adjusted EBITDA. We've already identified cross-selling opportunities and look forward to unlocking additional potential as we integrate DataSolutions into the Climb operating systems in the months ahead. Shortly after the acquisition of DataSolutions, we announced our technical services division, known as Cloud Know How, completed a rebrand to Climb Global Services. This rebranding signifies our commitment to unifying our operating divisions under one uniform brand to build a truly global platform. Currently, our service team delivers migration, modernization, management and services for MSPs, resellers and their respective end user clients on platforms such as Microsoft Azure, ManageEngine and Acronis. We're excited about the continued expansion of our professional services arm to provide more comprehensive solutions and support to our growing customer base across the globe. Quickly touching on the macro environment. Despite broader challenges and global uncertainty, our vendor and acquisition pipelines remain strong, and customer sentiment for the next year continues to be positive. We continue to monitor our evolving economic landscape and the potential softening in the markets we serve, particularly where large competitors have experienced softness in the hardware sector. However, we believe we are still well-positioned to drive value and growth to our customers and vendors in the future as we scale our global footprint. As I've mentioned before, our team is always focused on the long game. Looking ahead, we will remain diligent in our M&A strategy as we evaluate opportunities that can bolster our line card and are immediately accretive to our financial profile, both in North America and overseas. With a strong balance sheet and a robust pipeline of targets, we can be selective as we pursue acquisitions that will further add scale to our business as we align with our culture and strategic goals. With that, I will turn the call over to our CFO, Drew Clark, who will take you through the financial results. Thank you. Drew?

Drew Clark, CFO

Thank you, Dale. And good morning, everyone. As we review our third quarter financial results, I would like to remind everyone that all comparisons and variance commentary refer to the prior year quarter unless otherwise specified. So jumping right in. As reported in our earnings press release, adjusted gross billings, or AGB, which is a non-GAAP measure, increased 7% to $281.9 million compared to $264.3 million in the year-ago quarter. In addition, net sales in the third quarter of 2023 increased approximately 3% to $78.5 million compared to $76.3 million, which primarily reflects the organic growth from our new and existing vendors. As we have communicated before, we focus on AGB as the true metric of our top line 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 third quarter, we had an increase in the sale of security, maintenance and cloud products, which are recorded net of related cost of sales, and therefore leads to a larger adjustment from AGB to net sales. Gross profit in the third quarter increased 6% to $14.3 million compared to $13.5 million. Again, the increase was primarily driven by organic growth from new vendors in our existing top 20 vendors in North America and Europe. This growth was partly offset by several large customers taking advantage of early pay discounts compared to the year-ago period. For example, in the month of September, we had approximately $500,000 more in early pay taken as compared to the prior year. Even with increased levels of early pay, gross profit as a percentage of adjusted gross billings remained consistent at 5.1%, and as a percentage of net sales, increased to 18.2% compared to 17.7% in the year-ago quarter. SG&A expenses in the third quarter were $10.1 million compared to $8.9 million for the same period in 2022. As we previously stated in other earnings calls, the increase was primarily attributable to investments in our infrastructure to drive future growth. So SG&A as a percentage of AGB was 3.6% compared to 3.4% in the year ago period. As we've committed to before, we expect SG&A as a percentage of AGB to decline in 2024 as we continue to scale our global operations and drive operating leverage. Net income in the third quarter of 2023 increased 6% to $2.4 million or $0.52 per diluted share compared to $2.2 million or $0.50 per diluted share for the comparable period in 2022. As mentioned in our press release, earnings per diluted share in the third quarter of 2023 were negatively impacted by $0.02 for foreign exchange and $0.06 in fees associated with the acquisition of DataSolutions, and approximately $0.19 per share in early pay taken by customers compared to the prior year. Adjusted EBITDA in the third quarter increased 2% to $5.1 million compared to $4.9 million. The increase was primarily driven by the aforementioned organic growth and partly offset by investments in our infrastructure and costs associated with the acquisition of DataSolutions. Adjusted EBITDA as a percentage of gross profit, or effective margin, was 35.5% compared to 36.6% in the year-ago period. Our effective margin and drop-through were impacted by the increase in customer early pay discounts, as referenced previously. Turning to our balance sheet. Cash and cash equivalents were $49.8 million on September 30, 2023, compared to $20.2 million on December 31, 2022, while working capital increased by $5.2 million during this period. The increase in cash was primarily attributed to the timing of receivable collections and vendor payments. The benefit of increased early pay is the timely collection of our receivables, which has maintained our DSO metric in the U.S. below 32 days. As of September 30, 2023, we had $1.4 million of outstanding debt with no borrowings outstanding under our $50 million revolving credit facility with JPMorgan Chase. Subsequent to quarter end and consistent with prior quarters, our Board of Directors declared on October 31, 2023, a quarterly dividend of $0.17 per share of our common stock payable on November 17, 2023, to shareholders of record as of November 13, 2023. Looking ahead, we will continue to leverage our strong liquidity position to explore acquisition opportunities in both domestic and international markets. This will enable us to expand our service and solution offerings, reach new customers, and accelerate our expansion into new markets. We look forward to closing out the fourth quarter on a strong note and continuing to execute our game plan in 2024 and beyond. This now concludes our prepared remarks. We will now open it up for questions from those participating in the call. Operator, back to you.

