Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of risk and uncertainties, including those set forth under the heading “Forward Looking Statements” and “Item 1A. Risk Factors” and elsewhere in this report and those set forth in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission on March 4, 2020. The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes included in this report and the consolidated financial statements and related notes included in our 2019 Annual Report on Form 10-K.
Overview
Wayside Technology Group, Inc. (the “Company,” “we,” “our,” or “us”) distributes software and hardware developed by others through resellers indirectly to customers worldwide. We also resell computer software and hardware developed by others to customers in the United States and Canada. In addition, we operate a sales branch in Europe to serve our customers in this region of the world. We offer an extensive line of products from leading publishers of software and tools for virtualization/cloud computing, security, networking, storage and infrastructure management, application lifecycle management and other technically sophisticated domains as well as computer hardware. We market these products through creative marketing communications, including our web sites, local and on-line seminars, webinars, social media, direct e-mail, and printed materials.
The Company is organized into two reportable operating segments. The “Climb Channel Solutions” segment (formerly Lifeboat Distribution) distributes technical software and hardware to corporate resellers, value added resellers (VARs), consultants and systems integrators worldwide. The “TechXtend” segment is a value-added reseller of software, hardware and services for corporations, government organizations and academic institutions in the USA and Canada.
COVID-19
We are closely monitoring the impact of the 2019 novel coronavirus, or COVID-19, pandemic on all aspects of our business.
In the first quarter of 2020, we took a number of precautionary measures designed to help minimize the risk of the spread of the virus to our employees, including temporarily closing our offices and requiring all employees to work remotely.
While we did not incur significant disruptions to our operations during the three months and six months ended June 30, 2020 as a result of the COVID-19 pandemic, we are unable to predict the impact that the COVID-19 pandemic will have on our business, liquidity or results of operations at this time.
This situation is changing rapidly, and additional impacts may arise that we are not aware of currently. For further information regarding the impact of COVID-19, see Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q.
Factors Influencing Our Financial Results
We derive the majority of our net sales though the sale of third-party software licenses, maintenance and service agreements. In our Climb Channel Solutions segment, sales are impacted by the number of product lines we distribute, and sales penetration of those products into the reseller channel. In our TechXtend segment sales are generally driven by sales force effectiveness and success in providing superior customer service, competitive pricing, and flexible payment solutions to our customers. Our sales are also impacted by external factors such as levels of IT spending and customer demand for products we distribute.
We sell in a competitive environment where gross product margins on adjusted gross billings have historically declined due to competition and changes in product mix towards products where no delivery of a physical product is required. To date, we have been able to implement cost efficiencies such as the use of drop shipments, electronic ordering (“EDI”) and other capabilities to be able to operate our business profitably as gross margins have declined.
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Selling general and administrative expenses are comprised mainly of employee salaries, commissions and other employee related expenses, facility costs, costs to maintain our IT infrastructure, public company compliance costs and professional fees. We monitor our level of accounts payable, inventory turnover and accounts receivable turnover which are measures of how efficiently we utilize capital in our business.
The Company’s sales, gross profit and results of operations have fluctuated and are expected to continue to fluctuate on a quarterly basis as a result of a number of factors, including but not limited to: the condition of the software industry in general, shifts in demand for software products, pricing, level of extended payment terms sales transactions, industry shipments of new software products or upgrades, fluctuations in merchandise returns, adverse weather conditions that affect response, distribution or shipping, shifts in the timing of holidays and changes in the Company’s product offerings. The Company’s operating expenditures are based on sales forecasts. If sales do not meet expectations in any given quarter, operating results may be materially adversely affected.
Dividend Policy and Share Repurchase Program. Historically we have sought to return value to investors through the payment of quarterly dividends and share repurchases. Total dividends paid and shares repurchased were $0.7 million and $3.5 million, which includes 261,631 shares of our outstanding common stock repurchased for $3.5 million in accordance with the Settlement Agreement, during the three months ended June 30, 2020. Total dividends paid and shares repurchased were $0.8 million and less than $0.1 million during the three months ended June 30, 2019, respectively. The payment of future dividends and share repurchases is at the discretion of our Board of Directors and dependent on results of operations, projected capital requirements and other factors the Board of Directors may find relevant.
Stock Volatility. The technology sector of the United States stock markets is subject to substantial volatility. Numerous conditions which impact the technology sector or the stock market in general or the Company in particular, whether or not such events relate to or reflect upon the Company’s operating performance, could adversely affect the market price of the Company’s common stock, par value $0.01 per share (“Common Stock”). Furthermore, the potential adverse effect of the current pandemic of COVID-19, fluctuations in the Company’s operating results, announcements regarding litigation, the loss of a significant vendor or customer, increased competition, reduced vendor incentives and trade credit, higher operating expenses, and other developments, could have a significant impact on the market price of our Common Stock.
