Earnings Call Transcript - CLMB Q3 2022

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, 2022. Joining us today are Climb's CEO, Mr. Dale Foster; the company's CFO, Mr. Drew Clark; and the company's Investor Relations Advisor, Mr. Sean Mansouri for Elevate IR. By now, everyone should have access to the third quarter 2022 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 would now like to turn the call over to Mr. Sean Mansouri for introductory comments.

Sean Mansouri, Investor Relations Advisor

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. We 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.

Dale Foster, CEO

Thank you, Sean, and good morning, everyone. We continued to execute on our core initiatives during the quarter, as reflected by the addition of several new vendors to our line card, while generating more than 30% organic growth with our top 20 vendors. This resulted in another strong quarter of growth and profitability, both up double-digits over the prior year. As I have mentioned in the past, our commitment to a limited and focused line card allows us to partner with the most innovative brands in the market. This past quarter, we evaluated 36 new prospective brands and signed agreements with only three, including a few I'd like to highlight. In this past August, we finalized our agreement with Salt Security, an API Security Company that provides a protection platform to prevent attacks using machine learning and AI to automatically and continuously identify and protect APIs. We view the Salt Security offerings as truly next-level security for the modern data center. Shortly after in September, we partnered with Beyond Identity, a SaaS platform, which is empowering the next generation of secure digital business by replacing passwords with fundamentally secure certificates. The Beyond Identity approach creates an extended chain of trust that includes the user device identity logs along with real-time information of devices, security posture and identification. We believe that the cloud-native solution will enable our partners to offer more efficient and passwordless solutions. We look forward to an excellent partnership with the Beyond Identity team. Most significantly during the quarter, we closed the acquisition of Spinnakar, a UK-based IT channel distributor focused on storage, cloud, security, and data management across the EMEA region. With a deep executive bench that brings over 40 years of IT distribution experience, Spinnakar adds 50 new vendor partners to the Climb umbrella, most notably VAST Data, and it significantly enhances our distribution capabilities in Europe. As of October, Spinnakar has been fully integrated into the Climb operating and reporting structure. And while Spinnakar did not have a material impact on Q3, we have now begun to realize the benefits from the acquisition in Q4. I would like to publicly welcome Gerard Brophy and the entire Spinnakar team to the Climb family. Looking ahead, we will continue to be diligent in our M&A strategy as we evaluate new targets, both domestically and abroad, with a strong balance sheet and growing pipeline of targets. We can be selective as we pursue acquisitions that will be accretive to our business and align with our culture and strategic goals. Turning to recent changes across our senior leadership, I would like to highlight former Spinnakar CEO Gerard Brophy has taken over as the Chief Revenue Officer for Climb in EMEA. Gerard is a seasoned executive in IT distribution and has a deep understanding of how we differentiate Climb in the marketplace. Additionally, Matt Whitton will be taking over as Chief Operating Officer for Climb in EMEA, while he continues to head the Grey Matter Solutions business globally. We are looking forward to having Gerard and Matt spearhead our next phase of growth overseas. Finally, as I am sure you've heard and noticed, we rebranded to Climb Global Solutions which became effective earlier this week. Our new ticker symbol is CLMB. Growing our brand at scale has always been a key initiative across this business. Given our acquisitions and global expansion over the past few years, the time was right to rebrand our company to Climb Global Solutions. Changing not only our public company name, but our marketing and branding efforts will allow us to promote a uniform brand that is recognizable to our investors, our customers, our vendors, and across the globe. The switch further demonstrates our commitment to a simple and efficient way of promoting our business through our cohesive global strategy. And we look forward to starting the next chapter of the company's history as Climb Global Solutions. With that, I will turn over the call to Drew for our financial results.

