TSS Inc (TSSI) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Fortress International third-quarter earnings conference call.

During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions). This conference is being recorded today, Tuesday, November 13, 2012.

And I would now like to turn the conference over to Lee Roth from Investor Relations. Please go ahead, sir.

Thanks, Brittany. Good afternoon, everyone, and once again, thank you for joining us on Fortress International Group's conference call to discuss third-quarter 2012 financial results.

Joining me this afternoon from management of Fortress are Anthony Angelini, Chief Executive officer, and Chief Financial Officer, Ken Schwarz.

Before we begin the call, I would like to remind everyone to please take note of the cautionary language regarding forward-looking statements contained in the press release we issued at the close of trading today. That same language applies to the comments and statements made on today's conference call and in the subsequent Q&A session.

This call will contain-time sensitive information, as well as forward-looking statements, which are only accurate as of today, Tuesday, November 13, 2012. Fortress International Group 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 during this call. A reconciliation of the differences between these measures with the most directly comparable financial measures calculated in accordance with GAAP is included in today's press release.

With that, it is now my pleasure to turn the call over to Ken Schwarz, Chief Financial Officer. Ken?

Thanks, Lee. Before I present our third-quarter financials and results for the nine months of 2012, I would like to take a moment to introduce myself to our shareholders and those who follow Fortress International.

I joined the Company at the end of September after having worked both in rapidly growing companies and more recently turnarounds. I have been impressed with what has taken place at Fortress this year, and I'm excited about the possibilities ahead. So with that, let me get into the financial results for the quarter.

We reported $9.3 million in revenue for the third quarter of 2012 as compared to $15.5 million in the second quarter of 2012 and $7.7 million for the third quarter of 2011. As we have previously discussed, we had a large construction management program that winded down and accounted for a significant proportion of our revenue in the second quarter.

While we continue to pursue such business, we are increasingly focusing our sales efforts on higher gross margin services. We will discuss that a little bit more later.

Our revenue breakdown for the third quarter of 2012 was as follows --- technology consulting, $357,000 compared to $400,000 in the second quarter of 2012; construction management, $4.4 million compared to $9.5 million; and facilities management, $4.5 million as compared to $5.6 million in the second quarter of 2012. Gross profit totaled $2.6 million in the third quarter of 2012 compared with $2.3 million in the second quarter of 2012, a 13% sequential increase. Gross margin was 28.4% in the third quarter compared with 15% in the second quarter of 2012. This sequential improvement gross margin was reflective of the continued shift in the quarter's revenue mix, which saw a higher percentage of total revenue generated from our FM services.

Our SG&A for the third quarter totaled $2.7 million, which includes $225,000 for severance of our former CFO and $172,000 in stock-based compensation. This compares with $2.4 million in the second quarter of 2012, which included approximately $55,000 of bad debt expense and $58,000 in stock-based compensation.

We believe we have made a good headway in reducing our SG&A to the low $2 million range and continue to look for improvements while investing in growing our business.

Net loss for the quarter of 2012 was $267,000 or $0.02 per share for both basic and diluted compared with a net loss of $2.3 million or $0.16 per share basic and diluted in the second quarter of 2012. Our net loss for the second quarter of 2012 included the effect of a $2.1 million non-cash impairment charge. No such charge was recognized in the third quarter.

Normalized adjusted EBITDA, which excludes interest, taxes, depreciation, amortization, stock-based compensation, one-time items and other expenses, was $337,000 in the third quarter of 2012 compared to normalized adjusted EBITDA of $150,000 in the second quarter of 2012 and $287,000 in the third quarter of last year.

Turning to the nine-month results, we reported $39.1 million in revenue for the nine months of 2012 as compared to $27.8 million in the first nine months of 2011. Our revenue breakdown for the period was as follows -- technology consulting, $1.2 million as compared to $2.6 million in the first nine months of 2011; construction management, $22.6 million as compared to $11.4 million; and facilities management, $15.3 million as compared to $13.8 million.

As you can see, we are continuing to focus our sales efforts on facilities management services, which provide for recurring revenue and higher gross margins. Our gross profit totaled $7 million in the nine months ended September 30, 2012, compared with $11 million in the nine months ended September 30, 2011. Gross margin was 17.9% in the first nine months of 2012 compared with 39.6% in the first nine months of 2011.