Forward Looking Statements
This report includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements in this report regarding future events or conditions, including but not limited to statements regarding industry prospects and the Company’s expected financial position, results of operations, business and financing plans, are forward-looking statements. These statements can be identified by forward-looking words such as “may,” “will,” “plan,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” and “continue,” or similar words.
Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Substantial risks and uncertainties unknown at this time could cause actual results to differ materially from those indicated by such forward-looking statements, including, but not limited to, the continued acceptance of the Company’s distribution channel by vendors and customers, the timely availability and acceptance of new products, product mix, market conditions, competitive pricing pressures, contribution of key vendor relationships and support programs, including vendor rebates and discounts, as well as factors that affect the software industry in general and other factors generally. Currently, one of the most significant factors is the potential adverse effect of the current pandemic of COVID-19 on the Company, the global economy and financial markets. The extent to which COVID-19 impacts the Company will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, including the impact on our reseller partners and the end customer markets they serve, among others. We strongly urge current and prospective investors to carefully consider the cautionary statements and risk factors contained in this report and our annual report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission on March 4, 2020.
The Company operates in a rapidly changing business, and new risk factors emerge from time to time. Management cannot predict every risk factor, nor can it assess the impact, if any, of all such risk factors on the Company’s business or the
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extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements.
Accordingly, forward-looking statements should not be relied upon as a prediction of actual results and readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The statements concerning future sales, future gross profit margin and future selling and administrative expenses are forward looking statements involving certain risks and uncertainties such as availability of products, product mix, pricing pressures, market conditions and other factors, which could result in a fluctuation of sales below recent experience.
Financial Overview
Net sales increased 12%, or $5.9 million, to $56.6 million for the three months ended June 30, 2020 compared to $50.7 million for the same period in the prior year. Gross profit decreased 9%, or $0.7 million, to $7.1 million for the three months ended June 30, 2020 compared to $7.8 million for the same period in the prior year. Selling, general and administrative (“SG&A”) expenses for the three months ended June 30, 2020 increased 2%, or $0.1 million, to $5.6 million for the three months ended June 30, 2020 compared to $5.5 million for the same period in the prior year. Legal and financial advisory expenses – unsolicited bid and related matters for the three months ended June 30, 2020 were $0.5 million compared to no expense for the same period in the prior year. Acquisition related costs for the three months ended June 30, 2020 were $0.2 million compared to no expense for the same period in the prior year. Net income for the three months ended June 30, 2020 was $0.6 million compared to $1.9 million for the same period in the prior year. Diluted income per share for the three months ended June 30, 2020 was $0.13 compared to $0.41 for the same period in the prior year.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements that have been prepared in accordance with US GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, intangible assets, income taxes, stock-based compensation, contingencies and litigation.
The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
The Company believes the following critical accounting policies used in the preparation of its consolidated financial statements affect its more significant judgments and estimates.
Revenue
The Company makes estimates regarding performance obligations inherent in the products and services it sells including, whether ongoing maintenance obligations performed by third party vendors are distinct from the related software licenses, and allocation of sales prices among distinct performance obligations. These estimates require significant judgement to determine whether the software’s functionality is dependent on ongoing maintenance or if substantially all functionality is available in the original software download. We also use judgement in the allocation of sales proceeds among performance obligations, utilizing observable data such as stand-alone selling prices, or market pricing for similar products and services.
Allowance for Accounts Receivable
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management determines the estimate of the allowance for uncollectible accounts receivable by considering a number of factors, including: historical experience, aging of the accounts receivable, and specific information obtained by the Company on the financial condition and the current creditworthiness of its customers. If the
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financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. At the time of sale, we record an estimate for sales returns based on historical experience. If actual sales returns are greater than estimated by management, additional expense may be incurred.
Accounts Receivable – Long Term
In limited circumstances, the Company offers extended payment terms to customers for periods of 12 to 48 months. The related customer receivables are classified as accounts receivable long-term and discounted to their present value at prevailing market rates at the time of sale. In subsequent periods, the accounts receivable is increased to the amounts due and payable by the customers through the accretion of interest income on the unpaid accounts receivable due in future years. The amounts under these long-term accounts receivable due within one year are reclassified to the current portion of accounts receivable. At times the Company sells receivables to a financial institution on a non-recourse basis for cash, less a discount. The net proceeds from such sales are included in the operating section of the statement of cash flows as changes in accounts receivable.
Inventory Allowances
The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-offs may be required.
