Wayside Technology Group Inc

F:PYA

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Wayside Technology Group conference call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce your host for today's conference, Melanie Caponigro. Ms. Caponigro, you may begin your conference at this time.

[Melanie Caponigro, executive]

Thank you, and good morning. Welcome to Wayside Technology's Third Quarter 2018 Earnings Call. Before turning the call over to Steve DeWindt, the company's President and CEO, I'll dispense with the customary cautionary language and comment about the webcast for this earnings call.

We released earnings for the third quarter at approximately 5:00 p.m. Eastern time, Monday, November 5, 2018. The earnings release is available at the company's Investor Relations website at waysidetechnology.com. Today's call, including all questions and answers, is being webcast live, and a rebroadcast will be available at waysidetechnology.com/site/content/webcast. This conference call and the associated webcast contain time-sensitive information that is accurate only as of today, November 6, 2018. A detailed discussion of risks and uncertainties are discussed in our Form 10-Q and also in greater detail in our Form 10-K. Wayside Technology Group, Inc. sees no obligation to update and does not intend to update any forward-looking statements.

Now I would like to turn the call over to Steve DeWindt. Steve?

[David DeWindt, executive]

Thanks, Melanie. Good morning, everyone. Thank you for joining us today to discuss our third quarter 2018 operating results.

This quarter had mixed results. On the plus side, our sales and operational teams worked hard to deliver revenue growth of 23% year-over-year. On the negative side, our gross margins were squeezed once again due to competitive pressure and product mix, coming down to 13.2% compared to 16.0% last year. So gross profit dollars only increased by 1%. In addition, our operating expenses increased due to higher business development and field sales personnel expenses. However, our net income was flat due to the benefit of a lower federal tax rate.

Wayside's position in the marketplace has always focused on introducing new vendors and technology into the IT sales channel. In Q1, we began to invest in a business development team and regional field sales team for the enterprise marketplace to expand and solidify our reseller network with new products and high-touched sale support. Our product segments include security, hyper-converged, storage, data management and networking products.

As you may have seen in recent press releases, we are continuing to add new products in an accelerated fashion, having signed several new intriguing emerging technology vendors this year. We are encouraged by the enthusiasm our reseller partners have shown in our initiatives as we make investments now to position ourselves for the future. We continue to make progress towards our strategic goals this year.

We continue to have a strong balance sheet and ended the quarter without any debt. The company historically returned some of our consistent profits to investors as a dividend, with the yield of about 5%, and once again, we've declared a dividend of $0.17 this quarter. This past quarter continues to show that demand for IT solutions delivered through a reseller channel remains robust, with opportunity for shared gains and growth in security, hyper-converged, storage, data management and networking products.

As we continue to add to our product portfolio, execute well with our sales teams, expand our customer base and focus on controlling costs and improving our IT delivery and reporting systems, we are feeling very good about the outlook for the rest of the year. We look forward to updating you about these focus areas on future calls. Let me now hand off to Michael Vesey, our Chief Financial Officer.

[Michael Vesey, executive]

Thanks, Steve. I'll review our financial results for the third quarter, then discuss our balance sheet and liquidity.

Overall net sales for the quarter increased 23% to $47.9 million compared to $39 million even for the same quarter last year. Lifeboat Distribution net sales were up 27% for the quarter to $44.1 million, while TechXtend sales for the quarter were down 12% to $3.8 million.

As we've discussed in the past, our Lifeboat segment accounts for about 90% of our net sales and has shown consistent top line growth over the past several years, while TechXtend sales tend to fluctuate from quarter-to-quarter, based on the timing of deal flow. The growth in Lifeboat reflects some initial traction in our initiative to broaden our footprint by investing in our vendor recruitment in field sales organizations, with a few larger enterprise deals from new vendors in SD-WAN and containerization space this quarter.

These transactions were high-dollar, low-percentage margin compared to our traditional business, but showed some initial payback on our investment in our field sales and development teams and progress in expanding our presence as a distributor of emerging technology products. Overall, adjusted gross billings on a non-GAAP basis increased 26% to $134 million from $106.7 million in the prior year.

