TSS - Earnings Call - Q3 2020

Transcript

Operator (participant)

Welcome to the TSS third quarter 2020 earnings call. My name is Darryll and I'll 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. During the question-and-answer session, if you have a question, please press star then one on your touch-tone phone. Please note that this conference is being recorded. I will now turn the call over to John Penver. John, you may begin.

John Penver (CFO)

Thank you, Darryll. Good afternoon, ladies and gentlemen. Thank you for joining us today on TSS's conference call to discuss our third quarter 2020 financial results. I'm John Penver, the Chief Financial Officer for TSS, and joining me on the call today is Anthony Angelini, the President and 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 16th, 2020.

TSS expressly disclaims any obligation to update, amend, supplement, or otherwise review any information or forward-looking statements made on this conference call or 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 U.S. Securities and Exchange Commission. In addition, we will be referring to non-GAAP financial measures. A reconciliation of the differences between those measures with the most directly comparable financial measures calculated in accordance with GAAP is included in today's press release. So I will begin the call with a review of our third quarter 2020 results and then turn the call over to Anthony for his comments on the business and changes we see coming.

Now, earlier today, we released a press release announcing our financial results for the third quarter of 2020. A copy of that release will be made available on our website at www.tssiusa.com. Our third quarter results reflect a reversal of the negative impacts of the COVID-19 pandemic that we experienced during the second quarter of 2020. Programs and projects that have been delayed in Q2 due to the pandemic have been able to resume with some limitations, and the supply chain issues that we've been experiencing, particularly with our reseller business in Q2, have now been mitigated. We are still experiencing ongoing impacts from the pandemic but have had time to adjust our business practices and adapt while delivering and deploying our services for our customers. With the turnaround of these challenges, we were able to report very strong financial results for the third quarter of 2020.

Compared to the third quarter of 2019, our quarterly revenues increased by 397% or $16.6 million, so from $4.2 million in 2019 to $20.8 million in 2020. On a year-to-date basis, through nine months of 2020, our revenues have grown by 206% or $25.4 million, from $12.4 million in 2019 to $37.8 million in 2020. The majority of these increases come from the reseller business that we introduced in the third quarter of 2019. So in the third quarter of 2020, we had $15.8 million of reseller business from the total quarterly revenue increase of $16.6 million. For the nine-month period, we recorded $25.6 million of reseller revenues. The timing and volume of orders from our reseller business is still lumpy as we work to develop this incremental line of business, and we expect it to continue to fluctuate on a quarterly basis.

But by providing our reseller services, including the procurement of hardware, software, and services for our customers, we help drive additional integration services for our business as well as grow the top line. This helps with the utilization of our integration facility and is allowing us to add new customers, partners, and business relationships. We do generate lower margins on the procurement services compared to our integration and maintenance services. So growth from reseller services will result in lower gross profit margins but will drive increases in our actual level of gross profit and our operating profits. Absent this growth in our reseller business, revenue from our traditional integration and facilities business units improved by 21% or $0.9 million in the third quarter of 2020 compared to the third quarter of 2019.

These business units also saw strong growth compared to our second quarter results, and in fact, revenue from these two business units increased by $1.5 million or 43% as we were able to recommence deployment of modular data centers and from growth in our systems integration unit. On a year-to-date basis, our facilities business revenues are still down 19% or $1.5 million compared to the same period of 2019, showing the negative impact on this business from the COVID-19 pandemic, where travel and other site restrictions delayed us in performing the deployment of modular data centers. A number of projects continue to get deferred, and we expect full-year results to be down for this business unit as a result. Year-to-date revenues in our traditional systems integration business increased by $1.4 million or 29% compared to 2019.

Although this business was impacted in particular in Q2 by supply chain challenges, these challenges dissipated in the third quarter and helped drive strong growth in this business unit. We have continued to operate our production facilities through this COVID-19 pandemic and incurred much higher operating costs in labor and other services as we adapted to operate in a socially distanced way that protected our workforce and allows us to still meet our customers' needs. We also incurred additional costs this year as we onboarded new business from an OEM partner, and we've been working to reduce these incremental costs as we get experience with our new operating normal.