Acquisition Accounting
We allocate the purchase price of an acquired business, using the acquisition method of accounting, to its tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The excess purchase price over fair value of net assets acquired is recorded as goodwill. Certain assumptions and judgements are used to estimate the fair value of acquired assets and liabilities. We engage outside appraisal firms to assist in the fair value determination of identifiable intangible assets. We may adjust the preliminary purchase price allocation, after the acquisition closing date and through the end of the measurement period of one year or less, as we finalize the valuation of acquired assets and liabilities. Changes in estimates used in the preliminary purchase price allocation could have a material effect on the final valuation and result in changes to goodwill and intangible assets. Additionally, if forecasts supporting the valuation of intangible assets or goodwill are not achieved, then an impairment charge could be recorded.
See further information on acquisition accounting in Notes 7 to the Consolidated Financial Statements in Item 1 of this report.
Income Taxes
The Company considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance related to deferred tax assets. In the event the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.
Share-Based Payments
Under the fair value recognition provision, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period. We record the impact of forfeitures when they occur. We review our valuation assumptions periodically and, as a result, we may change our valuation assumptions used to value stock-based awards granted in future periods. Such changes may lead to a significant change in the expense we recognize in connection with share-based payments.
Interest, Net
Interest, net consists primarily of income from the amortization of the discount on accounts receivable long term, net of interest expense on the Company’s credit facility.
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Recently Issued Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments - Credit Losses (Topic 326)” ("ASU 2016-13"). ASU 2016-13 revises the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded. Originally, ASU 2016-13 was effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. In November 2019, FASB issued ASU 2019-10, “ Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842).” This ASU defers the effective date of ASU 2016-13 for public companies that are considered smaller reporting companies as defined by the SEC to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company is planning to adopt this standard in the first quarter of fiscal 2023. The Company is currently evaluating the potential effects of adopting the provisions of ASU No. 2016-13 on its Consolidated Financial Statements, particularly its recognition of allowances for accounts receivable.
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” as part of its initiative to reduce complexity in the accounting standards. The standard eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies and simplifies other aspects of the accounting for income taxes. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the impact that this guidance will have upon its financial position and results of operations, if any.
Results of Operations
The following table sets forth for the periods indicated certain financial information derived from the Company’s unaudited condensed consolidated statements of earnings expressed as a percentage of net sales. This comparison of financial results is not necessarily indicative of future results:
Six months ended
Three months ended
June 30,
June 30,
2020
2019
2020
2019
Net sales
100.0
%
100.0
%
100.0
%
100.0
%
Cost of sales
87.2
84.2
87.4
84.6
Gross profit
12.8
15.8
12.6
15.4
Selling, general and administrative expenses
9.3
11.6
9.9
11.0
Legal and financial advisory expenses - unsolicited bid and related matters
1.5
—
0.9
—
Acquisition related costs
0.5
—
0.4
—
Income from operations
1.4
4.2
1.3
4.4
Other income
0.3
0.4
0.3
0.3
Income before income taxes
1.7
4.6
1.7
4.7
Income tax provision
0.5
1.1
0.6
1.1
Net income
1.2
%
3.5
%
1.0
%
3.7
%
Key Operating Metrics
Our management monitors several financial and non-financial measures and ratios on a regular basis in order to track the progress of our business. We believe that the most important of these measures and ratios include net sales, adjusted gross billings, gross profit, adjusted EBITDA, gross profit as a percentage of adjusted gross billings and adjusted EBITDA as a percentage of gross profit. We use a variety of operating and other information to evaluate the operating performance of our business, develop financial forecasts, make strategic decisions, and prepare and approve annual budgets. These key
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indicators include financial information that is prepared in accordance with US GAAP and presented in our Consolidated Financial Statements as well as non-US GAAP performance measurement tools.
Six months ended
Three months ended
June 30,
June 30,
June 30,
June 30,
2020
2019
2020
2019
Net sales
$
119,206
$
95,534
$
56,586
$
50,676
Adjusted gross billings (Non-GAAP)
$
331,838
$
284,461
$
158,738
$
142,594
Gross profit
$
15,279
$
15,053
$
7,114
$
7,819
Gross profit - Climb Channel Solutions
$
13,806
$
13,322
$
6,643
$
7,124
Gross profit - TechXtend
$
1,473
$
1,731
$
471
$
695
Adjusted EBITDA (Non-GAAP)
$
5,209
$
4,989
$
2,087
$
2,732
Gross margin % - Adjusted gross billings (Non-GAAP)
4.6%
5.3%
4.5%
5.5%
Effective margin % - Adjusted EBITDA (Non-GAAP)
34.1%
33.1%
29.3%
34.9%
We consider gross profit growth and effective margin to be key metrics in evaluating our business. During the six months ended June 30, 2020, gross profit increased 1%, or $0.2 million, to $15.3 million compared to $15.1 million for the same period in the prior year while effective margin increased 100 basis points to 34.1% compared to 33.1% for the same period in 2019, reflecting the scalability in our business model.
