TSS, Inc. (TSSI) Q3 2019 Earnings Report, Transcript and Summary

Welcome to the TSS Third Quarter 2019 Earnings Call. My name is Adrianne, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded. I will now turn the call over to John Penver. John, you may begin.

Thank you, Adrianne. Good afternoon, everyone and thank you for joining us on TSS conference call to discuss our third quarter 2019 financial results. I'm John Penver, the Chief Financial Officer for TSS and joining me today on this call is Anthony Angelini, the President and the Chief Executive Officer of TSS. As we begin the call, I would like to remind everyone to take note of the cautionary language regarding forward-looking statements contained in the press release that we issued today. That same language applies to comments and statements made on today's conference call. This call will contain time sensitive information as well as forward-looking statements, which are only accurate as of today, November 14, 2019. TSS expressly disclaims any obligations to update, amend, supplement or otherwise review any information or forward-looking statements made on this conference call or the replay to reflect events or circumstances that may arise after the date indicated, except as otherwise required by applicable law. For a list of the risks and uncertainties, which may affect future performance, please refer to the company's periodic filings with the Securities and Exchange Commission. In addition, we will be referring to non-GAAP financial measures. A reconciliation of the differences between these measures with the most directly comparable financial measures calculated in accordance with GAAP is also included in today's press release. I will begin the call with a review of our third quarter results and then turn the call over to Anthony for his comments on the business and the changes we see coming. Now earlier today, we released a press release announcing our financial results for the third quarter of 2019, and a copy of that release is available on our website at www.tssiusa.com. Our third quarter results were very similar to our overall results in the second quarter where we did achieve higher revenues with the similar level of profits compared to the previous quarter. We had anticipated more growth from some new service lines in the third quarter and although we did record our first revenue from providing reseller services we will not see a material impact from this business until the fourth quarter as we will expand upon in this call a little bit later. Our core business is still down slightly compared to the prior year, largely due to some customer program changes and delays as well as some supply challenges on the integration business. Despite these challenges, we have been able to sustain positive EBITDA earnings throughout each quarter this year. Now the comparability of our results the previous year should take into account the power and cooling business in December 2018. The results for that business are included in the 2018 numbers, but not in our 2019 results. I'm going to reference the differences throughout my comments to assist you in understanding how our underlying core business is performing on a comparable basis. On a year-to-date basis, our core business revenues are down 6% compared to 2018 and our operating profit is down $395,000. Now one of our goals for 2019 is to replace the revenue and profit we had in our power and cooling business with increased revenue and profits from our core integration facilities maintenance businesses and with revenues and profits from these service offerings which Anthony will talk about shortly. So let me provide some more detail on our third quarter and our year-to-date 2019 results. Our revenue for the third quarter 2019 was $4.2 million. This compares to $6.4 million in the third quarter of 2018 and is up from $3.5 million in the second quarter of 2019. Our power and cooling business that we sold, contributed $1.8 million in the third quarter 2018. Now, our facilities business was down $1.7 million or 40% compared to the prior year, but absent the results for the power and cooling business, our facilities businesses was actually up $89,000 or 4% compared to the prior year based on a higher number of deployments in modular data centers this year. The system integration business is down $495,000 or 23% compared to the third quarter last year on lower levels of Rec [ph] and modular data center integration activities. On a year-to-date basis, our revenue of $12.4 million compared to $16.6 million in the same period of 2018. The power and cooling business contributed $3.4 million in the 2018 results. As I said, absent this business our year-to-date revenues are down $771,000 or 6% compared to 2018 with the decrease predominately being from lower volumes in our system integration business. Now volume within our system integration business can fluctuate significantly quarterly due to changes in customer demand including demand for modular data centers, component availability and other factors. And because of the fixed costs associated with operating integration facility, increasing of volume and inconsistency of volume within this business are key operating goal for us and our ability to improve this will be a key influence on our level of profit moving forward. We are actively seeking to add more customers and services to increase utilization of the system integration facility and to drive growth in our profits. Now let me briefly discuss our new reseller services that we commenced in the third quarter of 2019. We generate revenue from the fees we charge customers to procure third-party hardware, software and professional services on their behalf that are then used in our integration services as we integrate these components to deliver a completed system to our customer. We recognize our reseller services revenue upon completion of the procurement activity which is usually close to the date we ship the product. We recognized the revenue from the integration activities upon shipment of the completed system to the customer. Now in some cases we arrange for the purchase of third-party hardware, software, or professional services that are being resold directly to our customers including our OEM customer. In these instances, we are merely acting as an agent in the transaction and we recognize our revenues, the amount of any field commission that we expect to be entitled to from the transaction and which we recognized at the time that the product is sold through to the customer. Now the margins on reseller services are materially lower than for our traditional facilities and systems integration services. So the material growth in the volume of our reseller services will result in materially lower margins, gross margins for our business. In absolute dollars however, these transactions have the potential to drive significant growth in our level of gross profit and operating profit and in our ability to diversity our customer base as many of these new partners seek to take advantage of our integration services capabilities. So fluctuations in the volume of reseller activity might lead to material quarterly fluctuations in reported revenues and gross profit margins. And while gross profit margin of 36% during the third quarter of 2019 was lower than the 39% margin we had in the third quarter of 2018, and it is down from 41% from the second quarter of 2019. Year-to-date our margin of 37% in 2019 compares to 39% in the prior year and our margins continue to fluctuate based on the mix of services in a given period. The slightly lower margin mitigated the impact of our revenues this quarter from the previous and our gross profit of $1.5 million was $0.3 million lower than the third quarter of 2018 excluding the results of the power and cooling business. Now the year-to-date our gross profit of $4.6 million is $1.9 million lower than the $6.4 million we had in the first nine months of 2018, and if you exclude the power and cooling results from this comparison our year-to-date gross profit is down $0.6 million or 11% compared to the first nine months of last year. Our selling, general, and administrative expenses during the third quarter of 2019 were $1.4 million that's down $229,000 or 14% compared to the $1.65 million we had in the third quarter 2018. This decrease compared to the prior year really reflects the absence of operating costs of the power and cooling business in the 2019 number and our costs were up $54,000 from the second quarter of 2019 due to higher personnel recruiting related costs, but year-to-date our selling, general and administrative expenses are down $446,000 or 9% compared to 2018. After all the above, we recorded an operating loss of $12,000 in the third quarter 2019. This does compare to an operating profit of $771,000 in the third quarter of 2018 and an operating profit of $2000 in the second quarter of 2019. And if you exclude the results of the sold business from our comparable 2019 results, on a pro forma basis our third quarter 2018 would have shown an operating profit of $219,000 [ph]. After interest and tax costs, we have a net loss of $95,000 or $0.01 per share in the third quarter 2019. This compares to net income of 652,000 or $0.04 a share in the third quarter of 2018. On a pro forma basis, excluding our power and cooling business from our results, the comparable third quarter 2018 would have shown net income of $98,000 or $0.01 per share. Year-to-date our net loss was $220,000 or $0.01 per share and this compared to net income of $1.05 million or $0.07 a share last year, which on a pro forma basis would have been $175,000 or $0.01 per share in the first nine months of 2018. Now adjusted EBITDA, which excludes our interest tax depreciation, amortization and stock-based compensation was a profit of $157,000 for the third quarter of 2019. This compares to $168,000 in the second quarter of 2019 and adjusted pro forma EBITDA of $372,000 in the third quarter of 2018. Now looking to the balance sheet, as we commenced activities around our new reseller services, there's been some major changes in our balance sheet since we reported our Q2 results. So we purchased and resaved approximately $1.1 million in inventory in September in advance of shipping products to customers in October. This drive increases in our inventory and in our accounts payable. And as our level of reseller business increasing, this will likely result in large increases in our receivables, inventories, and our accounts payable as we manage the cash flows around these transactions. We continue to have strong liquidity, working capital, and stockholders' equity. There has also been some large changes in the balance sheet since we reported our fiscal 2018 results, due to the adoption of the new lease accounting standard under Accounting Standards Codification Topic ASC 842 that was effective on January 1, 2019. And under that new standard we are required to account for all our operating leases on our balance sheet, rather than off-balance sheet, as had been the norm. So upon adoption of this ASC 842, we recognized the $2 million right to use lease assets and the associated $2 million of leased liabilities on our balance sheet with effect of January 1, 2019. So we closed the quarter with $5.9 million of cash on hand down slightly from the $6.1 million we had at the end of Q2. And we had $6.2 million for reference into 2018. And net working capital position decreased by $598,000 compared to the end of 2018 which was almost entirely due to the adoption of the new lease accounting standard and recording a portion of those lease liabilities as account liability in accordance with GAAP. We do expect the working capital position will continue to fluctuate due to the timing of billings in our maintenance revenue contracts, but believe we have adequate liquidity to operate the business and provide the flexibility for us to explore potential opportunities as they arrive. We also in the first quarter 2018 added a $1.5 million bank revolving line of credit agreement to provide an additional source of liquidity, we have not yet drawn against that facility. So with that, I will now hand the call over to Anthony for his comments on our 2019 results and how we see the business moving forward into next year. Thanks. Anthony?