Our overall level of operating expenses is higher than in 2019 as we added additional staff in 2020 to deal with the pandemic, to prepare for growth in the business, and to assist the activity of our sales team to drive new customer acquisitions. We believe we've made significant progress in the development of new customer opportunities despite delays related to the change in business activity due to the pandemic. On our last call, we indicated that the third quarter would show improvement compared to the second quarter as the COVID impacts reversed. We would expect moving forward, our quarterly results will begin to normalize as we have less impact from the pandemic. Our level of reseller materials could change materially on a quarterly basis, and we do expect them to be lower in the fourth quarter than the third quarter.

We expect we will continue to be able to operate the business profitably despite the fluctuating revenues as we move forward. We did benefit in Q2 from the receipt of almost $890,000 in loan proceeds from the Small Business Administration's Payroll Protection Program of the Coronavirus Aid, Relief, and Economic Security Act of 2020, or the CARES Act. We applied to the lender for forgiveness of some or all of this loan amount during the third quarter, with the amount which may be forgiven equal to the sum of our eligible payroll costs covered rent and utilities incurred by us during the eight-week period following the effective date of this loan, calculated in accordance with the terms of the CARES Act. We've not yet received notification of forgiveness, but we anticipate that we will get this in the fourth quarter of 2020.

Now, there can be no guarantee, however, that we will receive forgiveness for any fixed amount of the loan proceeds received. So let me provide a little bit more detail into the third quarter results. Our revenue for the third quarter was $20.8 million. This compared to $4.2 million in the third quarter of 2019 and $6.4 million in the second quarter of 2020. Our third quarter 2020 revenue included $15.8 million from our reseller activities. Our facilities business was down $0.2 million, or 8%, compared to the third quarter of 2019 as travel and site restrictions imposed due to the COVID-19 pandemic caused a number of customer deployments of modular data centers to be delayed.

The systems integration business revenues were up 1,032%, or $16.8 million, compared to the third quarter of 2019, as our 2020 number included $15.8 million from the IT reseller services, which we had only just begun offering in the third quarter of 2019. Absent this reseller business, our system integration business was still up $1.1 million, or 72%, compared to the third quarter of 2019, mainly due to additional revenues from onboarding a new business unit for one of our OEM partners. On a year-to-date basis, our 2020 revenues of $37.8 million are up by $25.4 million, or 206%, from the $12.4 million we had in the first nine months of 2019.

This increase primarily reflects $25.5 million of reseller services in 2020, a $1.4 million, or 29%, increase in integration service revenue offset by a $1.5 million, or 19%, decrease in our facilities revenue, which was primarily due to that inability to provide the deployment services as travel and other customer restrictions emanating from the pandemic prevented us from completing services. Supply chain challenges in our system integration business meant that approximately $8 million of reseller revenues moved from the second quarter into the third quarter of 2020, which also helped drive the increase in revenues this quarter. Increasing and maintaining the volume of business and the stability of volume in our systems integration business is a key to us sustaining and increasing operating profits for the company because of the fixed overhead cost associated with operating the integration facility.

As we've witnessed in 2019 and again this year, volumes can fluctuate significantly on a quarterly basis due to changes in customer demand, including demand for modular data centers, component availability, and other factors. We're actively seeking to add more customers and services to increase the utilization of the system integration facility and to drive growth in our profits, and our reseller service is one of the ways in which we hope to accomplish this growth. Our gross profit margin of 13% during the quarter was down from 36% in the third quarter of 2019. The impact of our reseller services on our margin is the main factor that causes this year-over-year decrease. Margins on our core business did decrease compared to the previous year because of continued higher operating costs in our integration facility during the quarter.