Reconciliations of Non-GAAP Financial Measures
Six months ended
Three months ended
June 30,
June 30,
June 30,
June 30,
Reconciliation of net sales to adjusted gross billings (Non-GAAP):
2020
2019
2020
2019
Net sales
$
119,206
$
95,534
$
56,586
$
50,676
Costs of sales related to Software – security and highly interdependent with support and maintenance, support or other services
212,632
188,927
102,152
91,918
Adjusted gross billings
$
331,838
$
284,461
$
158,738
$
142,594
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We define adjusted gross billings as net sales in accordance with US GAAP, adjusted for the cost of sales related to Software – security and highly interdependent with support and maintenance, support and other services. We provided a reconciliation of adjusted gross billings to net sales, which is the most directly comparable US GAAP measure. We use adjusted gross billings of product and services as a supplemental measure of our performance to gain insight into the volume of business generated by our business, and to analyze the changes to our accounts receivable and accounts payable. Our use of adjusted gross billings of product and services as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under US GAAP. In addition, other companies, including companies in our industry, might calculate adjusted gross billings of product and services or similarly titled measures differently, which may reduce their usefulness as comparative measures.
Six months ended
Three months ended
June 30,
June 30,
June 30,
June 30,
Net income reconciled to adjusted EBITDA:
2020
2019
2020
2019
Net income
$
1,417
$
3,319
$
581
$
1,857
Provision for income taxes
641
1,035
362
548
Depreciation and amortization
239
261
143
126
Interest expense
41
40
24
32
EBITDA
2,338
4,655
1,110
2,563
Share-based compensation
400
334
233
169
Legal and financial advisory expenses - unsolicited bid and related matters
1,833
-
509
-
Acquisition related costs
638
-
235
-
Adjusted EBITDA
$
5,209
$
4,989
$
2,087
$
2,732
We define adjusted EBITDA, as net income, plus provision for income taxes, depreciation, amortization, share-based compensation, interest, legal and financial advisory expenses – unsolicited bid and related matters and acquisition related costs. We define effective margin as adjusted EBITDA as a percentage of gross profit. We provided a reconciliation of adjusted EBITDA to net income, which is the most directly comparable US GAAP measure. We use adjusted EBITDA as a supplemental measure of our performance to gain insight into our businesses profitability when compared to the prior year and our competitors. Adjusted EBITDA is also a component to our financial covenants in our credit facility. Our use of adjusted EBITDA has limitations, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under US GAAP. In addition, other companies, including companies in our industry, might calculate adjusted EBITDA, or similarly titled measures differently, which may reduce their usefulness as comparative measures.
Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019
Acquisition
On April 30, 2020 we completed the acquisition of Interwork Technologies Inc. (“Interwork”) for a purchase price of $3.6 million, subject to certain working capital adjustments, and a potential earnout of $0.8 million payable approximately one year after the acquisition date. The operating results of Interwork are included in our operating results effective May 1, 2020. See further information on acquisition accounting in Note 6 to the Consolidated Financial Statements in Item 1 of this report.
Net Sales and Adjusted Gross Billings
Net sales for the three months ended June 30, 2020 increased 12%, or $5.9 million, to $56.6 million compared to $50.7 million for the same period in the prior year. Adjusted gross billings for the three months ended June 30, 2020 increased 11%, or $16.1 million, to $158.7 million compared to $142.6 million for the same period in the prior year.
Climb Channel Solutions segment net sales for the three months ended June 30, 2020 increased 15%, or $6.9 million, to $54.2 million compared to $47.3 million for the same period in the prior year. The increase in net sales was primarily due to sales from Interwork for the two months ended June 30, 2020 and incremental sales from new vendor
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relationships added in 2018 and 2019. These increases in sales were partially offset by a decline in sales from several of our larger established vendor partner lines. Adjusted gross billings for the Climb Channel Solutions segment for the three months ended June 30, 2020 increased 13%, or $18.0 million, to $154.8 million compared to $136.8 million for the same period in the prior year.
TechXtend segment net sales for the three months ended June 30, 2020 decreased 29%, or $1.0 million, to $2.4 million compared to $3.4 million for the same period in the prior year. Sales in our TechXtend segment may vary significantly from quarter to quarter based on the timing of IT spending decisions by our larger customers. Adjusted gross billings for the TechXtend segment for the three months ended June 30, 2020 decreased 32%, or $1.9 million, to $3.9 million compared to $5.8 million for the same period in the prior year.
