Wayside Technology Group, Inc. (NASDAQ:WSTG) Q3 2019 Earnings Conference Call November 6, 2019 10:00 AM ET
Melanie Caponigro - IR
Dale Foster - President
Charles Bass - VP, Marketing and Vendor Alliances
Michael Vesey - CFO & VP
Conference Call Participants
Good morning, ladies and gentlemen, and welcome to the Wayside Technology Group conference call. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to introduce your host for today's conference, Melanie Caponigro. Ms. Caponigro, please begin.
Thank you, and good morning. Welcome to Wayside Technology's Third Quarter 2019 Earnings Call. Before turning the call over to Dale Foster, the President of Lifeboat Distribution, I'll dispense with the customary cautionary language and comments about the webcast for this earnings call.
We released earnings for the third quarter at approximately 9:00 a.m. Eastern Time, Wednesday, November 6, 2019. 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 the rebroadcast will be available at www.waysidetechnology.com/site/content/webcast.
I'd like to remind you that certain comments made in this conference call and webcast are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Those statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning these risks and uncertainties is contained in our Form 10-Q and 10-K filed with the SEC. Wayside Technology Group, Inc. sees no obligation to update and does not intend to update any forward-looking statements. Our presentation also includes certain non-GAAP financial measures, including adjusted gross billings, non-GAAP net income and non-GAAP earnings per share. All non-GAAP measures have been reconciled to the most directly comparable GAAP measures in accordance with SEC rules. You'll find reconciliation charts in the earnings release and Form 8-K we furnished to the SEC.
Now I would like to turn the call over to Dale.
Thank you, Melanie, and good morning to everyone. I appreciate everyone joining us today for today's call and discuss our third quarter 2019 operating results. I would like to introduce the speakers for today that would be joining me: Mike Vesey, our CFO and VP of Finance; along with Charles Bass, our VP of Marketing and Vendor Alliances, will be on the call today to discuss the progress we're making in the - in Q3 results. In this quarter, we continued to execute on the plan that we set in motion over a year ago. The plan is fairly simple and has 2 operating - or 2 primary components. First, we invested in a territory field-based sales team and coverage model. And then second, we invested in a recruit team that is responsible for launching and growing new and emerging vendors. We continue to show progress on this plan as we are reporting our second consecutive quarter of double-digit growth in gross profit.
Our Q3 adjusted gross billings on a non-GAAP basis increased from $134 million to $149.1 million, an increase of 11% over the same period of 2018. Our gross margin dollars also increased to $800,000 or 12% from prior year's Q3. Our year-to-date results continue to show improvement, with gross profit up 12% to $22.1 million, and we just had a good - finishing up a good third quarter. Charles, could you talk more about the sales team and the emerging vendors?
Yes. Thank you, Dale. So we are now 20 months into the execution of our shift in strategy. We've been driving toward becoming a sales-led organization. And our strategy has focused on adding incremental field personnel and incremental vendor partners with a focus on cross-selling to our entire base of our customers.
We've made two significant related investments. First, we've built our field sales team into seven geographically assigned sales territories. In addition to these sales teams, we've also dedicated field sales resources specifically focused on strategic customer accounts. These teams have been fully integrated into the existing Lifeboat inside sales teams, and we've implemented aligned goals to ensure that we're effectively driving consistent cross-selling behavior.
Second, we've implemented a comprehensive vendor recruit plan. We've been using an establishment to recruit plan a methodology that's designed to work in concert with our outside sales teams, efforts to recruit resellers and cross-sell emerging technology brands to our partner base. We've used this vendor recruitment to evaluate over 300 new or emerging prospective vendors. And we've entered into contractual agreements with over 40 of those vendors based on a best fit for our go-to-market strategy. Both these investments in field sales and vendor recruiting are not point-in-time actions, but rather investments that we view as ongoing commitments to drive sales results.
I would now like to turn the call over to Michael Vesey, our CFO, to discuss our third quarter financial results.
Thanks, Charles. I'll review our financial results for the third quarter then discuss our balance sheet and liquidity. Overall, net sales for the quarter increased 9% to $52.4 million, compared to $47.9 million for the third quarter last year. Lifeboat Distribution sales were up 11% for the quarter to $48.8 million, while TechXTend sales were down 6% for the quarter to $3.6 million. Overall adjusted gross billings on a non-GAAP basis increased 11% to $149.1 million from $134.0 million in the prior year. The difference in growth rates between net revenue and adjusted gross billings on a non-GAAP basis is due to the change in mix of items recorded net of cost of sales under GAAP.
