TSS, Inc. (TSSI) Q1 2023 Earnings Call Transcript

TSS, Inc. (OTCQB:TSSI) Q1 2023 Earnings Conference Call May 15, 2023 4:30 PM ET

Company Participants

Darryll Dewan - President and Chief Executive Officer

John Penver - Chief Financial Officer

Conference Call Participants

Maj Soueidan - GeoInvesting

Operator

Ladies and gentlemen, good afternoon. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the TSS First Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. [Operator Instructions] Thank you. And I will now turn the conference over to John Penver, Chief Financial Officer. You may begin.

John Penver

Thank you, Abby. Good afternoon everyone. Thank you for joining us on our conference call to discuss the first quarter 2023 financial results. I am John Penver, the Chief Financial Officer for TSS. And joining me today on the call is Darryll Dewan, the President and Chief Executive Officer for TSS.

As we begin the call, I’d 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, May 15, 2023.

TSS expressly disclaims any obligation to update, amend, supplement or otherwise review any information or forward-looking statements made on this conference call 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. And a reconciliation of the differences between these measures with the most directly comparable financial measures that are calculated in accordance with GAAP is included in today’s press release.

Darryll will kick off today’s call with an overview, I’ll provide some detail on our first quarter 2023 results, and then I will turn the call over to Darryll to discuss our strategy and our direction going forward. Darryll?

Darryll Dewan

John, thank you very much. Hello, everybody. Earlier today, we released a press release announcing our financial results for the first quarter 2023. A copy of that release will be made available on our website at www.tssiusa.com.

Overall, we made great strides on our plan in Q1. Our plan can be summed up as, number one, operationally restructure our systems integration business, where we were in a loss-making position in the latter part of 2022 and we were not able to demonstrate to our key customer our ability to scale that business. We talked about that in our Q4 earnings call, and we’re going to continue to focus on that as we go forward. Number two, build out a high-level team. This will support our own ability to drive demand for our existing services. We rely heavily on a single large OEM customer, and we must be selling directly to end customers and in many cases, alongside our OEM partner. Number three, develop capabilities to build our core strengths and open up new markets to drive significant long-term growth.

Our first quarter results were largely in line with, although they were directly impacted by the slippage of two large reseller transactions, representing almost $600,000 in combined profit. We have or expect to close those transactions in the second quarter. While not in common with larger deals, we need to develop more pipeline recovered for these types of situations, something we commented on in our Q4 earnings call and something that we continue to focus on.

During Q1, we made significant progress to lower the run rate of our labor costs and to improve overall efficiency in our systems integration business, in particular. We’ve reduced our total headcount, including contract labor in this business by 25% since December 31, ‘22. And you will see the impact of this in our second quarter and beyond. Todd Marrott, Senior Vice President of Operations has done a lot to improve the efficiency of our factory and to return this business to profitability. Compared to the first quarter of ‘22, revenues in this business were up 90% as our rack and stack and our fulfillment activities both increased from higher customer demand.

We have also made planned investments during this quarter. We hired an experienced sales leader to drive revenue growth and business growth in both our facilities management and our systems integration business. We are looking to expand our customer base and generate more leads for our services, and we expect, over the next several quarters, you will see the benefits of these investments. We anticipate that our second quarter results will show a substantial increase in revenues and that we will return profitability.

I’ll dive into this further, but let me first turn it back to John to provide some financial detail. John?

John Penver

Thanks, Darryll. As Darryll said, looking at the first quarter, the results were really impacted by several reseller transactions that we had expected to close during the first quarter. One deal has revenue of $7.4 million and has already shipped in the second quarter. The second is anticipated to close at any time. These two transactions would have provided $600,000 of operating income and allowed us to have positive EBITDA in the first quarter. With these items moving into the second quarter, you should anticipate our revenue and profits to turn around in the second quarter.