Operator, Operator

Our first question comes from Vince Colicchio with Barrington Research.

Vincent Colicchio, Analyst

Yes. I just want to call out that I couldn't hear Drew's comments very well until he started talking about the balance sheet. Having said that, Dale, curious if any vendor categories slowed in the quarter versus your expectations and how the overall business is trending in October.

Dale Foster, CEO

Yes, looking at the quarter, we encountered some challenges. Typically, the government's fiscal year concludes on September 30, and we faced a difficult comparison from the previous year. We experienced some softness in certain areas, which varied by territory rather than by product category. We monitor a couple of key indicators, including our quote volume, as we can track how quotes convert to orders over time. Some of this was deferred into Q4. I can assure you that Q4 looks promising with some of the vendors we've onboarded and the integration of teams, particularly in sales and marketing. We haven't yet noticed a significant impact. We are also assessing our pipeline, and I believe this is one of our strongest quarters for evaluating new vendors, with a substantial number coming our way. We’re in the process of signing three new ones, and there are three more waiting to launch due to timing constraints. Additionally, while we discuss onboarding new vendors, we also quietly manage those that are underperforming or stagnating. These vendors are moved to a division called Climb Elevate, where transactions occur, but they lack access to our core sales and marketing resources. They can return to our primary portfolio once they're ready to invest in the market or hire personnel for coverage. Until then, they remain in the Climb Elevate division.

Vincent Colicchio, Analyst

And did your top 20 vendors perform in line with the rest of the business?

Dale Foster, CEO

They did across the board. Those are the ones that are driving that. And same with our customers. We had some of our larger customers a little flat in the quarter as well. And we had some stuff on our Spinnakar side we can talk about that got pushed into Q4 that we already have those orders in and just didn't give them in the last week of September.

Vincent Colicchio, Analyst

And then on DataSolutions, any help on what type of revenue contribution you expect in Q4 and maybe '24?

Dale Foster, CEO

Drew?

Drew Clark, CFO

Yes. At this point, we're not going to share that information, Vince. But we'll try and provide some info as we get into the Q4 earnings call.

Vincent Colicchio, Analyst

Okay. So for the quarter, I assume that very little of the organic growth came from your Spinnakar acquisition. Is that correct?

Drew Clark, CFO

The Spinnakar contributed very little in the same quarter last year. We acquired them in August and their contribution this quarter was also very minor.

Operator, Operator

Our next question comes from an Individual Investor.

Unknown Attendee, Individual Investor

Congratulations on another solid quarter. Can you hear me okay?

Dale Foster, CEO

Sure can. Thanks for your support.

Unknown Attendee, Individual Investor

Sure. If I could ask just a couple of questions on the DataSolutions acquisition just to get a little bit more kind of detail on the numbers. So as I see it, you paid around a little over $16 million for it, and then there's a post-closing earn-out. And without giving the amount, is that like a 10% potential? Or is that more substantial of a potential earn-out amount for that acquisition?

Drew Clark, CFO

Yes, the earn-out has a range of 85% to 115% of the EBITDA number. In terms of the consideration we've disclosed in the filings, it's expected to be about 15% to 20%.

Unknown Attendee, Individual Investor

Okay. With an EBITDA of $3.3 million for the fiscal year ending March 31, you're looking at around 5 times EBITDA. Is that how you plan to evaluate acquisitions moving forward? Is that the typical pricing structure for you?

