TSS, Inc. — Q3 2019 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2019; interim financial statements are unaudited. TSS provides data-center and mission-critical facility services, including facilities maintenance, deployment, systems integration and IT reseller services. All revenue is from the U.S. The company sold its critical power and cooling business in Q4 2018, affecting year-over-year comparisons.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $4.176m | $6.371m | $12.375m | $16.587m |
| Gross profit | $1.497m | $2.516m | $4.585m | $6.447m |
| Gross margin | 36% | 39% | 37% | 39% |
| Operating income (loss) | ($12k) | $771k | $40k | $1.403m |
| Net income (loss) | ($95k) | $652k | ($220k) | $1.050m |
| Diluted EPS | ($0.01) | $0.03 | ($0.01) | $0.05 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $142k | $1.113m |
Q3 revenue fell 34%; nine-month revenue fell 25%. Management attributed much of the decline to the disposed business: $1.8m of Q3 2018 revenue and $3.4m of nine-month 2018 revenue came from it. Excluding that sale, remaining-business revenue was down 11% for the first nine months. Q3 facilities revenue declined 37%, while the remaining facilities business grew 9%; systems integration revenue declined 30% in the quarter. The lower revenue and margins reduced Q3 gross profit 41% year over year.
At September 30, 2019, cash was $5.922m, current assets $8.525m and current liabilities $6.251m, implying working capital of $2.274m. Total assets were $11.879m and stockholders’ equity $2.408m. Long-term borrowings had a carrying value of $1.978m; operating lease liabilities totaled $1.746m. Cash declined $256k from year-end 2018. Nine-month investing cash outflow was $301k, mainly capital expenditures; financing cash outflow was $97k, including $156k of share repurchases/withholding-related purchases and $59k of option proceeds.
Changes, outlook and risks
- Cost of revenue was 64% of sales in Q3 versus 61% a year earlier; management cited lower maintenance margins, deployment mix and underutilization of the integration facility. It expects margins to benefit from more employee labor, but warned that a larger reseller-services mix typically reduces gross margin.
- The company invested approximately $1m in reseller inventory during Q3. Management noted that reseller activity could create substantial working-capital swings.
- Management said it expects adequate capital for at least the next 12 months if cash-flow projections are achieved. This depends on revenue, cost and working-capital assumptions; management noted additional financing may be needed for growth or acquisitions and is not assured.
- The $1.5m asset-based revolving facility had no balance outstanding at quarter-end, but borrowing availability was approximately $137k. The bank waived the minimum interest-coverage covenant for Q3; TSS anticipated compliance in Q4. The facility also requires at least $500k of liquidity, excluding availability.
- Revenue is highly concentrated: one U.S. IT OEM generated 93% of Q3 and 91% of nine-month 2019 revenue, and represented 69% of receivables at quarter-end. Management warned that loss or reduced orders from this customer could materially harm results.
- Term loans include $1.595m principal from entities affiliated with the board chairman, carry 12% interest (partly paid in kind), mature in July 2022 and are secured by substantially all assets. Related-party warrants and the chairman-affiliated investment manager’s performance-related fee are also disclosed.
- ASC 842 adoption on January 1, 2019 added approximately $1.96m of operating lease right-of-use assets and related liabilities. No interim goodwill or intangible impairment trigger was identified. The filing reports no material litigation or off-balance-sheet arrangements and says disclosure controls were effective.
Investor facts to verify
- Whether the OEM relationship and order levels remain stable, given the extreme customer concentration.
- Whether Q4 covenant compliance was achieved and whether the bank facility’s limited borrowing availability is sufficient.
- Whether reseller growth can be funded without materially straining working capital, and how it affects gross margins.
- Whether operating cash flow and profitability recover after the sharp year-over-year declines, excluding the disposed business.
- The terms, related-party aspects and repayment capacity for the secured 12% loans and outstanding lease obligations.