Our gross margin in the first nine months of 2011 was driven by a higher-margin CM project, which we completed last year.

Our SG&A for the nine months ended September 30, 2012, totaled $8 million, which included $55,000 in bad debt expense; $665,000 in severance, consulting and legal charges; $279,000 in restructuring costs; and $318,000 in stock-based compensation. This compares with $8.6 million in the nine months ended September 30, 2011, which included approximately $90,000 in bad debt expense and $367,000 in stock-based compensation.

Our results for the nine months ended September 30, 2012, also included the effects of a $2.1 million non-cash impairment loss on goodwill and other intangibles that we recognized in the second quarter. Net loss for the nine months ended September 30, 2012, was $3.8 million or $0.27 per basic and diluted share compared with net income of $3.1 million or $0.23 per basic and $0.21 per diluted share in the nine months ended September 30, 2011.

In the first nine months of 2012, we incurred approximately $994,000 in restructuring and other one-time charges. Excluding these charges, normalized adjusted EBITDA loss for the third first nine months of 2012 would have been $24,000. This compares with normalized adjusted EBITDA of $2.9 million in the nine months ended September 30, 2011.

Our backlog at September 30 was $15.6 million compared with $19.1 million on June 30, 2012. Our backlog includes approximately $8 million related to one contract that extends into multiple years.

It also excludes most of our multiyear programs related to our facilities management business, which are subject to annual renewal. We have experienced favorable renewal rates on these contracts and are looking at how we can better present this information to you in the future.

Turning to the balance sheet, we ended the quarter with a cash balance of $5.4 million and working capital of $5.3 million. We continue to carefully monitor our cash and working capital balances to ensure maximum financial liquidity. Overall, we have been very successful in stabilizing the business and positioning the Company for growth.

With that, I would like to turn the call over to Anthony for his review of the quarter.

Thank you, Ken, and thank you all for attending this call. During my remarks today, I'm going to focus on our performance in the third quarter and near-term outlook for the marketplace, growth opportunities, our go-to-market strategy, and our efforts to continually enhance the organization. Finally, I will discuss some strategic initiatives.

We achieved normalized adjusted EBITDA of $337,000 in the third quarter. We have steadily improved our numbers from the $1.1 million loss in the fourth quarter of 2011. We will continue to build on this in a way that allows us to improve our results quarter over quarter and position our core business profitably on an ongoing basis.

A key to our business transition efforts is forming a base of revenue at higher gross profit margins with a greater element of recurring business. By building around a core of higher-margin recurring revenue contracts and positioning our construction management business as an incremental component, we believe we can maintain gross margins on our core business in the low to mid 20% range. We are very proud of the progress we have made over the last nine months and will continue to drive further improvements.

While we see some near-term pressure in the fourth quarter based on the timing of project starts and the holiday schedules, we expect revenue may be down slightly from third-quarter levels. We believe that margins will decline slightly, but should hold in the 20% to 25% range. We expect normalized adjusted EBITDA to range from slightly negative to slightly positive.

However, due to some significant projects booked and projects in the final stages of our pipeline, we are optimistic for the first half of 2013.

Overall, we continue to be excited about the opportunities ahead of us. The data center and mission-critical markets are strong and continue to grow. We are in a multiyear growth cycle being supported by cloud computing, the proliferation of mobile, advancements in digital video, big data and other data-intensive applications.

One segment that we believe is instrumental to our transition efforts is the modular data center market. We had a strong service offering in this market that we are continuously improving. We are leveraging the strength of our modular offering into a leadership position in this growing market through a combination of new customer wins and incremental business with our existing customers.

Further, we are developing extensions to our current offerings through a number of our strategic initiatives that I will discuss later. We have one follow-on business from several key modular customers with new projects timed for commencement in the new year and a number of pipeline opportunities that could materialize as we head into 2013.