Drew Clark, CFO

We were fortunate to get a little bit of a discount on the EBITDA multiple. But as we said before, over in Europe, the transactions will probably have a premium due to the fact that, as Dale likes to say, the Germans buy from the Germans, the French buy from the French. So we would expect actually multiples to be slightly higher than that on a go-forward basis in Western Europe, but we thought it was a fair transaction for both the sellers and us.

Dale Foster, CEO

To provide more detail on our acquisitions, we consider various factors in relation to our trading position. Typically, we may pay a bit more for acquisitions in North America. We also assess vendor and customer concentration to see if there are discounts available. Additionally, we examine the margin profile. There are many elements involved in this process. This particular acquisition came from a company that was working with multiple distributors, attracting interest not only for the Irish market but also for some of their vendors. A key highlight is their partnership with Citrix, which is nearly a Tier 1 vendor. Citrix and Microsoft complement each other well, and we aim to enhance our distribution in the U.K. to deliver multiple products to the same customer base. By combining our two companies, we can efficiently provide these product categories.

Unknown Attendee, Individual Investor

Can you provide some insight into DataSolutions' Q3 figures, specifically regarding adjusted gross billings or net revenue? I understand you didn't include those numbers in your projection, but if they had been accounted for, would that represent a $10 million increase in Q3, or perhaps a $5 million increase? What would the adjusted gross billings look like if they were included for that quarter?

Drew Clark, CFO

Yes, there is some cyclicality in their business. As we've mentioned in Q4, they will positively impact our top line, contribute to EBITDA, and enhance our EPS. I don't have the specific figures right now, and I prefer not to discuss them at this moment, but this will ultimately be a very beneficial transaction for us.

Dale Foster, CEO

I believe the adjusted gross billings over $130 million is reasonable, noting that we will need to consider net sales after the netting process. They are bringing in approximately $10 million monthly, though there is some cyclicality involved. Additionally, they have a solid core business with several key vendors. As previously mentioned, they have established a strong presence in the Irish market. The vendors they partner with have a very high percentage of market share on the Irish side, approaching 90 percent. In the last 3.5 years, they have also expanded into the U.K., where they are rapidly increasing their market share. In their product mix, they tend to lead the market wherever they operate.

Unknown Attendee, Individual Investor

And do you see that having legs outside of the U.K.? Or is that kind of where it stops for?

Dale Foster, CEO

We are reviewing their top five brands and examining their contracts to determine if we can expand these into the rest of Western Europe. They are selling some unique products, and since they are based in an EU country, it’s straightforward to ship to the other 28 EU states, which simplifies the process post-Brexit. This presents potential opportunities with some of their contracts. We have already integrated them into some existing contracts we have with common vendors, like Cato and Orca. If we can expand Citrix into other regions, that would be significant for us in addition to the team we acquired.

Unknown Attendee, Individual Investor

Yes, a huge win for you. So my second question generally is I'm looking at Q4, which last year, you just knocked the cover off the ball with your adjusted gross billings about $320 million, which is a big step-up, obviously, from Q3, and it's obviously seasonally your strongest quarter. But you had words in the press release about broader challenges in the macro environment. And there's other issues, global uncertainty, that kind of thing. But in terms of posting a number above that kind of with the DataSolutions maybe adding $30 million or so in adjusted gross billings, are you confident in exceeding last year's exceptionally strong number in Q4 for your adjusted gross billings?

Dale Foster, CEO

I'm a sales marketing person, so I have a lot of confidence in our team's performance. We already have the October numbers, as Drew and his team shared in a flash report, and we're on track to meet our goals. While there may be some challenges in the final days of the month due to vendors delaying submissions, we monitor our quote volumes closely. This helps us predict any potential dips, as we understand the number of quotes needed to secure an order based on specific manufacturers. I'm optimistic that we will meet our targets for Q4.

Unknown Attendee, Individual Investor

Great. Great. Well, congrats again on another solid quarter. I love the continued focus on performance and execution.

Drew Clark, CFO

Operator, can you hear us okay?

Operator, Operator

Yes. You're coming clear on my side. I know a few people are working on the back end for some of our listeners. Our next question comes from Bill Dezellem with Tieton Capital Management.