During the three months ended June 30, 2020, we relied on two key customers for a total of 47% of our net sales, with one of these customers accounting for 29% and the other customer accounting for 18% of our total net sales. The Company had two major customers that accounted for 27% and 18%, respectively, of its total net sales during the three months ended June 30, 2019. The Company had two major vendors that accounted for 16% and 10%, respectively, of total purchases during the three months ended June 30, 2020 and 22% and 15%, respectively, of total purchases during the three months ended June 30, 2019.
Gross Profit
Gross profit for the three months ended June 30, 2020 decreased 9%, or $0.7 million, to $7.1 million compared to $7.8 million for the same period in the prior year. Climb Channel Solutions segment gross profit for the three months ended June 30, 2020 decreased 7%, or $0.5 million, to $6.6 million compared to $7.1 million for the same period in the prior year. The decrease in Climb Channel Solutions segment gross profit was impacted by three factors; 1) a decrease of approximately $0.4 million in income from non-routine items such as marketing events, rebates and early pay discounts, 2) early pay discounts of $0.3 million offered to a large customer in exchange for a change in payment terms (see Liquidity and Capital Resources section below), and 3) a decrease in sales from several of our larger established vendor lines discussed above. TechXtend segment gross profit for the three months ended June 30, 2020 decreased 32%, or $0.2 million, to $0.5 million compared to $0.7 million for the same period in the prior year.
Customer rebates and discounts for the three months ended June 30, 2020 were $1.3 million compared to $0.8 million for the same period in the prior year. This increase is primarily attributable to a change in payment terms with one of our larger customers during the three months ended June 30, 2020. Customer rebates and discounts are dependent on reaching certain targets we set and timing of payments by our customers.
Vendor rebates and discounts for the three months ended June 30, 2020 were $0.9 million compared to $1.0 million for the same period in the prior year. Vendor rebates are dependent on reaching certain targets set by our vendors. The Company monitors vendor rebate levels, competitive pricing, and gross profit margins carefully. We anticipate that price competition in our market will continue in both of our business segments.
Selling, General and Administrative Expenses
SG&A expenses for the three months ended June 30, 2020 increased 2%, or $0.1 million, to $5.6 million for the three months ended June 30, 2020 compared to $5.5 million for the same period in the prior year. SG&A expenses were 9.8% of net sales for the three months ended June 30, 2020, compared to 10.8% for the same period in the prior year. SG&A expenses include expenses from Interwork for the two months ended June 30, 2020. Our intent is to integrate the administrative functions of the two organizations during the third and fourth quarter of 2020.
The Company expects that its SG&A expenses, as a percentage of net sales, may vary depending on changes in sales volume, as well as the levels of continuing investments in key growth initiatives. We plan to continue to expand our investment in business development, sales and marketing to maximize our market penetration.
Legal and Financial Advisory Expenses – Unsolicited Bid and Related Matters
Legal and financial advisory expenses – unsolicited bid and related matters for the three months ended June 30, 2020 were $0.5 million compared to no expense for the same period in the prior year. These expenses relate to the costs incurred in conjunction with the unsolicited bid and shareholder demand discussed below.
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Acquisition Related Costs
Acquisition related costs for the three months ended June 30, 2020 were $0.2 million compared to no expense for the same period in the prior year. These expenses relate to costs incurred in conjunction with the acquisition of Interwork discussed below.
Income Taxes
For the three months ended June 30, 2020 and 2019, the Company recorded a provision for income taxes of $0.4 million and $0.5 million, respectively. The effective tax rate for the three months ended June 30, 2020 and 2019 was 38.4% and 22.8%, respectively. The Company’s effective tax rate for the three months ended June 30, 2020 was impacted by limitations on the deductibility of certain facilitative acquisition related costs.
Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019
Net Sales and Adjusted Gross Billings
Net sales for the six months ended June 30, 2020 increased 25%, or $23.7 million, to $119.2 million compared to $95.5 million for the same period in the prior year. Adjusted gross billings for the six months ended June 30, 2020 increased 17%, or $47.4 million, to $331.8 million compared to $284.5 million for the same period in the prior year. Net sales increased at a higher rate than adjusted gross billings due to a higher percentage of sales being derived from software licenses and hardware, which is recorded on a gross basis, for the six months ended June 30, 2020, when compared to the same period in the prior year.
Climb Channel Solutions segment net sales for the six months ended June 30, 2020 increased 28%, or $24.1 million, to $111.5 million compared to $87.4 million for the same period in the prior year. The increase in net sales was primarily due to sales from new vendor partners added in 2018 and 2019 and the results of Interwork for the two months ended June 30, 2020. Adjusted gross billings for the Climb Channel Solutions segment for the six months ended June 30, 2020 increased 18%, or $49.5 million, to $320.6 million compared to $271.1 million for the same period in the prior year.