I believe that we are well-positioned to benefit from favorable trends in the modular market. Industry data that we have reviewed shows that the modular and prefabricated data center market is expected to grow 2.5 times faster than the overall data center construction market through 2016. This is primarily driven by the overall demand for data center capacity and some unique advantages of the modular approach. Those include faster time-to-market, more efficient use of capital, and increased efficiency through lower operating costs, primarily driven by greater power usage effectiveness.

The market potential is only half of the equation as these opportunities will only benefit us if we are able to execute. To that end, we are making changes that we believe will help develop our sales channel and enhance our customer acquisition and retention capabilities. We are evaluating several opportunities to partner with other industry participants whose service portfolios complement our offerings. And we can also leverage their customer relationships to pursue incremental project and contract opportunities. Overall, we see a significant opportunity to enhance our go-to-market approach through a commendation of direct and indirect representatives and development of a significant channel through resellers and distributors, as well as OEM and consulting service providers.

Turning to our organization, we continue to develop tools and processes to improve our forecasting capabilities and deliver further scalability and efficiencies within our business. We are developing our team further with a focus on our program and account management capabilities, as well as our ability to self-perform additional services on a geographically expanded basis.

As I've discussed before, we have several strategic initiatives underway that we are hopeful will continue to reposition and expand on our core offerings. We have enhanced our Total Site Solutions branding and refreshed our corporate website and logo to better represent the progressive nature of the changes we plan to deliver to the marketplace.

One core initiative is positioning our operational capabilities in the management of brick-and-mortar data centers into a more strategic partnership with data center real estate developers in a way that will allow us to be a long-term operator of core data center facilities.

Another significant initiative is tied to modular data centers. We are positioning our capabilities to reach deeper into the overall supply chain of modular development. This includes delivering and managing centers that will host these modular capabilities, as well as managing the asset recovery and refurbishment of modular units at the end of their lifecycle. We believe that expanding into this overall value chain will better position us in the modular ecosystem as a provider of key services as the modular business grows into a multibillion dollar market.

In summary, as I mentioned earlier in the year, 2012 would be a year when we transitioned business back to profitability and positioned Fortress for future growth. As we finalize our plans for 2013, our focus will be to execute on the near-term trends and opportunities, further strengthen the organization, and begin to drive upside profitability from both our core business and strategic initiatives.

As we look longer-term into 2014 and beyond, we see ourselves positioned to drive much higher gross and capitalize on the trends that exist within the data center ecosystem.

Finally, I would like to take a moment to welcome Ken Schwarz to the Fortress team. As you know, Ken joined the Company at the end of the third quarter and has a wealth of financial and operational experience and expertise in both transition and growth environments. We see Ken making great contributions to our strategy and operations, and we are thrilled to have him on board.

With that, I will now open the call for questions.

(Operator instructions). David Horn, Kiron Advisors.

Thanks for taking the questions and congratulations on stabilizing things. You've done great work since you got there.

Real quick note. The website still has Tim on there as the CFO, so you guys might want to update that. I just got that, but it's not a big deal.

My first question, can you just give me an idea ballpark of the gross margin for each segment?

We've kind of given ranges in respect to the segments in that, but we don't specifically break out each piece. But the facilities management piece can range in the 20% to 40% range, the consulting is roughly the same, and the contract management, construction management, depending on size of projects, is in the mid-single digit to low double-digit range.

Okay. I'm just trying to get an idea -- we did -- it sounds like we do about $9 million in revenue, and sort of showing how important the balance of where the revenue comes from, we did significantly less revenue than last quarter, but the gross profit was $300,000 more. So, clearly, topline is not important. It's nice that you're trying to get the higher-margin business.

I'm just trying to think --- is this somewhat of a representative quarter sort of a steady-state -- I guess, this had higher, slightly higher gross margin at 28%, and I guess SG&A was elevated a little bit with the severance, but it sort of came in at breakeven. How should we think about this quarter as far as sort of a baseline and then building off of this? Do you see things sort of what might happen where we dip back down again and start losing money again?

Well, let's maybe deal with the last comment. Obviously, as you've seen over the last nine months, there has been extraordinary focus on profitable --- driving to normalize adjusted EBITDA profit and getting the business at a level where we believe the gross profit in that mid to low $2 million range will keep us there. And that's what we've sized the organization to back when we made the adjustments at the end of the first quarter. And I think we spoke to that.