So let’s look at the first quarter. Our total revenue for the first quarter of 2023 was $6.6 million. This compared to total revenue of $5.2 million in the first quarter of 2022 and compares to $10.9 million in total revenue in the fourth quarter of 2022. Increased revenue in our system integration business of $1.2 million was the primary driver of the growth compared to the first quarter of 2022. Changes in the level of procurement and reseller revenue are the main driver of change compared to the fourth quarter of ‘22, as our reseller revenues decreased from $5.9 million – or by $5.9 million. So that was $7.6 million in the fourth quarter of 2022 and $1.7 million in the first quarter of 2023.

Our facilities business, which includes our modular data center deployment and maintenance services, generated $2.2 million of revenue during the first quarter of ‘23. And this was $0.2 million or 8% higher than such revenue in the first quarter of 2022. This was $1 million or 83% higher than the $1.2 million we had in our facilities business in the fourth quarter of 2022 as we completed a large MDC deployment during the first quarter after having no deployments during the fourth quarter of last year.

The most significant change in Q1 was in our systems integration from both revenue and operational perspectives. Revenues, as I said, were $2.6 million in the first quarter of 2022. So we’ve seen strong growth of 90% compared to the prior year and 24% compared to the preceding quarter. This growth was driven by a substantial increase in our RAC business and from the large fulfillment project that drove further revenue growth.

Our RAC business has grown 80% compared to 2022 due to strong demand from our OEM partner. We anticipate that our level of integration services will stay at similar levels in the second quarter and help drive strong revenue growth later in the year. We’ve also restructured several processes within the business to improve labor efficiency, which is still our largest operating cost. The labor efficiency will be more visible in Q2. And our production schedule is still impacted by the availability of components needed in production, although these supply chain issues are not as severe as what we experienced in 2022.

Our reseller revenues of $1.7 million were the same as the level in the first quarter of 2022. As I said, they were down $5.9 million compared to the fourth quarter of 2022. The timing and volume of these resell and procurement transactions, is often beyond our control. During the first quarter of 2023, we had 31 reseller transactions, of which 25 are what we call agent transactions. There, we recognized GAAP revenue as the amount of our fees or commission that we have paid, and some of these agent transactions can be quite large. The growth and value of all the procurement and reseller transactions during the first quarter were $6.7 million. Put that into perspective that compared to $34 million of gross transactions in the fourth quarter of 2022 and $10.2 million in the first quarter of 2022. But based on the accounting treatment of the agent transaction, we recorded $1.7 million in revenue during the quarter. We recommend investors focus on the gross profit generated by this business, which we will also continue to report.

We financed most of these deals for a shorter period – for a short period of time. Higher interest rates impact this business and our interest expense associated with these transactions of $90,000 was down from $390,000 in the fourth quarter because of the lower gross value of the transactions that we financed. We increased our pricing for procurement services in the latter part of 2022 to account for the higher interest rates and to protect our earnings.

In total, our gross profit margin of 26% during the first quarter of 2023 was down from 32% in the first quarter of 2022, but it was up from 18% in the fourth quarter of 2022. Our gross profit margin is directly influenced by several factors, including the mix of revenues between systems integration, facilities and our reseller and the accounting of the reseller revenues. In Q1 ‘23, reseller revenues were 26% of our total revenue compared to 34% of total revenues in the first quarter of 2022, and our resale revenues have been skewed towards these agent transactions. And overall, the actual gross profits were up 1% compared to the first quarter of 2022 to $1.7 million.

Our selling, general and administrative expenses during the quarter were $2.3 million. This was up $533,000 or 31% compared to the $1.7 million we had in the first quarter of 2022. It was down from the $2.6 million we had in the fourth quarter of 2022. In the first quarter, we also recorded the remaining P&L impact of the leadership transaction – transition that occurred in ‘22, including our CEO transition and the addition of Todd Marrott. These non-recurring costs associated with these changes were approximately $180,000. We don’t expect to incur any Q2 expenses relating to leadership transition.