TechXtend segment net sales for the six months ended June 30, 2020 decreased 5%, or $0.4 million, to $7.7 million compared to $8.1 million for the same period in the prior year. Sales in our TechXtend segment may vary significantly from quarter to quarter based on the timing of IT spending decisions by our larger customers. Adjusted gross billings for the TechXtend segment for the six months ended June 30, 2020 decreased 16%, or $2.1 million, to $11.2 million compared to $13.3 million for the same period in the prior year.
During the six months ended June 30, 2020, we relied on two key customers for a total of 47% of our net sales, with one of these customers accounting for 29% and the other customer accounting for 18% of our total net sales. The Company had two major customers that accounted for 26% and 18%, respectively, of its total net sales during the six months ended June 30, 2019. The Company had two major vendors that accounted for 19% and 10%, respectively, of total purchases during the six months ended June 30, 2020 and 25% and 15%, respectively, of total purchases during the six months ended June 30, 2019.
Gross Profit
Gross profit for the six months ended June 30, 2020 increased 1%, or $0.2 million, to $15.3 million compared to $15.1 million for the same period in the prior year. Climb Channel Solutions segment gross profit for the six months ended June 30, 2020 increased 4%, or $0.5 million, to $13.8 million compared to $13.3 million for the same period in the prior year. The increase in Climb Channel Solutions segment gross profit resulted from sales growth attributable to new vendor partners and the acquisition of Interwork discussed above, partially offset by higher early pay discounts and lower sales from some established vendor partner lines. TechXtend segment gross profit for the six months ended June 30, 2020 decreased 15%, or $0.3 million, to $1.5 million compared to $1.8 million for the same period in the prior year.
Customer rebates and discounts for the six months ended June 30, 2020 were $2.4 million compared to $1.6 million for the same period in the prior year. This increase is attributable to a change in payment terms with one of our larger
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customers during the three months ended June 30, 2020 and timing of payments from other larger customers. Customer rebates and discounts are dependent on reaching certain targets we set and timing of payments by our customers.
Vendor rebates and discounts for the six months ended June 30, 2020 were $1.9 million compared to $1.7 million for the same period in the prior year. Vendor rebates are dependent on reaching certain targets set by our vendors. The Company monitors vendor rebate levels, competitive pricing, and gross profit margins carefully. We anticipate that price competition in our market will continue in both of our business segments.
Selling, General and Administrative Expenses
SG&A expenses for the six months ended June 30, 2020 increased 1%, or $0.1 million, to $11.1 million compared to $11.0 million for the same period in the prior year. SG&A expenses were 9.3% of net sales for the six months ended June 30, 2020, compared to 11.5% for the same period in the prior year. SG&A expenses include expenses from Interwork for the two months ended June 30, 2020. Our intent is to integrate the administrative functions of the two organizations during the third and fourth quarter of 2020.
The Company expects that its SG&A expenses, as a percentage of net sales, may vary depending on changes in sales volume, as well as the levels of continuing investments in key growth initiatives. We plan to continue to expand our investment in business development, sales and marketing to maximize our market penetration.
Legal and Financial Advisory Expenses – Unsolicited Bid and Related Matters
Legal and financial advisory expenses – unsolicited bid and related matters for the six months ended June 30, 2020 were $1.8 million compared to no expense for the same period in the prior year. These expenses relate to the costs incurred in conjunction with the unsolicited bid and shareholder demand discussed below.
Acquisition Related Costs
Acquisition related costs for the six months ended June 30, 2020 were $0.6 million compared to no expense for the same period in the prior year. These expenses relate to costs incurred in conjunction with the acquisition of Interwork discussed below.
Income Taxes
For the six months ended June 30, 2020 and 2019, the Company recorded a provision for income taxes of $0.6 million and $1.0 million, respectively. The effective tax rate for the six months ended June 30, 2020 and 2019 was 31.2% and 23.8%, respectively. The Company’s effective tax rate for the six months ended June 30, 2020 was impacted by limitations on the deductibility of certain facilitative acquisition related costs.
