TSS, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unless otherwise stated, financial amounts below are in millions of dollars. TSS provides data-center facilities services and systems integration; all revenue was generated in the United States.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $5.367 | $4.198 | $10.216 | $8.587 |
| Gross profit | $2.065 | $1.754 | $3.931 | $3.613 |
| Gross margin | 38% | 42% | 38% | 42% |
| Operating income | $0.449 | $0.074 | $0.632 | $0.373 |
| Net income (loss) | $0.319 | ($0.024) | $0.398 | $0.229 |
| Diluted EPS | $0.02 | ($0.00) | $0.02 | $0.01 |
Q2 revenue increased 28% year over year. Facilities revenue was $3.167 million, up from $2.730 million; systems integration revenue was $2.200 million, up from $1.468 million. For the first half, facilities revenue rose to $6.546 million from $5.217 million, while systems integration revenue increased to $3.670 million from $3.370 million.
Cost of revenue was 62% of revenue in both Q2 and the first half, versus 58% in the comparable 2017 periods. Management attributed the lower gross margin primarily to weaker pricing and profitability in systems integration, as well as lower margins on modular deployments. SG&A fell 3% in Q2 and 6% for the first half. Q2 operating income improved substantially; first-half 2017 operating results included a $0.321 million gain on a business-component sale, absent in 2018.
Cash, debt and liquidity
Cash and cash equivalents were $3.312 million at June 30, 2018, compared with $2.268 million at year-end 2017. First-half operating cash flow was $1.188 million, versus cash used of $0.756 million in the first half of 2017. The improvement reflected higher profitability and a $1.062 million increase in deferred revenue, principally from advance maintenance-contract payments; higher receivables partly offset this. Investing cash outflow was $0.144 million, primarily capital expenditures. There was no financing cash flow in the first half of 2018.
Current assets were $5.528 million and current liabilities were $6.307 million, implying a $0.779 million working-capital deficit. Total liabilities were $8.253 million; reported long-term borrowings, net of discount and issuance costs, were $1.748 million. The debt includes related-party loans bearing 12% annual interest, half payable in cash and half in kind, and secured by substantially all company assets. Interest expense was $0.111 million in Q2 and $0.204 million for the first half. Stockholders’ equity was positive $0.208 million at quarter-end, compared with a $0.305 million deficit at year-end 2017.
Outlook, risks and unusual items
- Management said it expects adequate capital to operate for at least the next 12 months if cash-flow projections are achieved. However, the filing continues to state that substantial doubt exists about the company’s ability to continue as a going concern, citing its history of losses, negative working capital and prior stockholders’ deficit. Liquidity depends on revenue, cost and working-capital assumptions; further financing or cost reductions may be needed.
- One U.S.-based IT OEM accounted for 67% of Q2 revenue and 71% of first-half revenue. The company says loss of, or reduced orders from, this customer could materially harm results.
- Management described competitive pressure, quarterly fluctuations, and risks from fixed-price contracts, including cost overruns and labor or materials costs. Use of subcontractors or difficulty staffing specialized work may also affect margins.
- The company reported no formal earnings guidance. Management is focusing on facilities maintenance and systems integration and noted that advance maintenance payments are an important source of liquidity.
- On August 9, 2018, TSS received notice that its receivables-factoring agreement was terminated; it had not factored receivables under the agreement since June 2017 and incurred no termination penalty.
- Adoption of the new revenue-recognition standard on January 1, 2018 had no material reported impact. TSS anticipated that adoption of the new lease standard would add approximately $2–$2.5 million of lease-related assets and liabilities to its balance sheet.
- Related-party debt and warrants involve entities affiliated with the board chair. The filing also reports warrants issued to lenders with low exercise prices and potential dilution.
Important facts for investors to verify
- Whether operating cash flow and maintenance-contract advance payments continue to support liquidity, given the stated going-concern uncertainty and working-capital deficit.
- Revenue and order trends for the major OEM customer, and the effect of customer concentration on receivables and cash collection.
- Whether systems-integration and modular-deployment margins improve after the reported decline in gross margin.
- The full cost, maturity, security, related-party terms and potential dilution associated with outstanding loans and warrants.
- Capital-expenditure cash flow is stated as $0.144 million in the cash-flow statement but approximately $0.141 million in MD&A; investors may wish to reconcile the difference.