To your point, we have worked very hard throughout this organization on focusing on the level of profitability within our business. Certainly, revenue is important, but type of revenue is very, very important. And with the nature of our core service businesses, which includes FM and construction -- or FM and professional services, those draw a higher-margin percentage. The construction manager business is a great business, but it's a great business as an incremental piece.

So what we're trying to do is build to our core level and our core operating level can be driven off of our FM and other services business with then the incremental profit, which comes in at lower margin from the construction management business, will just --- will be just that, incremental. And so that's why we've worked to size at this level, and we believe because we also -- because that business also drives a higher level of recurring elements to it, our ability to predict and stabilize where the business is on an ongoing basis will be helped as well.

So for the construction management business, we did maybe $400,000 in revenue for the quarter. So even if that went away, obviously we wouldn't be profitable. But it wouldn't be --

Yes, but we did about $400,000 in technical consulting --

No, no, no, I'm sorry. I probably misspoke. At a 10% gross profit on $4.4 million of construction management revenue, I'm saying that that gross profit was only about $400,000.

Right.

Right. And so, which goes to show that might --- even if we doubled that to -- and so the revenue came in really high at $8.8 million, we still just would have been a little bit more money on a gross profit level. And so the lumpiness over time of the construction management really shouldn't have a massive impact on the bottom line.

Correct. And again, that's why --- and I've been echoing this I think since the first conference call here --- is we've been trying to work to make sure that the core business can generate that 20%, 25% overall margin. That's a good, strong, healthy business that we can operate on, especially with a lot of recurring elements. And then utilizing the CM business as an incremental piece that when we have CM awards it's great because those dollars fall right through.

Right. But you don't need it to keep the lights on. I feel like backlog is an odd --- it doesn't seem to correlate very high, and I realize there's a prior management team in there. But it just doesn't seem to be a very good indicator of what's coming forward. Can you help me a little bit with it? What is in the $15.6 million, what isn't in the $15.6 million, and how should we use that? I mean, it's as low as it's ever been, but the business is doing breakeven where we had much, much higher backlogs in the past, and we weren't breaking even. So I don't --- you know what I'm saying?

Yes. Well, the starting point is a large portion of that backlog historically was in CM business. So you do the math around how much that drags through and gross profit becomes --.

And then further, the cycle time, as an example, for our consulting business is very short. And so a lot of that comes and goes within a quarter, so you don't actually see pieces of that. And then the third element is within our recurring stream, because of the nature of renewals -- i.e., they are not contracts today, but our renewal rate is in the very, very high 90s -- we --- that isn't reflected in our backlog. So as that work comes through, you don't see it, and that business also has some nearer term cycle times than would be a traditional data center construction built.

No, I was just going to echo that. It's the changed nature --- we are required historically, because we were more of a construction company, to do the backlog. It is a SEC requirement. But it becomes less and less relevant. That's why, one of the reasons I said in my script, I want to try to find out other methods of providing information to try and give you a better way to get an understanding of our business and a recurring renewal type of business. So we are looking at that.

Okay, great. Yes, because I think it just doesn't really do, I think, what it's intended to do. That's not a bad thing; it's just maybe not the best indicator.

Okay. Thanks, guys. Good luck with the rest of the year, and we look forward to hearing from you in the first quarter.

(Operator instructions). I'm showing no further questions in the queue. I would like to turn the conference back to management for any closing remarks at this time.

Okay. Well, thank you all very much for attending. As we've been echoing through the year, we are focused on driving profitability within our core business and maximizing the margin and the efforts of all our employees. And I think we are on a --- we've proven that we are on a road to that goal. There is a lot more work to do, which we will continue to work hard to achieve further profitability as we move that business forward. Thanks, all, for attending.

Thank you.

Thank you. Ladies and gentlemen, this concludes the Fortress International third-quarter earnings conference call. This conference will be available for replay after 6.30 PM Eastern Standard time today through November 27, 2012, at midnight Eastern Standard time. You may access the replay system at any time by dialing 303-590-3030 or 1-800-406-7325 and entering the access code of 4573235 followed by the #.

Thank you for your participation. You may now disconnect.