Unsolicited Bid and Shareholder Demand
On July 15, 2019, the Company received a letter from Shepherd Kaplan Krochuk, LLC (“SKK”) and North & Webster SSG, LLC (“N&W”) announcing an unsolicited bid to acquire the Company for $14.37 per share (the “July 15 Proposal”), which reflected an approximate 32.8% premium over the Company’s adjusted closing stock price on July 12, 2019, one trading day earlier. The July 15 Proposal was subject to a number of contingencies, including the need for SKK and N&W to secure financing to complete a transaction. On August 23, 2019, the Company received another unsolicited offer from SKK and N&W, proposing to acquire the Company for $16.38 per share (the “August 23 Proposal”), which reflected an approximate 18.1% premium over the Company’s closing stock price one day earlier, and requesting members of the Board and management to enter into voting and support agreements in connection with the execution of a definitive merger agreement. The August 23 Proposal, similar to the July 15 Proposal, was subject to a number of contingencies, including the need for SKK and N&W to secure financing to complete a transaction.
On November 27, 2019, SKK, N&W, and Messrs. Shepherd, Kaplan, Krochuk and Kidston (collectively, the “SKK 13D Group”) entered into a Joint Filing Agreement and filed a Schedule 13D with the SEC, disclosing an aggregate 5.8% ownership stake in the Company. Also on November 27, 2019, Mr. Nynens entered into an agreement with SKK and N&W (the “November 27 Agreement”), granting SKK an irrevocable proxy to vote his shares of Common Stock (i) in favor of any acquisition proposal by SKK, (ii) against any third-party acquisition, and (iii) as directed by SKK with respect to the election
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of directors nominated by persons other than the Company. The November 27 Agreement also provides that, upon the consummation of the acquisition by an SKK-controlled entity of up to 100% of the outstanding capital stock of the Company, Nynens be appointed as Executive Chairman of the Company at an annual base salary of $250,000 in addition to stock option grants or comparable equity awards representing three percent (3%) of the outstanding equity of the Company, and for a minimum term of three (3) years.
On December 20, 2019, Mr. Nynens delivered a nomination notice to the Company regarding his intent to nominate Kim J. McCauley, Delynn Copley, Dennis M. Crowley, III and Nilesh Shah at the Meeting (the “Nomination Notice”).
On December 23, 2019, the SKK 13D Group filed Amendment No. 2 to its Schedule 13D disclosing the Nomination Letter and stating that it sought to engage in discussions with the Company’s management and Board about its composition, the Company’s financial position and other means of enhancing stockholder value, including the potential sale of the Company. Mr. Nynens filed Amendment No. 3 to his Schedule 13D, disclosing and stating the same.
On January 22, 2020, the Company received a letter from one of its stockholders demanding that the Board investigate and bring an action against Mr. Nynens for breaches of certain restrictive covenants contained in his Separation and Release Agreement, dated May 11, 2018 (the “Nynens Separation Agreement”), including his covenant not to seek future employment with the Company (the “Shareholder Derivative Demand”).
On February 11, 2020, after considering the proposals with its financial advisers, the Board responded to SKK and N&W that the expired proposal received on December 10, 2019 would not have been in the best interests of the Company’s stockholders because it undervalues the Company, and did not serve as a basis for further diligence or discussion.
On February 14, 2020, after conducting an investigation, and in response to the Shareholder Derivative Demand, the Company filed a lawsuit (the “Lawsuit”) against Mr. Nynens, SKK, and N&W in the Superior Court of New Jersey Monmouth County, asserting claims against Mr. Nynens for alleged breaches of the Nynens Separation Agreement, including for violating his covenant not to seek future employment with the Company, and claims for tortious interference against SKK and N&W for inducing Mr. Nynens to commit these breaches. In connection with its claims, the Company sought monetary damages, injunctive relief and a declaratory judgment.
On April 16, 2020 (the “Effective Date”), the Company entered into a Settlement Agreement (the “Settlement Agreement”) with Mr. Nynens, SKK, N&W, and each of Dennis Crowley, David Shepherd, David Kaplan, Timothy Krochuk and Samuel Kidston (collectively with SKK and N&W, the “SKK Parties”). Pursuant to the Settlement Agreement, the Company agreed to voluntarily dismiss the Lawsuit with prejudice, and it did so on April 21, 2020. The Company also agreed to purchase all of Mr. Nynens’ 261,631 shares of the Company’s common stock, par value $0.01 per share (“Common Stock”) owned, of record or beneficially, as of the Effective Date, at a price set by calculating the volume-weighted average price of such shares trading on the NASDAQ Global Market for the ten trading days ending on the close of the trading day immediately preceding the Effective Date, and with each party paying for its own fees and expenses. As of the Effective Date, Mr. Nynens and the SKK Parties agreed to terminate November 27 Agreement and did so on April 16, 2020. Further, the SKK Parties agreed to terminate the Joint Filing Agreement, dated November 27, 2019, by and between Mr. Nynens and the SKK Parties, and did so on April 16, 2020. Additionally, as of the Effective Date, Mr. Nynens agreed to withdraw the notice of intent to nominate director candidates for election at the 2020 annual meeting of stockholders of the Company, submitted by Mr. Nynens on December 20, 2019, and to cease all solicitation of proxies and other activities in connection with such annual meeting, and Mr. Nynens did so on April 16, 2020.
