TSS, Inc. (OTCQB:TSSI) Q3 2023 Earnings Conference Call November 14, 2023 5:00 PM ET
Company Participants
John Penver – CFO
Darryll Dewan – President & CEO
Conference Call Participants
Operator
Good afternoon, everyone. My name is Briana, and I will be your conference operator today. At this time, I would like to welcome you to the TSS Third Quarter 2023 Earnings Call. Please note that this call is being recorded. All lines are now in listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
I will now turn the call over to John Penver, Chief Financial Officer. Please go ahead, sir.
John Penver
Thank you, Briana. Good afternoon, everybody. Thank you for joining us on TSS’ conference call to discuss our third quarter 2023 financial results. I’m John Penver, the Chief Financial Officer of TSS. And joining me today on the call is Darryll Dewan, the President and Chief Executive Officer of TSS.
As we begin the call, I would like to remind everybody 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 13, 2023. TSS expressly disclaims any obligations 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 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 also included in today’s press release.
Darryll will kick off today’s call with an overview, and then, I’ll provide a review of our third quarter results and then turn the call back to Darryll to discuss our strategy and direction. Thank you, Darryll.
Darryll Dewan
Thanks, John. Earlier today, we released a press release announcing our financial results for the third quarter of 2023. A copy of that release will be made available on our website at www.tssiusa.com. Overall, we achieved very good financial results in Q3. We’re balancing, maintaining, sustaining profitable operations while simultaneously making strategic investments in our future, so we can propel TSS to greater levels of revenue and profitability.
We have diligently explored a variety of options to expand our business, both internally with our group of global OEM partners and externally into new markets with additional capabilities. We are confident that we are — that there are substantial growth prospects to be realized with both our current and prospective customers. However, achieving our ambitious goals necessitates a fresh perspective within TSS and a more extensive sales organization.
To this end, we’ve appointed Jim Olivier as the Chief Revenue Officer to lead our sales and spearhead strategic business development initiatives. As part of Jim’s initial efforts, we have made significant investments in new sales personnel to drive — to take advantage of the growth potential in our primary businesses and introduce new service capabilities to the market by 2024.
Since we last spoke, we have been working on several initiatives that I’ll summarize now and elaborate a little bit more later in the call, including the following. We have been making investments in marketing, sales positioning and enablement. A large part of our revenue comes through our OEM channels, and so one of our biggest challenges is that end user customers are unaware of TSS and the value we deliver as part of an OEM solution.
We endeavor to engage with those end customers as subject matter experts alongside our OEM partners as we are investing in marketing and PR to make our value more visible. In parallel, we will be working in 2024 to ramp Investor Relations activities in order to make our value clear to the investment community.
We will soon announce a new set of service capabilities, extensions of what we do today that our existing customers can utilize and that it also opened up new markets on our current customer base. We expect to close this year with strong growth in revenue, net profit and EBITDA compared to 2022. Our Q4 revenue opportunities could result in revenue growth as high as 60% for 2023 the full year.
So John, let me turn it back over to you to provide the financial detail. Thank you. Did we lose, John?
John Penver
Thank you, Darryll. Sorry about that. As Darryll said, looking at our third quarter results, the results were very strong with year-over-year growth in revenue and gross profit and another quarter of strong operating profit and adjusted EBITDA. Our revenues year-to-date are up 52% compared to the first three quarters of 2022. And despite higher operating expenses as we funded a number of strategic initiatives during 2023, we’re able to maintain our adjusted EBITDA as well.
So let me go into some of the details. Our total revenue for the third quarter of 2023 was $8.9 million. This represents growth of $0.8 million or 10% compared to the total revenue of $8.1 million in the third quarter of 2022. This is down from the $14.5 million of revenue we had in the second quarter of 2023. The growth compared to the third quarter of 2022 was primarily from a $2.3 million increase in our procurement and reseller activities compared to 2022, offset by a $1.5 million decrease in our facilities revenues as the number of new modular data center deployments has fallen since 2022.
The decrease from the prior quarter was due to a $5.2 million decrease in our procurement and reseller activities and a $0.7 million decrease in our systems integration revenue as our OEM demand fell. The fluctuations in the level of transactions in our procurement and reseller business have the largest impact on the changes in our quarterly financial statements.
As I just indicated, the most significant change in the third quarter compared to both the prior year and the immediately preceding quarter was from the changes in revenue and profits from our procurement and reseller services. The timing and volume of these reseller and procurement transactions is often beyond our control.
During the third quarter of 2023, we had 64 reseller transactions, 53 of which are what we call agent transactions, where we recognize GAAP revenue as the amount of any fee or commission that we have paid. The gross value of some of these agent transactions can be quite large.
In fact, the gross value of all the procurement and reseller transactions processed during the third quarter was $41 million compared to $24.4 million in the third quarter of 2022. But based on the accounting treatment of agent transactions, we recorded $5.4 million in revenue during the quarter. We recommend investors focus on the gross profits generated by this business, which we’ll continue to report.
