Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following management’s discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto. This discussion and analysis contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain risks and uncertainties, including those set forth under the heading “Risk Factors” and elsewhere in this report.
Overview
Our Company is a value added IT distribution and solutions company, primarily selling software and other third-party IT products and services through two reportable operating segments. Through our “Distribution” segment we sell products and services to corporate resellers, value added resellers (VARs), consultants and systems integrators worldwide, who in turn sell these products to end users. Through our “Solutions” segment we act as a cloud solutions provider and value-added reseller, selling computer software and hardware developed by others and provide technical services directly to end user customers worldwide. We offer an extensive line of products from leading software vendors 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.
We have subsidiaries in the United States, Canada, Netherlands, United Kingdom and Ireland, through which sales are made.
COVID-19
We are closely monitoring the impact of the 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. The majority of our employees continue to work remotely through the first quarter of 2021.
While we did not incur significant disruptions to our operations during the year ended December 31, 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.
Factors Influencing Our Financial Results
We derive most of our net sales though the sale of third-party software licenses, maintenance and service agreements. In our Distribution segment, sales are impacted by the number of product lines we distribute, and sales penetration of those products into the reseller channel, product lifecycle competitive, and demand characteristics of the products which we are authorized to distribute. In our Solutions segment sales are generally driven by sales force effectiveness and success in providing superior customer service and cloud solutions support, 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.
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We sell in a competitive environment where gross product margins have historically declined due to competition and changes in product mix towards products where no delivery of a physical product is required. In addition, we grant discounts, allowances, and rebates to certain customers, which may vary from period to period, based on volume, payment terms and other criteria. 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. We evaluate the profitability of our business based on return on equity and effective margin (see management’s discussion and analysis below).
Gross profit is calculated as net sales less cost of sales. We record customer rebates and discounts as a component of net sales and record vendor rebates and discounts as a component of cost of sales.
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, 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 the dollar value of shares repurchased were $3.0 million and $3.7 million for the year ended December 31, 2020, respectively, and $3.1 and $0.1 million for the year ended December 31, 2019, respectively. The payment of future dividends 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, distribution and services sectors of the United States stock markets is subject to substantial volatility. Numerous conditions which impact these sectors 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. Furthermore, fluctuations in the Company’s operating results, announcements regarding litigation, the loss of a significant vendor partner 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.
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Financial Overview
Net sales increased 21%, or $42.8 million, to $251.6 million for the year ended December 31, 2020, compared to $208.8 million for the same period in 2019. Gross profit increased 10%, or $3.0 million, to $33.0 million for the year ended December 31, 2020, compared to $30.0 million for the same period in 2019. Selling, general and administrative (“SG&A”) expenses increased 15%, or $3.0 million, to $23.9 million for the year ended December 31, 2020, compared to $20.9 million for the same period in 2019. Legal and financial advisory expenses, net - unsolicited bid and related matters were $1.6 million for the year ended December 31, 2020 compared to no expense for the same period in 2019. Acquisition related costs were $1.5 million for the year ended December 31, 2020 compared to no expense for the same period in 2019. Amortization and depreciation expense increased $0.2 million to $0.7 million for the year ended December 31, 2020 compared to $0.5 million for the same period in the prior year. Net income was $4.5 million for the year ended December 31, 2020 compared to $6.8 million for the same period in 2019. Weighted average diluted shares outstanding decreased by 3% from the prior year. Income per diluted share was $1.01 for the year ended December 31, 2020 compared to $1.51 for the same period in 2019.
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 generally accepted accounting principles in the United States of America (“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, investments, 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 utilizes judgment regarding performance obligations inherent in the products for 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 judgment 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 judgment 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 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.
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Accounts Receivable – Long Term
The Company’s accounts receivable long-term are discounted to their present value at prevailing market rates at the time of sale. In doing so, the Company considers competitive market rates and other relevant factors.
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.
Business Combinations
The Company accounts for business combinations using the acquisition method of accounting, which allocates the fair value of the purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions. The Company may utilize third-party valuation specialists to assist the Company in the allocation. Initial purchase price allocations are subject to revision within the measurement period, not to exceed one year from the date of acquisition. Acquisition-related expenses and transaction costs associated with business combinations are expensed as incurred.