After the above, we recorded an operating loss of $665,000 in the first quarter of ‘23. This compared to an operating loss of $173,000 in the first quarter of 2022 and an operating loss of $723,000 in the fourth quarter of 2022. After interest and tax costs, we had a net loss of $796,000 or $0.04 a share in the first quarter as compared to a net loss of $308,000 or $0.02 a share in the first quarter of 2022. Our adjusted EBITDA, which excludes interest, taxes, depreciation, amortization and stock-based compensation, was a loss of $436,000 in the first quarter of 2023, and that compared to an adjusted EBITDA profit of $43,000 for the first quarter of 2023.

Turning to the balance sheet. Our balance sheet position remains healthy. The timing of events around our reseller transaction definitely has a material impact on the balance sheet, and the changes in our cash balances and the increases in deferred cost inventory are even payable since year-end are primarily due to the timing of cash receipts and payments related to reseller transactions. At the end of 2022, we were able to be paid by our customers for a number of reseller transactions, but we had yet to pay our vendors to those same projects. This resulted in an increase of approximately $14 million, now cash and accounts payable at the end of 2022, which reversed when we paid those vendors during this first quarter. This decrease in accounts payable was partially offset by a $7 million increase related to the procurement of inventory for a reseller transaction that we completed in April.

We continue to feel good about the strength of the balance sheet, and we are looking at ways to utilize it to assist us in growing future growth and cash flows. We believe we will have adequate trade credit available to us to continue financing the reseller activities as we grow the business during 2023 and beyond. Last week, we also renewed our revolving line of credit facility with SASSA Bank. This $1.5 million line of credit was extended for another 12-month term and provides us with additional financial flexibility as we attempt to diversify our customer base.

With that, I’ll give the call back over to Darryll for some comments and how we see the business evolving over the remainder of 2023. Thanks, Darryll.

Darryll Dewan

Hey, John, thank you. Okay. At the outset of the call today, I revisited our plan for TSS, and we’re moving quickly on all fronts. Let me kind of review that. Let’s begin with operational efficiency in our systems integration business. We are balancing our labor force, and that’s a real important thing to do because between the direct intent to lower our overall labor costs, we have improved the process flow in our assembly lines to gain velocity and provide for scale. Our confidence to do this was based on the strength of our customer relationships and the visibility that we are getting into upcoming product projects. We now get a better demand signal from our key customer, which helps us a lot. We had good progress in Q1, and this will play out over the balance of 2023. In Q1, we increased our rack and stack business by 80% compared to the first quarter a year earlier, 80%.

We are expecting to continue on this space and even expand the business from current run rates. We have also refocused on our competitive differentiation in the systems integration business. A key value to our customers is our flexibility and our capabilities in a combination of integration and deployment. There are other larger lower-cost integrators, but we performed in more challenging programs often associated with new offerings from our OEM customers are those that require greater levels of customization and more white glove service. As we invest in systems to run our factory more efficiently, we are mindful of the speed and flexibility that we have to onboard customer programs. This is a competitive differentiator. As we have honed in on this messaging, we are finding it resonates with our customers.

Second, we are building out our team with eight players. I mentioned Todd earlier. In his first six months with us as a leader in our SI business, Todd has made an immediate impact. Beyond Todd, we hired an experienced revenue leader for our facilities management business, we announced that today in the press release. And in five weeks ago, the conversations that I am involved with now are significantly more exciting and business impacting, I believe with our existing customer as well as new potential customers in this exciting space. We are maniacally focused on profitable growth in each of our business segments and rack and stack integration fulfillment in our resale business and our facilities management business.

Our facilities management business has a lot of potential, and we are in active conversations with potential new partners to expand this business. As a reminder, this business deploys and maintains pre-integrated and configured modular data centers. Growing this business takes time, and it’s important to note that it’s a longer term play compared to our integration and reseller services. Component lead times continue to be long and the process to sell enclosed modular data centers is complex. We consulted with industry leaders on this business, and we feel we are on the right track. Hiring a demand gen leader is a critical step, and we are excited about this space. We have a high level of urgency in the management team at TSS. And so while restructuring our systems integration business and bringing on new talent, we have begun to explore new market opportunities. It’s early days, but we believe there is demand for high-value integration paired with deployment and maintenance of critical infrastructure.