As discussed in prior calls, we adopted the new accounting standard, ASC 606 Revenue from Contracts with customers effective January 1, 2018. The adoption had no impact on gross profit or operating income, but resulted in a significant portion of our revenue being reported net of cost of sales and increased our gross profit margin percentages. We present prior year results on a restated basis and provide reconciliations of our net sales to our adjusted gross billings as a non-GAAP measure in our earnings release and 10-Q filing to assist with comparability with our historical results. Gross profit for the quarter increased slightly to $6.3 million compared to $6.2 million for the same period last year. Lifeboat Distribution gross profit for the quarter increased 4% or $200,000 to $5.6 million, while TechXtend decreased 20% or $200,000, again reflecting the growth of Lifeboat and quarter-to-quarter variability in TechXtend, that I previously discussed. Gross profit margin as a percentage of net sales decreased by 280 basis points to 13.2% compared to 16% in the third quarter of last year. The change in gross profit margin was primarily due to incremental growth in gross margin dollars from a few large orders at a lower-percentage margin than some of our historical business. And secondarily, change in product mix compared to the same quarter last year. As I previously mentioned, third quarter results include several large orders for Enterprise Products from new vendors we added this year. While incrementally profitable, the gross margin as a percentage of sales on these large orders is lower than our historical average, resulting in a decline in our gross profit percentages overall.

Regarding product mix, under ASC 606, our gross margin as a percentage of net sales is a composite of items that are recorded net of the related cost of sales or 100% reported gross margin. And items that recorded on a gross basis, typically reflecting a high single-digit gross profit margin. The weighting of the 2 product categories in the composite margin is based on the relative percentage of GAAP net revenue in each category.

During the third quarter of 2018, approximately 8% of our net revenues were from security maintenance and other products, which were reported on a net basis or an effective 100% gross margin compared to 9% in the same quarter last year. This change in mix accounted for approximately 100 of the 280 basis points decline in gross profit as a percentage of net sales quarter-over-quarter. Total selling, general and administrative expenses for the quarter increased by $400,000 to $4.9 million compared to $4.5 million for the same quarter of 2017, due to higher personnel costs resulting from the investment in our business development and field sales organization and to a lesser extent, higher legal and public company costs. The investor in field sales and business development is expected to add to our operating expenses in the short run, but provide a future payback as we recruit new vendors and expand our reseller base into new market segments. SG&A expenses as a percentage of net sales was 10.2% in 2018 compared to 11.4% in 2017.

Pretax income for the quarter ended September 30, 2018, was $1.4 million compared to $1.8 million during the prior year, primarily as a result of increased sales and business development expenses.

For the third quarter of 2018, we recorded a provision for income taxes of $400,000 compared to $700,000 in the prior year. The company's effective tax rate on ordinary income was 24.2% for the 3 months ended September 30, 2018, compared to 33.3% for the same period in 2017, reflecting the lower federal tax rate resulting from the Tax Cuts and Jobs Act of 2017. Our effective tax rate for the full year is somewhat higher due to some state tax expenses and the impact of IRS Section 162(m) limitations on separation expenses recorded in Q2 2018. As a result, net income for the quarter ended September 30, 2018, was $1.3 million, which is in line with the prior year.

GAAP diluted net income per share for the quarter ended September 30, 2018, was $0.29 compared to diluted income per share of $0.30 for the same period in 2017.

Moving on to the balance sheet. We continue to manage a strong balance sheet and liquidity position with cash and equivalents of $6.5 million at the end of the period compared to $5.5 million at the end of 2017 and no outstanding borrowings under our $20 million credit facility. We paid approximately $800,000 in dividends during the quarter and as of September 30, 2018, stockholder's equity stood at $39.7 million compared to $38.7 million at the end of last year. Total working capital, including cash, was $33.8 million compared to $25.5 million at the end of last year.

In addition, our long-term receivable balance of approximately $4.5 million, which are not included in working capital, are available to us as sources of future liquidity.

On October 30, 2018, the Board of Directors declared a quarterly dividend of $0.17 per share of its common stock, payable November 20, 2018, to shareholders of record on November 13, 2018. So in summary, we showed top line growth this quarter and have begun to show some traction at the gross margin line from our increased investment in vendor recruitment and field sales of Lifeboat. While the gross profit is at a lower-percentage margin than our historical average and is not scaled to the point of absorbing all the costs of the new team, we're encouraged by our ability to engage and expand our footprint into key emerging technology segments. Steve?