Goodwill
We test goodwill for impairment on an annual basis, and between annual tests if an event occurs, or circumstances change, that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
In a qualitative assessment, we assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If, after assessing the totality of events or circumstances, we determine that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary.
If, after assessing the totality of events or circumstances, we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we perform the quantitative goodwill impairment test. We may also elect the unconditional option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test.
In the quantitative impairment test, we compare the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. Conversely, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
Intangible Assets
Intangible assets with determinable lives are amortized on a straight-line basis over their respective estimated useful lives, which is determined based on their expected period of benefit. Intangible assets are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recorded for the excess of the asset's carrying amount over its fair value. In addition, each quarter,
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the Company evaluates whether events and circumstances warrant a revision to the remaining estimated useful life of each of these intangible assets. If the Company were to determine that a change to the remaining estimated useful life of an intangible asset was necessary, then the remaining carrying amount of the intangible asset would be amortized prospectively over that revised remaining useful life.
Income Taxes
The Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the 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 make certain assumptions in order to value and expense our various share-based payment awards. In connection with our restricted stock programs we record the 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.
Foreign Exchange
The Company’s foreign currency exposure relates primarily to international transactions where the currency collected from customers can be different from the currency used to purchase the product. In cases where the Company is not able to create a natural hedge by maintaining offsetting asset and liability amounts in the same currency, it may enter into foreign exchange contracts, typically in the form of forward purchase agreements, to facilitate the hedging of foreign currency exposures to mitigate the impact of changes in foreign currency exchange rates. These contracts generally have terms of no more than two months. The Company does not apply hedge accounting to these contracts and therefore the changes in fair value are recorded in earnings. The Company does not enter into foreign exchange contracts for trading purposes and the risk of loss on a foreign exchange contract is the risk of nonperformance by the counterparties, which the Company minimizes by limiting its counterparties to major financial institutions. The fair value of forward purchase contracts at December 31, 2020 was not material to the consolidated financial statements.
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.
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Results of Operations
The following table sets forth for the years indicated the percentage of net sales represented by selected items reflected in the Company’s Consolidated Statements of Earnings. The year-to-year comparison of financial results is not necessarily indicative of future results:
Year ended
December 31,
2020
2019
Net sales
100.0
%
100.0
%
Cost of sales
86.9
85.6
Gross profit
13.1
14.4
Selling, general and administrative expenses
9.5
10.0
Legal and financial advisory expenses, net - unsolicited bid and related matters
0.6
0.1
Acquisition related costs
0.6
—
Amortization and depreciation expense
0.3
0.2
Income from operations
2.1
4.1
Other income
0.4
0.3
Income before income taxes
2.5
4.3
Income tax provision
0.7
1.1
Net income
1.8
%
3.3
%
Non-GAAP Financial Measures
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, net income, net income excluding separation expenses, net of taxes, 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 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.
Year ended
December 31,
December 31,
Reconciliation of net sales to adjusted gross billings (Non-GAAP):
2020
2019
Net sales
$
251,568
$
208,759
Costs of sales related to Software – security and highly interdependent with support and maintenance, support or other services
477,671
392,264
Adjusted gross billings
$
729,239
$
601,023
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
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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.
Year ended
December 31,
December 31,
Net income reconciled to adjusted EBITDA:
2020
2019
Net income
$
4,474
$
6,787
Provision for income taxes
1,746
2,261
Amortization and depreciation
704
487
Interest expense
116
58
EBITDA
7,040
9,593
Share-based compensation
1,278
759
Legal and financial advisory expenses, net - unsolicited bid and related matters
1,586
120
Acquisition related costs
1,518
-
Adjusted EBITDA
$
11,422
$
10,472
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.