Right. Thank you, John. While the third quarter looked a lot like he second quarter results, the numbers really don’t tell you about the transformations we are taking within the business to expand our service offerings to help us grow our range of services and diversify our customer base. We have experienced a number of delays to deployment projects from our channel partner and in its end customers over the last several quarters that was primarily around the modular business. This impacts both of our operating segments as it delayed the integration of the product and the subsequent deployment activities. Despite these events that were mostly beyond our control, because of the work we have done over the last couple of years to control our overhead and fixed costs we have been able to lower the breakeven point for the company and therefore we are pleased that we were able to still achieve positive adjusted EBITDA for the 14th straight quarter despite lower than anticipated revenue levels. As John indicated, we recorded the first revenue from our reseller activities in September. The initial project started later than we anticipated due to a delay of some components. We are confident that this will drive substantial growth in revenue in our fourth quarter. As I quoted in our press release, we expect our fourth quarter revenue to be higher than the first three quarters combined as our reseller program ramped up. In addition, we expect the adjusted EBITDA to nearly double the first three quarters in 2019 combined. I indicated on our last call that the majority of our services are provided as value add on predominantly consigned material. We handle over $1 billion of hardware product a year, that is almost all conscientious. Our reseller activities will involve that, but some portion of this volume for our customers where we believe there is virtually no risk as we have delivery order in hand prior to procurement. We will procure and resell hardware, software, and professional services. The lower but profitable mark up of these purchases will incrementally add to our gross and operating profits and will require no additional overhead for us to process. We don't believe there will be any significant working capital requirements with this reseller business. As the volume of reseller business grows you should expect substantial growth in quarterly revenues, lower gross margins, but higher absolute gross profits as a result this program will have the added benefits of driving additional services revenue and establish relationships with new third parties that we believe will drive additional revenue opportunities. We are excited about the traction in additional opportunities that we are already seeing. In addition, we've added a senior sales executive to drive focus on this third party work into 2020. We are in the early stage and it is difficult to predict long-term how this will impact our business, but we do anticipate strong year-over-year revenue growth as a result of undertaking these services and we expect this to drive growth in our 2020 revenues and as well as gross profit and operating profit. Based on our current picture, we expect to end the year with revenue in the high $20 million to $30 million range and gross margins in the low 20% range, generating between $400,000 to $700,000 in net income or about $1.2 to $1.5 in adjusted EBITDA. As all of the areas we're focusing on have large growth opportunities, we feel we have great momentum exiting 2019 and into 2020. We are focused on execution of our goals and we believe that we will wrap up a successful 2019 with great momentum going into 2020. With that, we're happy to answer any questions you have.