Drew Clark, CFO

Thank you, Dale, and good morning, everyone. First, I would like to reiterate the power behind our rebranding initiative that includes a change to CLMB as our stock symbol on the NASDAQ Stock Exchange. As we review our financial results, I want to remind everyone that all comparisons and variance commentary refer to the prior year quarter unless otherwise specified. Q3 results marked our sixth consecutive quarter of double-digit profitability improvements. As reported in our earnings press release, adjusted gross billings, which is a non-GAAP measure, increased 17% to $264.3 million compared to $226.9 million in the year-ago quarter. The increase reflects continued growth from our new and existing vendors with limited contribution from our acquisition of Spinnakar this past August. However, as Dale previously noted, Spinnakar is already positively impacting our business in the fourth quarter, which we will be able to further highlight during our next earnings call. In addition, net sales in the third quarter of 2022 increased 11% to $76.3 million compared to $68.9 million. Excluding the negative impact of foreign exchange, net sales actually increased 12% to $77.5 million. Gross profit in the third quarter increased 19% to $13.5 million compared to $11.3 million. The increase, again, was primarily driven by organic growth from our top 20 vendors in both North America and Europe. In addition to the onboarding of new vendors and the impact of several large customers not taking a portion of their early pay discounts, our gross profit as a percentage of adjusted gross billings was 5.1% versus 5.0% and as a percentage of net sales was 17.7% compared to 16.4% in the prior quarter. Now, let me address our SG&A expenses. Total SG&A expense in the third quarter was $9.8 million compared to $8.1 million for the same period in 2021. Total SG&A as a percentage of adjusted gross billings was 3.7% compared to 3.6%. The slight increase in SG&A was attributable to the following: variable commission expense attributed to the increased sales volume, acquisition-related costs that are separately identified on the income statement, acceleration of the amortization expense from our UK ERP also specified on the income statement, and the onboarding of our Spinnakar team which, as I mentioned previously, did not have a meaningful contribution in Q3 but will have a meaningful contribution in Q4. Net income in the third quarter of 2022 was $2.2 million or $0.50 per diluted share compared to $2.4 million or $0.55 per diluted share for the comparable period in 2021. I'd like to point out that excluding the negative impact of foreign exchange, net income actually increased 6% to $2.6 million or $0.59 per diluted share. There was no material impact from foreign exchange in the prior year quarter. In addition, acquisition-related costs of approximately $40,000 reduced our reported EPS by $0.10 per diluted share. Adjusted EBITDA in the third quarter increased 17% to $4.9 million compared to $4.2 million for the same period in 2021. This increase was driven almost entirely by organic growth from both new and existing vendors. Adjusted EBITDA as a percentage of gross profit or effective margin was 36.6%, which continues the sequential growth of the first two quarters of the year. This compares to 37.4% for the third quarter of 2021. However, excluding the approximate $0.5 million increase in foreign currency transaction loss, our effective margin in the quarter was 40.3%. Turning to our balance sheet. Cash and cash equivalents were $24.0 million for September 30, 2022, compared to $29.2 million at year-end, while working capital decreased by approximately $5.7 million during this period. The decrease in cash was primarily due to the acquisition of Spinnakar. In addition, cash and our working capital position was impacted by the previously referenced large customers deferring or foregoing payments at the end of the quarter. Payments were still in accordance with contractual terms, but beyond the window to earn an early pay discount. As of September 30, 2022, we had $1.9 million of debt outstanding with no borrowings outstanding under either our $20 million or £8 million credit facilities. Subsequent to the quarter-end on November 1, 2022, our Board of Directors declared a quarterly dividend of $0.17 per share of our common stock. That dividend is payable on November 18, 2022, to shareholders of record on November 14, 2022. As we look to the end of 2022 and into next year, we remain diligent in our M&A strategy as we are constantly evaluating targets that can enhance our geographic footprint in addition to our service and solution offerings, both in the U.S. and abroad. We look forward to executing on our plan as we close out 2022 and delivering another year of strong organic and inorganic growth in 2023. This concludes our prepared remarks, and we'll now open it up for questions from those participating in the call. Operator, back to you. Thank you, everyone.

Operator, Operator

We have our first question from Vincent Colicchio from Barrington Research. Vincent, your line is now open. Please ask your question.

Vincent Colicchio, Analyst

Dale, I'm curious about your pipeline of new vendors for Q4. Do you anticipate adding a similar number of emerging technology vendors in that quarter?

Dale Foster, CEO

Hey Vincent, I'll share some insights from our team. We’re continually assessing the situation, and they regularly update us. I believe the pipeline is currently in the high teens. I expect at least one new addition in Q4. However, as I've mentioned before, we're looking to slow things down a bit and focus on what we believe the vendors can actually achieve.

Vincent Colicchio, Analyst

Thank you, Dale. I have a question about the economic backdrop. Any signs of changes in sales cycles or any change in behavior in any of your geographic markets?

Dale Foster, CEO

We have not seen any cancellations. Last year, we mentioned that contracts would delay into the next quarter, but we didn’t encounter any significant orders that were actually canceled. So everything is on track for us to finish strong in Q3, and we've actually had some positive momentum going into Q4.

