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. COVID-19 has resulted and will continue to result in significant economic disruption, which could also impact 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 and nine months ended September 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. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers and shareholders. 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.
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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.
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, fluctuations in foreign currency rates 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 $0.1 million during the three months ended September 30, 2020. Total dividends paid and shares repurchased were $0.8 million and less than $0.1 million during the three months ended September 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. Because these forward-looking statements are subject to risks and uncertainties, actual results could differ materially from those indicated by such forward-looking statements. These risks and uncertainties include, but are 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 COVID-19 pandemic 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.
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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 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 16%, or $8.5 million, to $60.9 million for the three months ended September 30, 2020 compared to $52.4 million for the same period in the prior year. Gross profit increased 3%, or $0.1 million, to $7.2 million for the three months ended September 30, 2020 compared to $7.1 million for the same period in the prior year. Selling, general and administrative (“SG&A”) expenses for the three months ended September 30, 2020 increased 21%, or $1.1 million, to $6.2 million for the three months ended September 30, 2020 compared to $5.1 million for the same period in the prior year. Legal and financial advisory expenses, net – unsolicited bid and related matters for the three months ended September 30, 2020 were a recovery of $0.1 million compared to no expense for the same period in the prior year. Acquisition related costs for the three months ended September 30, 2020 were $0.3 million compared to no expense for the same period in the prior year. Net income for the three months ended September 30, 2020 was $0.5 million compared to $1.4 million for the same period in the prior year. Diluted income per share for the three months ended September 30, 2020 was $0.13 compared to $0.32 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.
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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 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 6 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.
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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.
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:
Nine months ended
Three months ended
September 30,
September 30,
2020
2019
2020
2019
Net sales
100.0
%
100.0
%
100.0
%
100.0
%
Cost of sales
87.5
85.1
88.1
86.5
Gross profit
12.5
14.9
11.9
13.5
Selling, general and administrative expenses
9.6
10.9
10.1
9.7
Legal and financial advisory expenses, net - unsolicited bid and related matters
1.0
—
(0.1)
—
Acquisition related costs
0.5
—
0.6
—
Income from operations
1.4
4.0
1.3
3.8
Other income
0.2
0.3
(0.1)
0.1
Income before income taxes
1.6
4.3
1.3
3.9
Income tax provision
0.5
1.1
0.4
1.1
Net income
1.1
%
3.2
%
0.9
%
2.8
%
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.
Nine months ended
Three months ended
September 30,
September 30,
September 30,
September 30,
2020
2019
2020
2019
Net sales
$
180,124
$
147,897
$
60,919
$
52,363
Adjusted gross billings (Non-GAAP)
$
502,856
$
433,519
$
171,018
$
149,058
Gross profit
$
22,515
$
22,108
$
7,237
$
7,055
Gross profit - Climb Channel Solutions
$
20,390
$
19,708
$
6,585
$
6,386
Gross profit - TechXtend
$
2,125
$
2,400
$
652
$
669
Adjusted EBITDA (Non-GAAP)
$
7,062
$
7,436
$
1,852
$
2,447
Gross margin % - Adjusted gross billings (Non-GAAP)
4.5%
5.1%
4.2%
4.7%
Effective margin % - Adjusted EBITDA (Non-GAAP)
31.4%
33.6%
25.6%
34.7%
We consider gross profit growth and effective margin to be key metrics in evaluating our business. During the three months ended September 30, 2020, gross profit increased 3%, or $0.1 million, to $7.2 million compared to $7.1 million for the same period in the prior year while effective margin decreased to 25.6% compared to 34.7% for the same period in the prior year. During the nine months ended September 30, 2020, gross profit increased 2%, or $0.4 million, to $22.6 million compared to $22.1 million for the same period in the prior year while effective margin decreased to 31.4% compared to 33.6% for the same period in the prior year.
Reconciliations of Non-GAAP Financial Measures
Nine months ended
Three months ended
September 30,
September 30,
September 30,
September 30,
Reconciliation of net sales to adjusted gross billings (Non-GAAP):
2020
2019
2020
2019
Net sales
$
180,124
$
147,897
$
60,919
$
52,363
Costs of sales related to Software – security and highly interdependent with support and maintenance, support or other services
322,732
285,622
110,099
96,695
Adjusted gross billings
$
502,856
$
433,519
$
171,018
$
149,058
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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.