Thank you. [Operator Instructions] And our first question comes from Ian Castle. Your line is open.

Hi, thank you. I have a couple of questions. The first one pertains to the reseller program. I was just curious kind of how that reseller program came about, yes, just curious about that?

Sure. Well, we've been working a number of different groups within our primary OEMs and what we've been able to do is, provide value added services in doing integration and deployments, et cetera, and now what we're doing with them is aggregating multiple partners into an overall solution that gets sold to an end-user. So that step in that process now has us procuring both hardware, software, and professional services aggregating that together and then putting that in an overall solution and selling that to an ultimate end-user.

Okay, and does the reseller program, has that pulled you into additional verticals with that customer or I'm just curious how that ties into the overall strategy?

Yes, so there's a number of benefits that comes out of this. So first off, from before our core services we attach our core service offering to each of those deals and in addition we now have relationships and establishing relationships every day with multiple other OEM partners, both in the hardware, software and professional services. And so we have opportunity with that group to develop because now we've got a master agreement with them we've got the ability to go and grow other opportunities with them that are third party based.

Okay and the last question I have is, so when you mentioned in your opening remarks, you hired a VP of Business Development, I wonder if you can give us a little bit more color into his role and what areas he will be addressing?

Sure, so as we've embarked on this process we obviously want to have a lot of focus on how do we maximize these other relationships that we're growing into, so there's really kind of three tenets that Matt [indiscernible] the individual we hired, that Matt's going to focus on. One is, as we develop these third party relationships through this OEM program, he is going to drive the additional revenue opportunities with those groups. In addition, we're still looking at other third-party OEMs, so he'll be focusing on that, and then as we look at potential M&A relationships to expand our service offering or diversify our customer base, he is going to be in that space. So those are kind of those three tenets. Karen [ph] is focused on continuing to develop the Dell opportunities and the growth in opportunities we have there. It is just that we saw so much in front of us, it was a great opportunity, luckily we were able to bring Matt on board and I feel like we have really strengthened our team and we've got a good opportunity to really exploit all those tenets.

Okay, excellent. Thank you.

All right, thank you, Ian.

[Operator Instructions] And we have no further questions. I will turn the call back over to Anthony Angelini for final comments.

So I really appreciate everybody joining this call. We've got a good attendance on the call that we can see, so that's good to see and I appreciate any question and really look forward to what we're doing in the fourth quarter and into 2020. So it is going to be an exciting time at TSS. So well, thank you very much and we will talk to you again in 2020.

Thank you, ladies and gentlemen, this concludes today's conference call. Thank you for participating, you may now disconnect.