Vincent Colicchio, Analyst

And a question for Drew. As we look to Q4, should we expect a similar year-over-year growth trajectory in adjusted gross billings and gross margins as a percentage of adjusted gross billings? Should we see that improve year-over-year?

Drew Clark, CFO

I would say, Vince, that at this point in time, we're very confident that we'll continue to have increased performance in Q4. We've got some initial visibility. As Dale mentioned, we aren't experiencing any headwinds with our customer base or our vendors. Without trying to provide too much guidance or direction, I believe we're confident that we will have another strong quarter in Q4.

Vincent Colicchio, Analyst

And one last one for me, and I'll go back in the queue. Any changes in the acquisition market from the economy, Dale? Are multiples getting any more attractive?

Dale Foster, CEO

Do you want to that one?

Drew Clark, CFO

Yes. No, that's fine. I'll take. Yes. Dale has really built a great pipeline. And to your point, Vince, with the strengthening dollar that is getting some pullback now with Canadian and the Euro and the GBP. But we'll continue to be very diligent in our negotiation process. And I think we'll be able to take advantage of our strength and some of the opportunities where they may be a little more flexible or there may be enhanced negotiations that could be in our favor. But the pipeline modeling is already on the queue right now.

Vincent Colicchio, Analyst

Okay. I'll go back in the queue. Thanks, gentlemen.

Operator, Operator

For the second question, Howard Kroop, your line is now open. Please ask your question.

Unidentified Analyst, Analyst

Great. So nice quarter, again. Dare I say another boring quarter, which I like. But I got kind of three questions here. The first one on the Spinnakar acquisition. What I see as you closed on at August 18. So it'd be like six weeks of this quarter would have Spinnakar in. I'm not kind of confused as to why it would have an immaterial effect. Can you kind of go over what the contribution was from that and the revenue adjusted gross billing and SG&A expense for the quarter?

Dale Foster, CEO

We will share more information about VAST Data in Q4. They have raised significant funding and operate in the high-speed data center market, servicing clients in high-volume transactional environments like Wall Street. Their business is likely to show fluctuations because their deals tend to be very large, often involving multi-million dollar contracts. With the integration of their team into ours completed on November 1, everyone has clear assignments now. We will provide more details at the end of Q4.

Unidentified Analyst, Analyst

Could you give just kind of a scope on an annual basis? I understand it's lumpy. That's good news because it's coming in the next year. But do you have a scope of the adjusted gross billings or net revenue that you expect to be added from Spinnakar?

Drew Clark, CFO

Yes. As we look into Q4, Howard, we're going to add somewhere between just on Spinnakar's performance, somewhere between $10 million to $20 million, is a good range right now, much lower than that in the six-week sub period that you referred to, probably slightly over $1 million in adjusted gross billings with a nice GP associated with that. But then we also absorbed approximately 12 team members and the cost structure associated with that. Again, very low operating expense, low overhead costs associated with Spinnakar. So it's an easy almost tuck-in similar to what we did with Interwork out of Canada almost two years ago. But they will be a meaningful contributor in Q4 and into next year. And as Dale mentioned, with some of their vendors, a much higher margin profile, which is nice. There is going to be this lumpiness of the curves because of the cycles of these data center sales. But also to Dale's point, as we cross-pollinate their vendors with our team and vice-versa, we think that they'll have some additional contribution associated with our growth in Q1 and beyond for 2023.

Unidentified Analyst, Analyst

Okay. Great. Regarding the SG&A contribution from Spinnakar, can you tell me how much of the increase in Q3 was due to Spinnakar? Additionally, for the fourth quarter, how much more do you expect to come from that?

Drew Clark, CFO

I think the net impact on SG&A was about $400,000 from Spinnakar. And then, if you looked at the M&A cost and you looked at the increased amortization expense, which was really when we acquired CDF over in England, they had an investment in their ERP that they implemented. We had an expectation of its useful life. Now with our new ERP implementation, we've reduced that useful life period down. So you'll see that increased amortization expense also in Q4 and Q1 of next year, and then it will be fully amortized as we implement the new ERP. And then I don't have an exact number on the increase of variable comp associated with our commission expense, but that was a meaningful piece of the SG&A growth.

Unidentified Analyst, Analyst

Thank you for the information. My second question is about the foreign currency transaction loss. I realize the dollar has been strengthening, but this is now the second consecutive quarter where we’ve seen a significant impact in the expenses. If the dollar stays stable, will this issue resolve itself in the fourth quarter? Have you considered hedging against this to avoid fluctuations due to foreign currency changes? I would like to know your thoughts on the foreign currency transaction loss moving forward and how you plan to mitigate its effects.