Nine months ended
Three months ended
September 30,
September 30,
September 30,
September 30,
Net income reconciled to adjusted EBITDA:
2020
2019
2020
2019
Net income
$
1,947
$
4,764
$
530
$
1,445
Provision for income taxes
881
1,624
239
589
Depreciation and amortization
403
380
164
119
Interest expense
60
48
19
8
EBITDA
3,291
6,816
952
2,161
Share-based compensation
1,037
620
637
286
Legal and financial advisory expenses, net - unsolicited bid and related matters
1,752
-
(81)
-
Acquisition related costs
982
-
344
-
Adjusted EBITDA
$
7,062
$
7,436
$
1,852
$
2,447
We define adjusted EBITDA, as net income, plus provision for income taxes, depreciation, amortization, share-based compensation, interest, legal and financial advisory expenses, net – 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 September 30, 2020 Compared to Three Months Ended September 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 September 30, 2020 increased 16%, or $8.5 million, to $60.9 million compared to $52.4 million for the same period in the prior year. Adjusted gross billings for the three months ended September 30, 2020 increased 15%, or $21.9 million, to $171.0 million compared to $149.1 million for the same period in the prior year.
Climb Channel Solutions segment net sales for the three months ended September 30, 2020 increased 17%, or $8.2 million, to $57.0 million compared to $48.8 million for the same period in the prior year. The increase in net sales was primarily due to sales from Interwork for the three months ended September 30, 2020 and increased sales from newer vendor
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partner lines added in 2018 and 2019. Adjusted gross billings for the Climb Channel Solutions segment for the three months ended September 30, 2020 increased 16%, or $22.5 million, to $165.7 million compared to $143.2 million for the same period in the prior year.
TechXtend segment net sales for the three months ended September 30, 2020 increased 8%, or $0.3 million, to $3.8 million compared to $3.5 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 September 30, 2020 decreased 10%, or $0.6 million, to $5.3 million compared to $5.9 million for the same period in the prior year.
During the three months ended September 30, 2020, we relied on two key customers for a total of 34% of our net sales, with one of these customers accounting for 22% and the other customer accounting for 12% of our total net sales. The Company had two major customers that accounted for 19% and 17%, respectively, of its total net sales during the three months ended September 30, 2019. The Company had two major vendors that accounted for 21% and 12%, respectively, of total purchases during the three months ended September 30, 2020 and 22% and 18%, respectively, of total purchases during the three months ended September 30, 2019.
Gross Profit
Gross profit for the three months ended September 30, 2020 increased 3%, or $0.1 million, to $7.2 million compared to $7.1 million for the same period in the prior year. Climb Channel Solutions segment gross profit for the three months ended September 30, 2020 increased 3%, or $0.2 million, to $6.6 million compared to $6.4 million for the same period in the prior year. The increase in Climb Channel Solutions segment gross profit resulted primarily from increased sales from the acquisition of Interwork and other vendor partner lines discussed above, partially offset by higher early pay discounts and other rebates and discounts offered to our customers. The increase in early pay discounts was impacted by a change in payment terms with one of our larger customers, which resulted in an early pay discount of approximately $0.4 million and a decrease in accounts receivable from the time the program was implemented of approximately $30 million (see Liquidity and Capital Resources below). TechXtend segment gross profit for the three months ended September 30, 2020 remained consistent with the same period in the prior year at $0.7 million.
Customer rebates and discounts for the three months ended September 30, 2020 were $1.6 million compared to $0.9 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 second quarter of 2020. Customer rebates and discounts vary based on terms of rebate and early pay discount programs offered to customers and timing of payments ultimately received from our customers.
Vendor rebates and discounts for the three months ended September 30, 2020 remained consistent with the same period in the prior year at $0.6 million. Vendor rebates are dependent on programs offered by our vendors and in some cases reaching certain volume 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 September 30, 2020 increased 21%, or $1.1 million, to $6.2 million compared to $5.1 million for the same period in the prior year, primarily due to higher sales related salaries and commissions, higher stock compensation expense and higher professional fees related to our obligations as a public company. SG&A expenses also include approximately $0.2 million of expenses from Interwork for the three months ended September 30, 2020, which we plan to phase out in the fourth quarter of 2020 as we complete the integration of our administrative organizations. SG&A expenses were 10.3% of net sales for the three months ended September 30, 2020, compared to 9.7% for the same period in the prior year.
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.