We financed most of these procurement and reseller transactions for a short period of time. Higher interest rates do impact this business and our interest expense associated with these transactions of $661,000 during the third quarter was up substantially from $262,000 in the third quarter of 2022 because of higher interest rates and the higher gross value of transactions financed. Now 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.
Our systems integration business was flat compared to the third quarter of 2022 and offset by a decrease in MDC fit-out revenues as the level of MDC deployments have decreased. Our rack integration revenues are up 47% or $1.3 million in 2023 due to higher pricing despite flat year-over-year demand from our OEM partners. Our facilities business, which includes our modular data center deployment and maintenance services, generated $1.8 million of revenue during the third quarter of 2023. And this was $1.5 million or 46% lower than such revenue in the third quarter of 2022.
Our recurring revenues from maintenance contracts have increased by 30% since 2022 due to a higher number of MDCs under annual maintenance contracts. This has helped offset part of the $3.6 million decrease in onetime deployment project revenue as the number of new deployments has fallen compared to 2022. We anticipate that our level of rack — system integration services, particularly rack integration, will continue to be slow in the fourth quarter of this year before rebounding next year based on forecast from our customers.
During the third quarter, we adjusted our staffing levels in the integration business to reflect decreased demand and to ensure we effectively manage our labor costs, which is our largest operating cost in the integration unit. Our production schedule is still impacted by the availability of components needed in production, particularly with regard to service for AI and for fiber optic cables, delaying projects for our integration business.
Now for the nine-month period ended September 30, 2023, our total revenues of $30 million are up by 52% or by $10.3 million from the $19.7 million that we had in the first nine months of 2022. As with the trends in our Q3 revenue, the growth in 2023 has been driven by a $12.1 million increase in our procurement and reseller business, a 31% or $1.6 million increase in our integration revenues and a decrease of $3.4 million or 38% in our facilities revenue from the decrease in MDC deployments.
During the first nine months of 2023, we actually processed 140 procurement and reseller transactions. And of these, 113 were agent-type transactions. The gross value of transactions possessed in the first nine months of 2023 was $90.5 million, and that translated into $17.7 million of revenue for GAAP purposes and $3.5 million of gross profit.
If you compare this to the first nine months of 2022, we processed 61 transactions, of which 55 were agent-type transactions. And the gross value of those transactions processed in 2022 was $39 million, and that translated into $5.6 million of reported GAAP revenue and $1.1 million of gross profits.
Our gross profit margin of 32% during the third quarter of 2023 was down from 34% in the third quarter of 2022, but it was up from 22% that we reported in the second quarter of 2023. Our gross profit margin is directly influenced by several factors, including the mix of revenues between our systems integration, facilities and our reselling activities.
And as this reselling business represents a larger portion of our total revenues, we expect our total gross margin to decrease as a result. So in Q3 ’23, reseller revenues were 61% of revenues compared to 39% of revenues in the third quarter of 2022, and these reseller revenues were skewed towards these agent-type transactions. Overall, the actual gross profit increased by 2% compared to the third quarter of 2022, and it was $2.8 million.
Year-to-date, in 2023, our gross profit margin was 26% compared to 36% in the first nine months of last year. And the decrease in margins is because of the higher proportion of our total revenues coming from procurement and reseller activities in 2023. These revenues have represented 59% of our revenue in 2023 compared to 29% of our revenues in the first nine months of 2022. In dollar terms, our gross profit has actually improved by $0.7 million to $7.7 million this year, up from $7 million in the first nine months of 2022.
Our selling, general and administrative expenses during the third quarter of 2023 were $2 million, and that’s up $217,000 or 12% compared to the $1.8 million that we had in the third quarter of 2022. Year-to-date, our selling, general and administrative expenses of $6.5 million were up $1.3 million from $5.2 million in the first nine months of 2022. These increases were primarily in higher headcount costs, including cost investments made as we’ve expanded our sales and leadership teams during the last year to help position the company for future growth.
And after the above, we recorded an operating profit of $715,000 in the third quarter of 2023. This compared to an operating profit of $871,000 in the third quarter of 2022. For the nine-month period ended September 30, 2023, our operating income was $1,025,000 compared to an operating profit of $1,637,000 in the first nine months 2022.
Our interest costs increased substantially during the third quarter. As I explained, the increase is due to the financing costs associated with funding procurement and reseller transactions. $587,000 of our interest expense in the third quarter was related to these procurement and reseller transactions. This compared to $224,000 in the third quarter of 2022.
You should expect large fluctuations on a level of interest expense as long as the volume and value of our reseller transactions continue to fluctuate quarterly. And as I said earlier, the gross value of transactions financed during the third quarter was $41 million compared to $24.4 million in 2022.