[David DeWindt, executive]

So with that, I think we'll take questions.

[Operator]

[Operator Instructions] And your first question comes from Peter Delgado.

[Peter Delgado, analyst]

Peter Delgado here from Global Value Research Corp. Congratulations on that top line, that revenue number, that's impressive to see. Guys, can I ask you -- we're obviously in the end of calendar 2018 looking out into 2019 now. Could you give us some sort of color on any new software products that might be coming next year? Anything that you guys are excited about? And I guess, second part of that question would deal with some of the new vendors. Could you give us some more color there? How are these relationships evolving for you guys?

[David DeWindt, executive]

Sure. Let me talk first about specific products. If you're asking for -- have we seen anything that is absolutely cool that you should buy stock in, I'm going to have to differ on that. We do see a number of very intriguing new products, and I think in particular, some of the ones that are most interesting for us are in the hyper-converge where we're seeing combinations of both hardware and software. The containers that these are being put into are very intriguing. I can't mention specific vendor names, but I would say as we're moving forward, some of the ones that are most intriguing in the brand-new vendors are in that space. One of the other things though that we're also seeing, Peter, is that we have been talking to vendors that we have been -- whose products we've been selling for a long time and who are pretty happy with our performance. And one of the things that we have been doing is going back, and seeing if we can revisit their overall distribution strategy so that we can hopefully talk to them about the idea of reducing the number of distributors that they have because as that happens, margins go up. And that allows us to invest more in helping them to get to market. And we've been -- we've seen success in doing this where some of our established vendors have gone back and have actually changed their distribution strategy and have actually reduced the number of vendor -- distribution partners that they have, and this bodes very well for us in the future. I hope that answers your questions.

[Peter Delgado, analyst]

Yes, Steve, I guess, second part of that question -- my initial inquiry, I wanted to ask if you could just give us a little bit more color on some of these vendor relationships? I know you guys have been spending a lot of time and effort on that.

[David DeWindt, executive]

We have -- let me give you just sort of an overview. Last year -- and these are sort of order of magnitude. But last year, we signed new vendors in, I would say under 10 for the year. This year, we've already brought on over 20, so far this year. And this is the direct result of our investing in this business development and field sales teams because this is what people are looking for from us. As we focus on these new vendors, bringing them on, and then helping them establish and create their go-to-market strategy, they need some assistance, both in terms of distribution knowledge and in terms of the relationships with both the largest resellers and then the regional value-added resellers, and we have both. And what we've been very pleased to see is this validation of our investment strategy of bringing on field salespeople who are more expensive than inside salespeople and business development people, who really understand the new vendor marketplace. Next question?

[Operator]

And your next question comes from the line of [ Dennis Crowley ].

[John Nouri, analyst]

My name is John Nouri, I'm with North & Webster. I have 2 questions. My first question is, looking at the cash flow statement, there's depreciation and amortization expense. However, looking at the balance sheet, there doesn't seem to be any intangible assets recorded. Is that figure baked into other assets?

[Michael Vesey, executive]

Yes, this is Mike. The answer to that is, yes. It's a pretty small amount of intangibles that we're amortizing, and they are included in the other assets number.

[John Nouri, analyst]

Mike, would you mind elaborating what specific intangibles?

[Michael Vesey, executive]

Like, trademarks, things like that.

[John Nouri, analyst]

Okay. My second question is regards to some of the working capital items on the balance sheet. If I were to take the change by just subtracting the 2016 to 2017 figures, they don't exactly tied to the cash flow working capital changes. Would you mind shedding some light on what those differences might be chalked up to?

[Michael Vesey, executive]

Sure. Probably the biggest item is that some of the -- our operations are in foreign currencies. So we need to do separate functional currency, cash flow statements and go through a consolidation process where the changes are accumulated in a separate line on the cash flow statement. That probably causes the majority of what you're seeing.

[Unknown Analyst]

I did have one more question in regards to the prior question I was asked. We talked about the going forward and the hyper conversion of hardware and software. Are you seeing more -- are you anticipating more hardware-based products coming on in 2019? And going forward, is that part of a IoT expansion? And -- could you just kind of explain a little bit more what you meant with your response to the prior questions that were asked?