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Legal and Financial Advisory Expenses, Net – Unsolicited Bid and Related Matters
Legal and financial advisory expenses, net – unsolicited bid and related matters for the three months ended September 30, 2020 were a recovery of $0.1 million relating to reimbursement for insurance proceeds realized compared to no expense for the same period in the prior year.
Acquisition Related Costs
Acquisition related costs for the three months ended September 30, 2020 were $0.3 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 and CDF discussed below.
Income Taxes
For the three months ended September 30, 2020 and 2019, the Company recorded a provision for income taxes of $0.2 million and $0.6 million, respectively. The effective tax rate for the three months ended September 30, 2020 and 2019 was 31.1% and 29.0%, respectively. The Company’s effective tax rate for the three months ended September 30, 2020 was impacted by limitations on the deductibility of certain facilitative acquisition related costs.
Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019
Net Sales and Adjusted Gross Billings
Net sales for the nine months ended September 30, 2020 increased 22%, or $32.2 million, to $180.1 million compared to $147.9 million for the same period in the prior year. Adjusted gross billings for the nine months ended September 30, 2020 increased 16%, or $69.3 million, to $502.8 million compared to $433.5 million for the same period in the prior year.
Climb Channel Solutions segment net sales for the nine months ended September 30, 2020 increased 24%, or $32.4 million, to $168.6 million compared to $136.2 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 inclusion of net sales of Interwork for the five months ended September 30, 2020. Adjusted gross billings for the Climb Channel Solutions segment for the nine months ended September 30, 2020 increased 17%, or $72.1 million, to $486.4 million compared to $414.3 million for the same period in the prior year.
TechXtend segment net sales for the nine months ended September 30, 2020 decreased 1%, or $0.1 million, to $11.6 million compared to $11.7 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 nine months ended September 30, 2020 decreased 14%, or $2.8 million, to $16.4 million compared to $19.2 million for the same period in the prior year.
During the nine months ended September 30, 2020, we relied on two key customers for a total of 40% of our net sales, with one of these customers accounting for 26% and the other customer accounting for 14% of our total net sales. The Company had two major customers that accounted for 24% and 20%, respectively, of its total net sales during the nine months ended September 30, 2019. The Company had two major vendors that accounted for 20% and 9%, respectively, of total purchases during the nine months ended September 30, 2020 and 24% and 16%, respectively, of total purchases during the nine months ended September 30, 2019.
Gross Profit
Gross profit for the nine months ended September 30, 2020 increased 2%, or $0.4 million, to $22.5 million compared to $22.1 million for the same period in the prior year. Climb Channel Solutions segment gross profit for the nine months ended September 30, 2020 increased 3%, or $0.7 million, to $20.4 million compared to $19.7 million for the same period in the prior year. The increase in Climb Channel Solutions segment gross profit resulted primarily from increased sales from the acquisition of Interwork and newer vendor lines discussed above, partially offset by higher early pay discounts and rebates offered to our customers. The increase in early pay discounts was impacted by a change in payment terms with one of our larger customers, which resulted in an early pay discount of approximately $0.7 million and a decrease in accounts
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receivable from the time the program was implemented of approximately $30 million (see Liquidity and Capital Resources below). TechXtend segment gross profit for the nine months ended September 30, 2020 decreased 11%, or $0.3 million, to $2.1 million compared to $2.4 million for the same period in the prior year.
Customer rebates and discounts for the nine months ended September 30, 2020 were $4.0 million compared to $2.5 million for the same period in the prior year. This increase is attributable to a change in payment terms with one of our larger customers during the second quarter of 2020 and timing of payments from other larger customers. Customer rebates and discounts vary based on terms of rebate and early pay discount programs offered to customers and timing of payments ultimately received from our customers.
Vendor rebates and discounts for the nine months ended September 30, 2020 were $2.5 million compared to $2.4 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 nine months ended September 30, 2020 increased 7%, or $1.1 million, to $17.3 million compared to $16.2 million for the same period in the prior year, primarily due to higher sales related salaries and commissions, higher stock compensation expense and higher professional fees related to our obligations as a public company. SG&A expenses were 9.7% of net sales for the nine months ended September 30, 2020, compared to 10.9% for the same period in the prior year. SG&A expenses include approximately $0.3 million of expenses from Interwork for the five months ended September 30, 2020. We anticipate completing the integration of the administrative functions of the two organizations during the 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, Net – Unsolicited Bid and Related Matters
Legal and financial advisory expenses, net – unsolicited bid and related matters for the nine months ended September 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 nine months ended September 30, 2020 were $1.0 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 and CDF discussed below.