Gross profit for the quarter increased 12% to $7.1 million compared to $6.3 million for the same period last year. Lifeboat Distribution accounted for all of the growth in gross profit, increasing 13% to $6.4 million compared to $5.6 million for the third quarter last year. The increased gross profit at Lifeboat was driven by both incremental sales from new product lines and growth in some of our existing lines.
Gross profit from our TechXtend business remained relatively unchanged from the prior year. As discussed in previous quarters, the TechXtend business provides an opportunity for us to leverage our existing infrastructure and generate incremental profit contribution and cash flow. However, we believe our Lifeboat business provides the best opportunity for sustained growth. And accordingly, we have focused most of our sales and marketing efforts there.
Gross profit margin as a percentage of net sales increased to 13.5% compared to 13.2% in the third quarter last year. The change in gross profit margin was mainly due to the change in the percentage mix of products recorded on a net basis under ASC 606. 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 an effective 100% reported gross margin and items that are recorded on a gross basis, particularly reflecting a high single-digit profit margin. During the third quarter of 2019, approximately 9.3% of our net revenues were from security maintenance and other products, which are recorded on a net basis or an effective 100% gross margin, compared to 8% in the same quarter last year. This shift in product mix had the effect of increasing gross profit as a percentage of net sales by 120 basis points. This increase was partially offset by lower gross profit margins on software and hardware products recorded on a gross basis.
On a non-GAAP basis, gross profit margin as a percentage of adjusted gross billings remained constant with the prior period at about 4.7%.
Total SG&A expenses for the quarter increased by $200,000 to $5.1 million compared to $4.9 million for the same quarter in 2018. The increase is primarily due to increased salary and commission expenses at Lifeboat to support the increased sales.
SG&A expenses as a percentage of net sales for the quarter were 9.7% in 2019 compared to 10.2% in the prior year.
Income before the provision for income taxes of - was $2 million for the quarter ended September 30, 2019, compared to $1.7 million for the same period in 2018. During the third quarter of 2019, the company recorded a provision for income taxes of $600,000 compared to $400,000 for the same period in the prior year. The company's current period provision for income taxes was impacted by an increase in the provision for state income taxes for states which have enacted economic nexus statutes. As a result, net income for the quarter ended September 30, 2019, was $1.4 million compared to $1.3 million for the same period in 2018. Diluted income per share for the quarter ended September 30, 2019, was $0.32 compared to $0.29 for the same period in 2018.
Moving on to the balance sheet. We continue to manage a strong balance sheet and liquidity position with cash and cash equivalents of $10.2 million at the end of the period compared to $14.9 million at the end of 2018, and we have no outstanding borrowings under our $20 million credit facility. The decrease in our cash balance reflects an increased investment in working capital when compared to December 2018, reflecting seasonally lower payables due to year-end order volume and increased sales to one of our customers with extended payment terms. Stockholders' equity stood at $43.8 million compared to $40.6 million at the end of last year. Total working capital, including cash, was $40.6 million when compared to $36.2 million at the end of last year. We continue to run a capital-efficient business with return on invested capital of approximately 22% on a year-to-date basis for 2019 compared to 15% in the same period last year. We calculate return on invested capital by providing non-GAAP net income, excluding separation expenses, net of taxes, by our stockholders' equity, less cash. We continue to return a significant portion of our earnings to shareholders in the form of a dividend. On November 5, 2019, the Board of Directors declared a quarterly dividend of $0.17 per share of its common stock payable November 22, 2019, to shareholders of record on November 18, 2019.
So in summary, our quarterly results continue to show a payback in the investments we made in vendor recruitment and sales and marketing since the beginning of 2018, with revenues increasing 9% over the third quarter of last year and gross profits increasing $800,000 or 12% over the prior year. The results also demonstrate the leverage in those investments and scale in the business with more than 40% of our incremental gross profit growth dropping through to the pretax income line. And notably, this growth was driven by our core strategy of investing in vendor recruitment and field sales at our Lifeboat Distribution business. We also continue to strengthen our balance sheet while returning over half of our net income to shareholders in the form of a dividend.
I'll now turn it back to Dale. Dale?
Thanks, Mike. And as you can see, we've made some important progress this year in transitioning the company into a sales-first approach with a focus on vendor and customer relationships, and we're always enhancing our customer service to both our partners on the vendor side and the customer bar side. We have a great team here at Wayside, and we will continue to build on this success, along with targeting areas in the company that we can become more efficient, to increase our value to the customers and vendor partners.