After interest and tax costs, we had net income of $209,000 or $0.01 per share in the third quarter of 2023. This compared to a net income of $605,000 or $0.03 a share in the third quarter of 2022. And for the nine month period, we had a net loss of $262,000 or $0.01 a share compared to net income of $1,068,000 or $0.05 a share in the first nine months of 2022.
Our adjusted EBITDA, which excludes interest, taxes, depreciation, amortization, stock-based compensation, was a profit of $940,000 in the third quarter of 2023. That compares to an adjusted EBITDA profit of $1,043,000 in the third quarter of 2022. For the nine month period ended September 30, 2023, our adjusted EBITDA was a profit of $1,727,000. This compares to an adjusted EBITDA profit of $2,202,000 in the first nine months of 2022.
Now turning to the balance sheet. Our balance sheet position remains healthy. The timing of events around the reseller transactions definitely has a material impact on our balance sheet. And the changes in our cash balance and the increases in our accounts receivable, inventories, accounts payable and deferred revenue since the prior year are all primarily due to the timing of cash receipts and payments related to reseller transactions. The volume of reseller activities was higher at the end of the third quarter of 2023 compared to both the third quarter of 2022 and the end of fiscal ’22.
At the end of this most recent quarter, we were able to be paid by our customers for a number of large procurement projects, but we had yet to recognize revenue or to pay our vendors for these same projects. This resulted in an increase of approximately $11 million in our deferred revenue and approximately $10 million in our outstanding payables at September 30, 2023, compared to September 30, 2022. And compared to our financial year-end ’22 balances, our deferred revenues have increased by $11 million, and our receivables have increased by $4 million because of the higher level of reseller activities, helped driving the $8.3 million increase in cash during 2023.
As we ship these projects and recognize revenue during our fourth quarter, you should anticipate a large decrease in our payables, deferred revenue and our cash on hand at the end of 2023 compared to the balances at the end of September.
With that, I will now hand the call over to Darryll for some additional comments on the business and how we see it evolving in 2024. Thanks, Darryll.
Darryll Dewan
Thank you, John. During the previous earnings call, I shared an update on our company’s strategic focus and progress. I want to ensure that I continue to remind everyone of our key areas of focus and provide updates on our progress. Our goals are to improve our systems integration processes and business model, pursue and place talent to prepare for and accelerate our growth and develop a strategy to capitalize on emerging trends in the markets. I’m happy to report that we’ve continued to make solid progress in each of these areas.
We have modernized our integration facility here in Round Rock, Texas. We can now service 4 times to 5 times the level of rack integration business at less cost than before with fewer and more skilled TSS personnel. We’re working closely with our OEM partners to share our insight into the complicated requirements of these solutions, including form factors, cooling and deployment, which results in our ability to rapidly embrace emergency technologies such as AI and direct liquid cooling.
We have been focused on building a high-caliber leadership team that can drive our existing business while exploring new opportunities. We’ve made substantial progress on this front with several key hires. With this team in place, we’re confident in our organization’s ability to realize our goals and take on new challenges. The progress of our organization is inextricably linked to our ability to attract and retain top-tier talent.
Today, what excites me and the team at TSS is that our services and solutions provide IT users with a level of customization that is unparalleled in the industry. Our core value prop includes flexible, agile, high-quality IT systems integration and deployment services. This value proposition has been recognized as key to our OEM partners and end customers. As IT and data center infrastructure rapidly evolve based on the development such as AI and machine learning, our OEM partners’ offerings and strategies to deliver new offerings must adjust and ramp quickly.
As a result, and as an example, the density of compute solutions to deliver AI is rising very quickly, driving advancements in direct liquid cooling, and this is all happening as data centers are moving to be as green as possible. The end customer of our OEM partners are increasingly asking how they can get compute solutions as quickly as possible. Hopefully, this example explains why our OEM partners not only open to our participation within customer discussions. They are seeking it.
On November 14, 2022, almost a year ago, I embarked on my journey with TSS, and it has been an exhilarating one. I vividly recall my first earnings call where I admitted to being unfamiliar with the building, but that was then. Today, I stand confident in my knowledge and experience, and I’m optimistic about our future path as a business.
I’m immensely grateful to our investors who have stood by us along the way and every step of the way, and to the entire TSS team whose unwavering dedication has enabled us to deliver exceptional value to the marketplace. Our future is bright with endless growth opportunities, and I’m excited to be on the team and leading the way. So thank you for your continued support as we work towards achieving our goals.
I will now turn the call back over to John and to answer any questions you may have. Thank you.
John Penver
Briana, let’s see if there’s any questions.
Question-and-Answer Session
Operator
Darryll Dewan
Thank you, Briana. As I mentioned, I’m proud of this team. I thank our investors. I thank our customers for their trust in our ability to make things happen and to provide a way to provide value to our customer base. So thank you again for participating in our earnings call, and I wish everybody a happy Thanksgiving. And we’ll talk to you soon. Thank you.
Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for joining us. You may now disconnect.
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