Drew Clark, CFO

Sure. Howard, great question. And you're right; unfortunately, we did have the whipsaw effect of both sterling against the dollar and Canadian dollar against the U.S. dollar. We didn't have a full hedging strategy in place, and we suffered the results. I will tell you this. Of the $500,000 identified as a foreign currency translation loss in Q3, only $85,000 of that was actually realized from settled contracts either on the vendor or the customer side. So again, you've got $415,000 that is just recorded, but not recognized, and that will decrease, already is going to change in Q4. So we're hesitant to try and go into a more deliberate hedging strategy as the dollar continues to sort of pull back against GBP and Canadian dollars. But you'll see actually a positive impact most likely in Q4, and then we'll see what happens in 2023.

Unidentified Analyst, Analyst

Okay, great. Finally, I want to discuss the positive outlook. Dale, in the last conference call, you spoke in detail about your desire for acquisitions. This time, it wasn't a major focus. Given your strong underlying organic growth rate and the performance of your top vendors, along with new ones coming on board, it seems you don’t necessarily need acquisitions to achieve your revenue goals. However, accretive acquisitions can certainly enhance that growth. What is your appetite for acquisitions? How do you view your capacity to manage more acquisitions? Additionally, how do you see the difference between organic growth and any inorganic growth from acquisitions over the next few years?

Dale Foster, CEO

We are going to be opportunistic and our interest in acquisitions is very strong. We are selective, as you have seen us be in the past. The good thing about Spinnakar is that we were able to integrate them into our systems quickly. By the middle of next year, everyone will be on one ERP system as we transition to a new one in the West. The pipeline is still strong and continues to grow, as Drew mentioned in his statement regarding who we are in discussions with. Regarding Spinnakar, in addition to VAST Data and their products, they are based just outside London. Previously, we excelled in managing vendors but lacked a vendor recruitment team. Now we have that team in place, including Gerard from Exclusive Networks, one of our competitors in big tech, who will lead our vendor recruitment and evaluation efforts. Our strategy will avoid getting too involved with the lower tier of vendors we work with. This long tail will be handled by our Climb Elevate team. In the UK and Europe, we will implement the same approach, pushing those vendors down and concentrating on our top 40, which generate over 90% of our revenues. Our appetite for acquisitions remains strong with many promising targets, primarily in Western Europe, and we will proceed carefully as we move forward.

Unidentified Analyst, Analyst

Great. Congratulations again on another outstanding boring quarter. Exactly, what I'd like to see and wonderful in today's markets to see your performance. Thanks.

Dale Foster, CEO

And Howard, thanks. I appreciate that. And you don't have to use Wayside anymore and that kind of stuff. So I appreciate it.

Drew Clark, CFO

Thanks, Howard, from your favorite executive boring team.

Operator, Operator

Right. Sir, for your next question, it comes from the line of Casey Olka from INFY. Casey, your line is now open. Please ask your question. Once again, Casey from INFY your line is now open. Please ask your question. All right. We're moving on to the next analyst. So we're getting a question from Vincent Colicchio from Barrington Research. Vincent, your line is now open. Please ask your question.

Vincent Colicchio, Analyst

Dale, I have a question about the Solutions business, a relatively small business but an important component of your business. Curious how it performed in the quarter? And then given your pipeline of acquisitions and organic expectations, should we expect Solutions to increase as a portion of the mix in 2023?

Dale Foster, CEO

We have indeed observed this question arise in recent meetings where we discussed a key aspect of our business, which is Grey Matter. I would also like to mention our cloud expertise because our team is expanding its capabilities in this area and will provide support in the U.S. through some of our vendors for initial and follow-up assistance. The encouraging aspect of our Solutions is, as you know, Vince, that the margin profile is nearly double that of our distribution segment. In terms of my Grey Matter team, about 70% of their business comes from sales to Independent Software Vendors, who we view as similar to resellers or Managed Service Providers, and they do cater to MSPs as well. This is definitely a sector we plan to invest in with potential targets to strengthen our team in the U.S. and also internationally.

Operator, Operator

All right. Presenters, there are no further questions at the moment. I would now like to turn the conference back to Mr. Dale Foster for closing remarks.

Dale Foster, CEO

Thank you, operator, and thanks, everyone for joining us on the call today also to all of our stakeholders as we go into Q4, we look for another strong finish to 2022, and I appreciate everybody's support. Thank you.

Operator, Operator

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