We incurred significantly higher labor and safety costs to safely operate our facility during the pandemic, as well as higher facility costs as we temporarily added additional storage and workspace to continue operating. As we've gained more experience operating through the pandemic, we're seeing these costs come down, and we're returning to more traditional levels. Our selling general administrative expenses during the third quarter of 2020 were $1.7 million. They're up $243,000, or 17%, compared to the $1.4 million we had in the third quarter of 2019. Our headcount-related expenses were higher than in the prior year as we invested in additional personnel to drive new customer acquisitions and to improve our sales operations that will benefit our future periods. We had higher facility costs but experienced lower travel expenses because of the pandemic.

Year-to-date, our operating expenses of $5 million were $710,000, or 17%, higher than the $4.3 million we had in the first nine months of 2019. After all the above, we recorded an operating profit of $966,000 for the third quarter of 2020. This compared to an operating loss of $12,000 in the third quarter of 2019 and an operating loss of $949,000 in the second quarter of 2020. After interest and tax costs, we had net income of $852,000, or $0.05 per share in the third quarter of 2020, compared to a net loss of $95,000, or $0.01 per share in the third quarter of 2019. On a year-to-date basis, our net loss in 2020 is $558,000, or $0.03 per share, and that compared to a net loss of $220,000, or $0.01 per share in the first nine months of 2019.

Our Adjusted EBITDA, which excludes interest, taxes, depreciation, amortization, and stock-based compensation, was a profit of $1,142,000 in the third quarter of 2020. This compared to an Adjusted EBITDA profit of $157,000 in the third quarter of 2019, and year-to-date, our Adjusted EBITDA profit of $369,000 compares to an Adjusted EBITDA profit of $528,000 for the first nine months of 2019. Now, turning to the balance sheet, with our strong third quarter operating performance, our balance sheet position remains strong. The timing of events around our reseller transactions definitely has a material impact on the balance sheet, and the increases in our cash balances and the changes in receivables, inventory, and payables since the last quarter are all due to the timing of reseller transactions.

Compared to our prior year-end balance sheet, our total cash position is up about $0.8 million, and we ended the quarter with $9.5 million of cash and equivalents on hand. This was up from $7.1 million at the end of the second quarter. To date, we've been able to structure our reseller transactions in such a way as to minimize their overall impact on our liquidity by using trade creditors as the primary way to finance these activities. However, due to timing, it's possible to see fluctuations on a quarterly basis for reseller contracts in progress at the end of a particular reporting period. We currently believe we have adequate trade credit to continue financing our reseller activities as we grow this business during 2020 and beyond.

It is possible, as this business evolves and as we introduce new partners and customers, that we may need access to additional credit to continue growing this business. Our net working capital position is basically unchanged compared to the end of 2019, and overall, we retain a healthy balance sheet. We do evaluate alternative sources of funding that may be necessary to help us continue to grow the reseller business as different customer opportunities present themselves to us. We helped finance our 2020 operations through the loan proceeds we received from the PPP program, and we have applied for forgiveness of this loan in the third quarter, but we've not yet heard back from the lender with regard to the forgiveness.

We anticipate we'll hear back on the fourth quarter about the forgiveness of this loan, although there can be no guarantee we'll receive forgiveness for any or all of these proceeds. So with that, I will hand the call over to Anthony for his comments on the third quarter results and how we see the business going forward. Thanks, Anthony.

Anthony Angelini (President and CEO)

All right. Excuse me. Thank you, John. Wow. This was a record quarter for TSS during my tenure. It shows we have the ability to deliver a very high level of revenue and profitability on a quarterly basis and can be a model for us going forward. While some of this was a makeup for some of the delayed projects in the second quarter, it shows our ability to deliver and scale to a much higher level. I think we are all ready for 2020 to end in the next six weeks. We have all adapted our businesses to this new environment, and while the potential for vaccine is improving, we believe most of 2021 and possibly beyond will exist in what we now call the new normal. We are preparing for that, and our protocols and safety steps are assuming a relative status quo for the next year.