Income Taxes
For the nine months ended September 30, 2020 and 2019, the Company recorded a provision for income taxes of $0.9 million and $1.6 million, respectively. The effective tax rate for the nine months ended September 30, 2020 and 2019 was 31.1% and 25.4%, respectively. The Company’s effective tax rate for the nine months ended September 30, 2020 was impacted by limitations on the deductibility of certain facilitative acquisition related costs.
Unsolicited Bid and Shareholder Demand
On July 15, 2019 and August 23, 2019, the Company received letters from Shepherd Kaplan Krochuk, LLC (“SKK”) and North & Webster SSG, LLC (“N&W”) announcing an unsolicited bid to acquire the Company. The 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%
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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 of directors nominated by persons other than the Company.
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. 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 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, including his covenant not to seek future employment with the Company. As a result, the Company filed a lawsuit (the “Lawsuit”) against Mr. Nynens, SKK, and N&W in the Superior Court of New Jersey Monmouth County, on February 14, 2020.
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 to purchase all of Mr. Nynens’ 261,631 shares of the Common Stock owned, of record or beneficially, as of the Effective Date, at fair market value, as defined in the agreement. Mr. Nynens and the SKK Parties terminated the November 27 Agreement and the Joint Filing Agreement. Additionally, 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. For further information, see the Current Report on Form 8-K filed by the Company on April 17, 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.
The Company incurred approximately $1.8 million in legal and advisory expenses, net during the nine months ended September 30, 2020 related to the above matter. In connection with this, the Company made certain claims for reimbursement under its insurance policies. During the three months ended September 30, 2020, reimbursement for insurance proceeds realized totaling $0.1 million has been recorded, while any potential additional insurance proceeds reimbursed under these policies as of September 30, 2020 have not been recorded as they have not been realized.
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Acquisitions
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.
CDF Group Limited
On November 6, 2020, Wayside Technology UK Holdings Limited (“Buyer”), a private limited company under the laws of England and Wales and a newly-incorporated, wholly-owned subsidiary of the Company, entered into a Share Purchase Agreement (“SPA”) and purchased the entire share capital of CDF Group Limited, a private limited company under the laws of England and Wales, for an aggregate purchase price of approximately £13.3 million (equivalent to approximately $17.4 million USD), subject to certain working capital and other adjustments.
The SPA contains customary English warranties and covenants, a guaranty by the Company of the performance by Buyer of its obligations under the SPA and customary indemnification obligations of Seller, subject to certain customary limitations and insurance caps.
Liquidity and Capital Resources
Our cash and cash equivalents increased to $40.3 million as of September 30, 2020 compared to $15.0 million as of December 31, 2019. The increase in cash and cash equivalents was primarily the result of $32.5 million of cash and cash equivalents provided by operating activities resulting from a change in payment terms with one of our customers, offset by $3.6 million of cash used to purchase treasury stock, $2.3 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 nine months ended September 30, 2020 was $32.5 million, comprised primarily of net income adjusted for non-cash items of $3.7 million and changes in operating assets and liabilities of $28.8 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 of approximately $30 million from the date the program was implemented. This change in terms also had the impact of reducing our net sales and gross profit by approximately $0.4 million and $0.7 million for the three and nine months ended September 30, 2020, respectively, 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 nine months ended September 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.
On November 6, 2020, the Company entered into the SPA to purchase CDF Group Limited for an aggregate purchase price of £13.3 million (equivalent to approximately $17.4 million USD), subject to certain working capital and other adjustments.
Net cash and cash equivalents used in financing activities during the nine months ended September 30, 2020 was $5.9 million, primarily comprised of the purchase of treasury stock of $3.6 million and dividend payments on our Common Stock of $2.3 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.
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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. On August 31, 2020, the Company entered into an amendment to the Credit Facility (the “Amended Credit Facility”) pursuant to a First Amendment to Second Amended and Restated Revolving Credit Loan Agreement and Other Loan Documents (the “Amended Loan Agreement”) and First Allonge to Second Amended and Restated Revolving Credit Loan Note (the “Amended Note”). The Amended Credit Facility, which will continue to be used for working capital and general corporate purposes, matures on June 30, 2023, at which time the Company must pay all outstanding principal of all outstanding loans plus all accrued and unpaid interest, and any, fees, costs and expenses. As of September 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 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.
Off-Balance Sheet Arrangements
As of September 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.