Key Financial Metrics
Year ended
December 31,
December 31,
2020
2019
Net sales
$
251,568
$
208,759
Adjusted gross billings (Non-GAAP)
$
729,239
$
601,023
Gross profit
$
33,040
$
29,967
Gross profit - Distribution
$
29,136
$
26,773
Gross profit - Solutions
$
3,904
$
3,194
Adjusted EBITDA (Non-GAAP)
$
11,422
$
10,472
Gross margin % - Adjusted gross billings (Non-GAAP)
4.5%
5.0%
Effective margin % - Adjusted EBITDA (Non-GAAP)
34.6%
34.9%
We consider gross profit growth and effective margin to be key metrics in evaluating our business. During the year ended December 31, 2020, gross profit increased 10%, or $3.0 million, to $33.0 million compared to $30.0 million for the same period in 2019 while effective margin decreased 30 basis points to 34.6% compared to 34.9% for the same period in 2019. The decline in gross margin percentage and effective margin during the year ended December 31, 2020
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compared to the prior year is partially attributable to the implementation of an early pay discount program for one of our large customers (see Liquidity and Capital Resources below)
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Acquisitions
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.
On November 6, 2020 we completed the acquisition of CDF Group Limited (“CDF”) for a purchase price of $17.4 million, subject to certain working capital adjustments. The operating results of CDF are included in our operating results effective November 7, 2020. See further information on acquisition accounting in Note 6 to the Consolidated Financial Statements in Item 1 of this report.
Operating results of Interwork are included in our Distribution segment. Operating results of CDF are included in either our Distribution segment or Solutions segment.
Net Sales
Net sales for the year ended December 31, 2020 increased 21%, or $42.8 million, to $251.6 million compared to $208.8 million for the same period in 2019.
Adjusted gross billings, a non-GAAP financial measure, for the year ended December 31, 2020 increased 21%, or $128.2 million, to $729.2 million compared to $601.0 million for the same period in 2019.
Net sales in our Distribution segment for the year ended December 31, 2020 increased 21%, or $40.2 million, to $233.8 million compared to $193.6 million for the same period in the prior year. The increase in net sales in our Distribution segment was primarily due to sales from the CDF and Interwork acquisitions, as well as organic growth from our existing vendor lines. Adjusted gross billings for the Distribution segment for the year ended December 31, 2020 increased 22%, or $124.7 million, to $700.1 million compared to $575.4 million for the same period in 2019.
Net sales in our Solutions segment for the year ended December 31, 2020 increased 17%, or $2.6 million, to $17.8 million compared to $15.2 million for the prior year. The increase in net sales in our Solutions segment was primarily due to sales from the CDF acquisition for the period from acquisition through December 31, 2020. Adjusted gross billings for the Solutions segment for the year ended December 31, 2020 increased 14%, or $3.5 million, to $29.1 million compared to $25.6 million for the same period in 2019.
During the year ended December 31, 2020, we relied on two key customers for a total of 38% of our total net sales. One major customer accounted for 24% and the other for 14%, of our total net sales during the year ended December 31, 2020. These same customers accounted for 19% and 9%, of total net accounts receivable as of December 31, 2020.
Gross Profit
Gross profit for the year ended December 31, 2020 increased 10%, or $3.0 million, to $33.0 million compared to $30.0 million for the same period in 2019. Distribution segment gross profit for the year ended December 31, 2020 increased 9%, or $2.3 million, to $29.1 million compared to $26.8 million for the same period in 2019 due to higher net sales discussed above, which were partially offset by the impact of lower gross margin as a percentage of net sales. The decline in gross margin as a percentage of net sales was partially attributable to early pay discount programs implemented in 2020, resulting in lower accounts receivable and increased cash and liquidity (see Liquidity and Capital Resources). Solutions segment gross profit for the year ended December 31, 2020 increased 22%, or $0.7 million, to $3.9 million compared to $3.2 million for the same period in 2019 due to the increased level of net sales discussed above and a higher
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gross margin as a percentage of net sales resulting from the inclusion of the CDF business. CDF Solutions sales gross profit as a percentage of net sales is generally higher than our historical average.
Customer rebates and discounts for the year ended December 31, 2020 were $6.3 million compared to $3.8 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 year ended December 31, 2020 were $3.9 million compared to $3.3 million for the same period in 2019. 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 year ended December 31, 2020 increased 15%, or $3.0 million, to $23.9 million, compared to $20.9 million for the same period in 2019 primarily due to expenses from Interwork and CDF for the period from acquisition to December 31, 2020. Sales related salaries and commissions, higher stock compensation expense and higher professional fees related to our obligations as a public company also increased during the period. SG&A expenses were 9.5% of net sales for the year ended December 31, 2020, compared to 10.0% for the same period in 2019.