In summary, I joined TSS because I believe there is a significant opportunity to profitably grow our business. I have said that in our last call, and I am going to say it again because I believe it. I am more convinced about this business five months later. We have tried today to carefully explain the higher Q4 and Q1 costs we experienced and the steps we are taking to lower the run rate of those costs going forward. We are investing in the people, training systems and with sales demand gen to be able to profitably and substantially grow our company.

With that, let me turn the call back over to John, and we will go over any questions you may have. John?

John Penver

Okay. Actually, Abby, let’s see if we have any questions from our listeners.

Question-and-Answer Session

Operator

[Operator Instructions] And with no questions at this time, I will turn – I do apologize. We just received a question from Maj Soueidan with GeoInvesting. Your line is open.

Maj Soueidan

Hi Darryll. Thanks for the nice summary today. I just have a quick question again on – in terms of the diversification away from your largest OEM. I think you touched upon it, but I want to know more about like what your – what the plans are to do that? And how you are doing that? And what kind of customers we could expect that to be maybe in the future?

John Penver

Well, in particular, where you – when you say diversification, are you asking in general or you are asking about in an area of our business, like a system integration rack and stack or…?

Maj Soueidan

Yes. I think the similar integrations where I am really – we are really thinking about there.

John Penver

Okay. Well, Maj, I think you know that we take a demand signal from a customer and we jump. And we do everything we can to delight that customer and their end user. We will continue to do that, and we will do it with scale. So, we have the growth capability within our facility now through the good work that Todd has been leading to do more volume of that work. We are also expanding. And we have – as I mentioned, we hired, we have got a tremendous business development leader on the team now. He is going to help us with our Federal focus and also our OEM relationship with that particular customer. We are seeing early results of demand increasing and our sales force, if you will, our sales force implementation, how we track our pipeline, and that sector is doing better. Unfortunately, it’s never enough. No matter how good it is, it’s never enough, but we are improving. I think the exciting area that we are really digging into that we have opportunity and is in their modular data center business, in our facilities management business, there is a lead time that is required to get out in front of building these units or deploying these units, lead time for supply, if you will, and also a lead time to the selling process. And with the addition of Jim Olivier, who we announced earlier today, is our leader in that space, I have absolutely no doubt that Jim and Jim Woodward and our team teaming up will expand on the conversations we have had just a few weeks. So, let me give you a specific. There are consulting companies that influence the end user customer on whether – and what to buy in a modular data center. We haven’t ever talked to those people. We are now talking to them. That is an influence activity that I think hopefully will bear fruit. We are looking at having conversations with additional OEMs. And we have initiated some conversations there, which is exciting. And as we said many, many times, we need to go drive more demand beyond what we are doing today. We have been receiving, now we have got to get in the driver seat and make it happen. So, there are some areas in our business. We talked a little bit about the [indiscernible] business with a new bus dev leader. We are going to do more of that with our rack and stack business inside of our existing partner, our customer, help them sell and we will do a lot more exciting things with Jim’s leadership teaming up with Jim Woodward in the facilities management business. Hopefully, that gives you a little bit more insight.

Operator

[Operator Instructions] And with no further questions at this time, I would like to turn the call back to Mr. Darryll Dewan for closing remarks.

Darryll Dewan

Thank you. To everybody here, I appreciate, we appreciate, the team appreciates your support, your interest in what we do, being not profitable is not acceptable, period, end of story. But so to wrap this call up, I think we have got a plan. Hopefully, we have explained an update today where we are at with the plan. Thank you for participating today and certainly, we look forward to sharing our Q2 results with you and do order. So, thank you and keep safe.

Operator

Ladies and gentlemen, this concludes today’s conference call. We thank you for your participation. You may now disconnect.