[Michael Vesey, executive]

Yes, Steve, is that you or me? I sorry, we got -- for whatever reason, we got disconnected for a minute, so we had to dial back in.

[David DeWindt, executive]

Thank God, they got back in time for the balance sheet question. So going back to -- are we -- is this signifying a shift towards hardware? In general, no. We are still very, very focused on software and sometimes, the products as I mentioned, actually are a blend of hardware and software and other times, the software is what's sold and sometimes it's sold to the reseller who then bundles it onto hardware that sells, buying it separately. So you will see us with some additional mix of some hardware, but it will not be a -- within these new products. It is not going to be a significant increase in the percentage overall of hardware versus software.

[Unknown Analyst]

That's great. One other question. Looking at your revenue from the regions geographically, with this new business development team, are you anticipating more sales coming out of Europe and Canada? Or is this still a focus in on the United States?

[David DeWindt, executive]

Right at the moment, it's still a focus on the United States. I could envision some increase overall percentage-wise, perhaps of Canada. I don't envision that happening with EMEA.

[Operator]

[Operator Instructions] And there are no questions at this time. I'm sorry, you do have a follow-up from [ Dennis Crowley ].

[John Nouri, analyst]

Yes, just, didn't sound like there was anyone else in the queue, I didn't want to take too much, but if you are still available. Can you talk about how much of that change in the mix versus -- of gross margin versus compression?

[Michael Vesey, executive]

Yes, yes, sure. So this quarter -- and again, it varies from quarter-to-quarter, is the first point. But this quarter of the 280 basis point decline, when you look at the GAAP gross margins, 180 of it was due to the fact that the margins on our product sales were lower and 100 of it was due to the shift in mix, approximately. So that was the breakdown. But it is different each quarter. It just so happens that a couple of large orders that we sold this period were product sales, either software licenses or, like Steve was describing before, appliances or dedicated pieces of hardware to operate that software, not sales of generic hardware lines like "Hey, buy some servers here." It's more dedicated branded appliances that the software resides on. So that drove the margin decline really in both of those factors, because the overall sale itself was at a lower margin than what our smaller transaction product sales are, and it also drove the mix to something that we don't record on a net basis that we actually show it at the adjusted gross billings, gross margin or single-digit gross margin, if you want to look at it that way.

[John Nouri, analyst]

All right, great. Another question. Are there any categories that did better or worse?

[Michael Vesey, executive]

When you say categories, you mean the categories that we report as disaggregated. The 3 categories we show, the maintenance, security and product?

[John Nouri, analyst]

Yes, just getting into that product understanding out of the product lines, which ones are the best, where is it going?

[Michael Vesey, executive]

Yes. I think if you look at it over time, our security and maintenance part of the business has been coming a bigger percentage of the total pie, so if you look at it over the past few years, that's kind of the trend and that's probably still the trend this quarter, a little bit of anomaly because of the large transactions in the product side of it. So this quarter, the answer is, there's more product sales, but we don't see that as any kind of a trend in the business.

[John Nouri, analyst]

Got you. And so I was going to -- the last question was going to be, do you expect that to continue? And I think you kind of answered that towards the end, so that's perfect.

[Michael Vesey, executive]

Yes, it's little bit driven by the vendors, so if you extend -- in a number of the areas that Steve mentioned, right, depending on your level of success in any area, it could skew it in one direction or the other. We would still -- we look at it as long as we're making an acceptable return at the gross margin dollar on our investment, we're happy. If we happen to get some real good traction with say, a backup or storage vendor, they would tend to be skewed more towards their solution being delivered on a hardware -- a piece of hardware, which would skew the accounting for us. Yes, we just look at the fact that is it profitable or not? So it's -- looking forward, I don't know if I could guide you and give you specific information like this category is going to move more than the others, it's a little bit dependent on where the business takes us.

[Operator]

And at this time, there are no further questions.

[David DeWindt, executive]

Okay, well, thank you, everybody. We appreciate your following us, and we look forward to next quarter.

[Operator]

Thank you. At this time -- one moment. And this concludes today's conference call. You may now disconnect. Thank you for your participation.