William Dezellem, Analyst

I'll just say, Drew, in relation to your last question, as you were answering the prior questioner's question, there was a lot of garble that came through and was not only difficult to decipher but like indecipherable on this side. Relative to my question, the early pay discounts, I am surprised with higher interest rates that your customers are doing additional early pay discounts or more early pay discounts this year than they did last year. So have you raised your incentive for the early pay discounts? Or what's the dynamic behind the scenes there, please?

Drew Clark, CFO

Sure. Bill, can you hear me?

William Dezellem, Analyst

Yes.

Drew Clark, CFO

Okay. So the dynamic is we have one of our large DMRs that historically was very inconsistent. They're not publicly traded or private, and they brought on a new CFO about 1.5 years ago, who's reorganizing his team. They're focused on a number of different initiatives. And for whatever motivation, they are now adhering to the time frame in early pay discount. Don't have a real understanding as to why, but we just know that that's been a mandate from him to his team, to not forgo the early pay discount. So I don't know, again, what their balance sheet or financing terms look like, but they're taking full advantage of it now. They were probably taking early pay maybe 30% to 40% of the time. It was very inconsistent. We didn't have any rhyme or reason, but they're now taking it.

William Dezellem, Analyst

So if that behavior continues over the next 12 months, we won't see the same increase in early pay discounts from them, and the comparisons will be more consistent. Is that how you see it?

Drew Clark, CFO

Correct. And as we've stated, we were very positive on the fact that we were able to maintain gross profit as a percentage of adjusted gross billings at a consistent level despite the increased level of early pay taken by a couple of our key DMRs.

William Dezellem, Analyst

Great. Congratulations getting money in the door early.

Operator, Operator

Our next question is from Bob Sales with LMK Capital Management.

Robert Sales, Analyst

I have two questions. You broke up a bit while discussing the quarter's dynamics, particularly towards the end and in relation to the macro environment. Can you elaborate on organic growth and clarify what you observed, how that dynamic has developed, and the resulting 7% growth in adjusted gross billings?

Drew Clark, CFO

We achieved a nice mid-single-digit growth in adjusted gross billings despite the challenges faced by many of our larger distributors over the past several quarters, mainly due to hardware issues. Our outlook remains fairly confident that we will match the fourth quarter results from 2022 at least at the top line. Gross profit, however, will be affected by the continued early pay discounts taken by several DMRs. While there may be some economic headwinds affecting the data center security space that stem from hardware, we haven't seen significant impacts yet, though there are some early signs. Some opportunities are being delayed to the next quarter, but we are still optimistic that we can continue to execute our strategy effectively, as we have for the past ten quarters.

Dale Foster, CEO

We have quite a few public customers, like CDW, who have already released their earnings. They tend to have a larger hardware component. Over the past couple of years, we've seen significant hardware sales, especially as many are transitioning to remote operations. Our focus remains 90% on software, and our product mix varies from quarter to quarter. We consistently receive interest from various vendors in security, and we already have a substantial security portfolio, which continues to thrive. Each vendor approaches security differently. With the acquisition of DataSolutions, we will benefit from a strong CTO who will help establish a division focused on AI products. Most of our vendors are either already using or incorporating machine learning into their offerings, and now they are pushing those capabilities in marketing. Overall, we see a lot of positive developments in software, IT security, and the data center space, which are our top categories.

Robert Sales, Analyst

Great. And then my second question is on the DataSolutions acquisition. It looks like a home run in terms of accretion. I wanted to understand the tax situation given that it's an, I assume, Irish-domiciled company and whether that presents any of the advantages there because of the Irish standing.

Dale Foster, CEO

Yes. We are currently evaluating that situation, and we previously had a structure in place when we acquired CDF, anticipating a potential Brexit three years ago. We will explore where we can achieve tax savings. I believe the corporate tax rate in Ireland is 12.5%. Therefore, we will continue to investigate where orders originate, how they are processed, and where we can leverage this, both for other EU countries and the team in the U.K.

Operator, Operator

Thank you. At this time, I'm showing no further questions. I would like to turn it back to Dale Foster for closing remarks.

Dale Foster, CEO

Thank you, operator. And thanks, everyone, for joining today. Again, I want to welcome our DataSolutions team. We've had the luxury of spending some time in Dublin over the last 6 months with the teams. Our teams are getting integrated. Some of our sales and marketing team were in the U.K. over the last couple of days, getting things kicked off, and we'll really start talking as a combined team going into 2024. Thank you for your support, to the shareholders, and we look to have a strong 2023. Thank you.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.