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 information technology and sales marketing to support the growth of our business.
Legal and Financial Advisory Expenses, Net – Unsolicited Bid and Related Matters
Legal and financial advisory expenses, net – unsolicited bid and related matters for year ended December 31, 2020 were $1.6 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 year ended December 31, 2020 were $1.5 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.
Foreign Currency Transaction Gain
Foreign currency transaction gain for the year ended December 31, 2020 was $0.8 million compared to $0.1 million in for the same period in 2019. These expenses primarily relate to the change in the value of accounts payable and other monetary assets and liabilities denominated in currencies other than their functional currency between the date of origination and settlement.
Income Taxes
For the year ended December 31, 2020, the Company recorded a provision for income taxes of $1.7 million, or 28.1% of income before taxes, compared to $2.3 million, or 25.0% of income before taxes for the same period in 2019. The Company’s effective tax rate for the year ended December 31, 2020 was impacted by limitations on the deductibility of certain facilitative acquisition related costs.
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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% 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 $1.6 million in legal and advisory expenses, net during the year ended December 31, 2020 related to the above matter. In connection with the above matter, the Company made certain claims for reimbursement under its insurance policies. During the year ended December 31, 2020, reimbursement for insurance proceeds realized totaling $0.3 million has been recorded.
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
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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.
Liquidity and Capital Resources
Our cash and cash equivalents increased by $14.3 million to $29.3 million at December 31, 2020 from $15.0 million at December 31, 2019. The increase in cash and cash equivalents was primarily the result of $38.0 million of cash and cash equivalents provided by operating activities resulting from a change in payment terms with one of our customers, offset by $16.8 million of cash for acquisitions, $3.7 million of cash used to purchase treasury stock and $3.0 million of cash used for dividends.
Net cash provided by operating activities for the year ended December 31, 2020 was $38.0 million, comprised of net income adjusted for non-cash items of $6.7 million and changes in operating assets and liabilities of $31.3 million. 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 $1.1 million for the year ended December 31, 2020, however, we believe the additional liquidity will improve our return on equity and provide us greater flexibility in pursuing our strategic objectives.
Net cash and cash equivalents used in investing activities during the year ended December 31, 2020 primarily consisted of payments for acquisitions. 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. On November 6, 2020, the Company completed the purchase of 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. The Company financed these acquisitions from existing capital resources.
Net cash and cash equivalents used in financing activities during the year ended December 31, 2020 was $6.7 million, primarily comprised of the purchase of treasury stock of $3.7 million and dividend payments on our Common Stock of $3.0 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 December 3, 2014, the Board of Directors of the Company approved an increase of 500,000 shares of Common Stock to the number of shares of Common Stock available for repurchase under its repurchase plans. On February 2, 2017, the Board of Directors approved an increase of 500,000 shares of Common Stock to the number of shares of Common Stock available for repurchase under its repurchase plans. The Company is authorized to purchase 547,288 shares of Common Stock as of December 31, 2020. The Common Stock repurchase program does not have an expiration date.
As of December 31, 2020, we held 922,503 shares of our Common Stock in treasury at an average cost of $15.99 per share. As of December 31, 2019, we held 778,807 shares of our Common Stock in treasury at an average cost of $16.99 per share. We intend to hold the repurchased shares in treasury for general corporate purposes, including issuances under various stock plans.
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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. The interest rate for any borrowings under the Amended Credit Facility is subject to change from time to time based on the changes in the LIBOR Rate, as defined in the Amended Loan Agreement (the “Index”). The Index was 2.50% at December 31, 2020.
At December 31, 2020 and 2019, the Company had no borrowings outstanding under the Credit Facility. The Company incurred $0.1 million of interest expense, related to the Credit Facility for the years ended December 31, 2020 and 2019, respectively.
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 business is 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, Euro Dollar and British Pound-to-U.S. Dollar exchange rate.
Off-Balance Sheet Arrangements
As of December 31, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303 (a)(4)(ii) of SEC Regulation S-K.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Smaller reporting companies are not required to provide the information required by this item.
Item 8. Financial Statements and Supplementary Data
See Index to Consolidated Financial Statements at Item 15(a).
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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.