We expect our revenue and profit will continue to grow as we look at certain trends that we are engaged in and working with not only our primary customer but others. Our infrastructure and delivery models reinforce our ability to make a difference. While it might not seem sexy, our ability to grow and allow our customers to deliver their solutions is very strong. As John mentioned, we finished the quarter with excess of $9 million in cash. We expect to receive the proceeds of the PPP program, not guaranteed, of course, but we have met all the criteria. All our payables are current, and we believe we have opportunities to use this solid balance sheet to add to our enterprise in the coming quarters.

Although progress with some market-leading new logos has been slower than we thought, they are progressing as companies realize the value that we can help them deliver during these times and into the future. I can't wrap up without touching a few things. We believe our revenue will be around $8 million in the fourth quarter, and we should be Adjusted EBITDA profitable. There is an exceptional thank you to our employees who have delivered day-on-day despite very, very challenging circumstances. We are evaluating the future and how we make the enterprise reach the very higher goals that we have set for ourselves internally. With that, I'll open it up for questions.

Operator (participant)

If anyone has a question, you can press star then one on your touch-tone phone. Once again, if you have a question, it's star then one on your touch-tone phone. I'm standing by for questions. Once again, if you have a question, it's star then one. We have a question from Mark Levinson. Go ahead, Mark.

Yes. Thank you, and congrats on a really nice quarter. Just had a question again. What was your—I just listed the cash on hand at this time.

Anthony Angelini (President and CEO)

$9.5 million as of the end of the quarter.

Right. Okay.

Is that right, John?

And.

John?

John Penver (CFO)

Yeah.

Yeah. And why do you anticipate needing to raise more money now?

Anthony Angelini (President and CEO)

No. Well, one of the things we explained as we went into the reseller program, and we're not saying we're going to raise more money. We're just saying that as we expand the reseller program, and we've been able to do it on a very, very good cash-to-cash cycle, that there's opportunities that come in front of us that are in the tens of millions of dollar range. And with some third-party new logos, so in some cases, we may be in a position where we need additional working capital to finance those transactions so we can take advantage of those and get the incremental income from them. So that's really. I mean, it's not a "equity issue" as much as it is a. Do we have the ability from our balance sheet to take on $30 million deals, as an example, in a quarter?

I see. Okay. So that would be a good thing then. Sort of that would be a good thing.

Right. It's the right thing you want to be able to go do. Right. You want to be able to go do that in your business and take on those opportunities. We also are very cognizant that we don't want to do dilution. So we're very, and especially in this market where it's a little interesting, but obviously, financing costs are down, right? So debt costs are down. So we believe we could take advantage of some of that opportunity, but we also don't want to lose the chance to grow significantly with some new logos because we don't have enough working capital to finance. Thanks. Exactly.

Okay. Appreciate your help. Thanks for taking the time to answer my questions. Thank you.

You got it.

Operator (participant)

Our next question comes from Roger Nedrow. Go ahead, Roger.

Yeah. That was a good quarter, Anthony. You got a forecast of $8 million and some change for the fourth quarter. Was the big third quarter all just completing stuff that was kind of postponed in the second quarter? And what kind of a normalized quarter can we look for if 13 point whatever in the third quarter was way high and 8 point something in the fourth quarter? Is there some kind of a number that you can come up with that was kind of a normalized quarter? Is it going to be $8 million every quarter? Is it going to be $10 million every quarter? Unless, obviously, we get some new business.

Anthony Angelini (President and CEO)

Yeah. It's a very, very difficult question to answer in this environment, right? We wouldn't have expected our second quarter to be as low as it was, but we had the pandemic kick in, right? And then we were able to make up and move a lot of that business into the third quarter. So from quarter to quarter, we're still evaluating how these fluctuations occur. So I would suspect that us being in the $8 million-$12 million range per quarter on average, by the way, the fourth quarter also includes a lot of holidays, which makes up, right? So I would expect that our goals are to be in that $8-$12 for going into 2021 per quarter. And so kind of putting us at this $35 million-$45 million revenue range, and then it all comes down to the mix. But we haven't given guidance for 2021.