On April 23, 2020, the Company purchased all of Nynens’ 261,631 shares of Common Stock at $13.19 per share pursuant to the Settlement Agreement, representing approximately 5.8% of the issued and outstanding Common Stock of the Company, for an aggregate purchase price of $3.5 million.
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Acquisition of Interwork Technologies
On April 30, 2020, pursuant to a Stock Purchase Agreement dated April 20, 2020, CLIMB Channel Solutions (Canada) Inc. (“Buyer”), a newly-formed indirect subsidiary of the Company completed the purchase of Interwork Technologies Inc., a Delaware corporation (“Interwork US”) and Interwork Technologies Inc., a corporation incorporated under the laws of the Province of Ontario, Canada (“Interwork Canada”). Buyer acquired Interwork US and Interwork Canada for an aggregate purchase price of $5 million Canadian dollar (equivalent to $3.6 million USD), subject to certain working capital adjustments, paid at closing plus a potential post-closing $1.1 million Canadian dollar (equivalent to $0.8 million USD) earn-out.
Liquidity and Capital Resources
Our cash and cash equivalents increased to $45.0 million as of June 30, 2020 compared to $15.0 million as of December 31, 2019. The increase in cash and cash equivalents was primarily the result of $36.4 million of cash and cash equivalents provided by operating activities resulting from a change in payment terms with one of our customers, offset by $3.5 million of cash used to purchase treasury stock, $1.5 million of cash used for dividends and $1.1 million of cash used for an acquisition.
Net cash and cash equivalents used in operating activities for the six months ended June 30, 2020 was $36.4 million, comprised primarily of net income adjusted for non-cash items of $2.3 million and changes in operating assets and liabilities of $34.1 million. Net cash and cash equivalents used in changes in working capital were the result the timing of customer payments. During the second quarter of 2020, we implemented a change in the payment terms with one of our large customers. The impact of this change in payment terms resulted in a reduction of our accounts receivable and corresponding increase in cash during the second quarter of 2020. This change in terms also had the impact of reducing our net sales and gross profit by approximately $0.3 million for the three and six months ended June 30, 2020, however, we believe the additional liquidity will improve our return on invested capital and provide us greater flexibility in pursuing our strategic objectives.
Net cash and cash equivalents used in investing activities during the six months ended June 30, 2020 primarily consisted of payments for an acquisition. On April 30, 2020, the Company completed the purchase of Interwork US and Interwork Canada for an aggregate purchase price of $5 million Canadian dollar (equivalent to $3.6 million USD), subject to certain working capital adjustments, paid at closing plus a potential post-closing $1.1 million Canadian dollar (equivalent to $0.8 million USD) earn-out. The Company financed the acquisition from existing capital resources.
Net cash and cash equivalents used in financing activities during the six months ended June 30, 2020 was $5.0 million, primarily comprised of the purchase of treasury stock of $3.5 million and dividend payments on our Common Stock of $1.5 million. On April 23, 2020, the Company purchased 261,631 shares of its outstanding common stock at $13.19 per share, representing approximately 5.8% of its issued and outstanding shares for $3.5 million in accordance with the Settlement Agreement.
On November 15, 2017, the Company entered into a $20,000,000 revolving credit facility (the “Credit Facility”) with Citibank, N.A. (“Citibank”) pursuant to a Second Amended and Restated Revolving Credit Loan Agreement (the “Loan Agreement”), Second Amended and Restated Revolving Credit Loan Note (the “Note”), Second Amended and Restated Security Agreement and Second Amended and Restated Pledge and Security Agreement. The Credit Facility, which will be used for working capital and general corporate purposes, matures on August 31, 2020, at which time the Company must pay all outstanding principal of all outstanding loans plus all accrued and unpaid interest, and any interest, fees, costs and expenses, if any. As of June 30, 2020, no borrowings were outstanding under the Credit Facility.
We anticipate that our working capital needs will increase as we invest in the growth of our business. We believe that the funds held in cash and cash equivalents and our unused borrowings under our Credit Facility will be sufficient to fund our working capital and cash requirements for at least the next 12 months.
Foreign Exchange
The Company’s foreign subsidiaries are subject to changes in demand or pricing resulting from fluctuations in currency exchange rates or other factors. We are subject to fluctuations primarily in the Canadian Dollar and the Euro Dollar to-U.S. Dollar exchange rate.
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Off-Balance Sheet Arrangements
As of June 30, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Smaller reporting companies are not required to provide the information required by this item.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.