In closing, I'd like to recognize our Board of Directors and shareholders for their ongoing support and encouragement as we continue to make progress executing our long-term strategic business plan.
At this time, I'd like to have the operator open the call up to our investor and the analyst community for questions.
[Operator Instructions]. Our first question comes from Josh Peters.
Really appreciate the progress that you're making in the business. Certainly, the year-over-year numbers look quite strong. I'm wondering if maybe you could comment on the difference in results between the second quarter and the third quarter. Honestly, I'm scratching my head a little bit trying to figure out why the stock is reacting so negatively here, and that's just about the only thing I can think of.
Yes. Let me make a comment on that. And then, Dale, if you want to add to what we can. But the - our business is not exactly linear from quarter to quarter. So it could be people compare results to the last quarter sequentially. As we've explained in the past, our businesses tend to be kind of a barbell when you look at the four quarters. In the first quarter of the year, one of our larger vendors has their yearend, so it tends to be a strong quarter for us. Fourth quarter is generally a strong IT spending quarter. And also, several of our vendors have their yearend at December 31, just because there's a predominance to that. And then the middle 2 quarters are usually the slower of the two.
So sequentially, our results don't always go up quarter-to-quarter. The way we like to look at it is we look at the trailing average of 4 quarters and chart that out. You'll see that the progress has been continual through the third quarter that we just completed. And also, you'll note that it's - I'd like to point out that it's in Lifeboat business. So going back to the beginning of 2018, we made a decision to focus on Lifeboat. So we saw a market opportunity to grow sustainably there on a capital-efficient basis. So the fact that the growth is skewed towards that end of the business, while certain other parts where we think there's not good long opportunities have been more flattish. People may not be seeing that through the numbers if they don't listen to the context on the call. So I think maybe that could all have an impact.
Yes, Mike. I agree with that.
Okay. Well, I appreciate the color. No, that's all I was going to say. But yes, please, whatever you'd like to add.
Yes, real quick. This is Dale. Like Mike said, I mean, it's not linear. And if you look at Q2, we have, like I said, as Mike said, the first quarter, we have vendors that drift over and their orders drift over into Q2 that get recognized. And then also, at the end of Q2 and June is the end of most state's fiscal year, so we have a lot of customers that sell into state and local government, so we'll see a bump there as well, and that's probably Q2.
And our next question comes from Peter Lux.
Seems to be some investors are waiting in the grass or the weeds to get out on your numbers. I've seen, during the quarter, you did some outreach to the investment community. Right now, it doesn't look like any of it has really stuck. What is your continuing plan to make this a viable company with the investment community and perhaps get some strong hands rather than weak hands into the stock?
Yes, I'll open that one up. And then, Dale, you can add on to that. Peter, as you know, because you've been kind of following the story continuously here, we made an investment in changing the direction of the business 2018 through 2019, and we started some investor awareness programs, mainly through conferences in 2018. And the successes have started to show through in - primarily in the second and third quarter of 2019. So I think we're at the point where we're continuing the exposure through conferences. We're in dialogues and meetings with people continuously. And as you know, the first meeting is an introduction. And realistically, people like to follow the story for a few quarters and talk to management probably 4, 5 times before they might actively take position in the stock. So I think we're continuing to go down the road of developing relationships with people, answering their questions as they follow our progress, trying to explain why we're investing in the areas of the business we are. And we're going to continue to just expand the communication. And as long as the business performs, we expect that the investors will have the opportunity to follow, but we are going to continue in creating awareness and have been doing this over the past 18 months, for sure.
Just one other thing. You guys - Dale seems to have taken the lead as President of Lifeboat. But does the lack of a CEO of the entire company sort of hinder where you guys are? And what's the ongoing thought about having a permanent CEO?
So two things. I'll take that. Number one, it doesn't hinder us in the company, right? If you look at the way that it's structured, Mike and I are taking the leadership roles. And just like you've seen us out there here into the marketplace and becoming much more aware to your first question, that you've seen the company in more conferences. And also, we're doing a lot of the meetings, as Mike mentioned. So at the end of the day, it's really the results that we need to work on. And then that's up to the Board as far as on the CEO and the search that's ongoing.
And at this time, there are no further questions. Please continue with any closing comments.
I think we're good at this time. Thank you, operator. And thank you, everybody.
Ladies and gentlemen, thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
Thank you. Bye, bye.