I mean, there's a lot of stuff still happening in the environment, so we don't know is the winter going to be real soft because the cases are up and we can't get on sites to go do work, and so some of that gets pushed. I mean, it is a pretty crazy dynamic environment right now, to say the least, right? But I think our third quarter showed that we have the ability to go figure out some of those things, albeit it took us from the second quarter to the third quarter to do it. So we're now in a position that we can show we can deliver a $20 million quarter and $1.1 million-$1.2 million a quarter in EBITDA. I mean, that's what we're building the business for. So now we just have to align that.

And again, the macro environment is really the question mark. I don't think it's. I think our business model is solid, and I think the growth areas that we have within the business model are good. I think the challenge is what's the macro environment look like?

Good. So if our revenues are $8 million and some change, you fully expect to be profitable, whether it's $0.02, $0.03, or $0.04 for the quarter. It probably won't be the $0.05 that we made in the third quarter, but it could, I mean, on the low end, maybe $0.02, maybe on the high end, $0.04.

Yeah. John, help me there.

John Penver (CFO)

Yeah. Yeah. I mean, I think that's a reasonable assertion.

Okay. Okay. All right. Thank you.

Anthony Angelini (President and CEO)

All right. Thank you.

Operator (participant)

And once again, if anyone has a question, you can press star then one on your touch-tone phone. Once again, that's star then one on your touch-tone phone. And we have no more. Oh, wait. We do have a question. Hold on.

Roger Nedrow wants to ask another one.

Yep. Here comes Roger. Roger, go ahead.

Anthony Angelini (President and CEO)

Let's go, Roger.

Do you guys have any intentions of being able to present your company and what you're trying to accomplish and where you're going into the investment community somewhere? I think there was a report that was issued not too long ago by somebody that had done a little homework on TSS and wrote a little report. Is there some chances to maybe get into some ultra small-cap brokerage firm houses that might pick coverage up of TSS?

Yeah. So we have actively been evaluating how do we best do our investor relation work. And so we're looking at doing a number of conferences. I mean, conferences have gotten a little disjointed, right, because they're not live anymore, right? So we're actively looking at, do we on a quarterly basis sort of do a microcap or something conference that helps get some visibility into the space of the people that are most likely to be investors for us, right? So we are looking at that. Obviously, at the end of the day, the most important thing for the investors and for us is that we deliver on numbers, right? As long as we're, right? We hit numbers.

Agreed. Agreed.

Right? Right? So that's, but we are exploring that.

Okay. Yeah. I don't want to sell short your company, and I'd rather have you under-promise and over-deliver than vice versa.

Right. Credibility is number one.

Correct.

Right?

Okay. Thanks. Keep up the good work.

Okay. Thank you.

Operator (participant)

And once again, if you have a question, you can press star then one on your touch-tone phone. And we have no more questions.

Anthony Angelini (President and CEO)

Nope. No more questions. Okay. Thanks, Darryll. Hey, first off, I want to thank everybody for sticking with us here. We have. This has been an interesting year, like I said. We're six weeks away from hopefully 2020 ending. I mean, it just has been a crazy year, to say the least. Appreciate your patience as we've moved things around and worked to deliver. I mean, one of the biggest things, another takeaway for all of you, is we've continued to operate and have our people in the field and in the factory doing work through all of this. So there's a big kudos and thank you to all of them who have had to join together and put themselves at some risk, right? I mean, it'd be easier to stay home locked in a room, I guess. But we feel like we've got the business on track.

We feel like the markets that we're stepping into, including the 5G market and the edge rollouts, are going to bode well for us in the future. So long, thank you, but everybody stay safe and stay healthy, and with that, we'll end the call.

Operator (participant)

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