TSS, Inc. Q2 FY2025 Earnings Call

Greetings. Welcome to the TSS Inc. Second Quarter 2025 Financial Results Conference Call. I will now turn the conference over to your host, James Carbonara. You may begin.

Thank you, operator, and good afternoon, everyone. Thank you for joining us for TSS' conference call to discuss the company's second quarter 2025 results. Joining me today on this call are Darryll Dewan, President and CEO of TSS; and Danny Chism, the company's CFO. As we begin the call, I would like to remind everyone to take note of the cautionary language regarding forward-looking statements contained in the press release 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 accurate only as of today, August 6, 2025. TSS expressly disclaims any obligation to update, amend, supplement, or otherwise review any information or forward-looking statements made on this conference call or the replay to reflect events or circumstances that may change or arise after the date indicated, except as otherwise required by applicable law. For a list of the risks and uncertainties that may affect the company's future performance, please refer to the company's periodic filings with the SEC. In addition, we will be referring to non-GAAP financial measures. A reconciliation of the differences between these measures and the most directly comparable financial measures calculated in accordance with U.S. GAAP is included in today's press release. With that, Darryll, I will turn the call over to you.

Thank you, James, and good afternoon, everyone. Thank you for joining us today for our second quarter 2025 earnings conference call. The demand for complex high-performance computing systems, particularly those enabling AI applications, continues to accelerate at a remarkable pace, and we are squarely positioned to address that demand. This past quarter marked a major transformative milestone in our company's journey and positions us for what we expect will be a record year. I'm pleased to report that we are successfully operating in our new state-of-the-art 213,000 square foot facility in Georgetown, Texas, and it is now fully operational. It's also less than 100 degrees today. The build-out is a testament to detailed planning, teamwork, and the team's ability to execute. It is more than just additional square footage. This facility is a strategic asset, purpose-built to support rapid scaling of integration services of the most advanced and complicated computing solutions. The facility became operational across all capabilities late in the second quarter. With systems now validated and capable of running at full capacity, we're beginning to capture tangible benefits. We continue to produce faster delivery cycles, greater operational efficiency, and increased ability to support larger, more complex customer deployments. The completion and activation of this facility marks a turning point, and we are incredibly bullish about what lies ahead. In terms of our financial results, we delivered on our commitment of revenues in the first half of this year, exceeding the revenues in the second half of 2024. And comparing the first half of this year to the first half of last year, we tripled our diluted earnings per share and more than tripled our adjusted EBITDA. We are on track for what we believe will be a record year for our company. Our momentum is accelerating. The market is thriving and rich with opportunities, and we're excited about the execution and our focus and precision. So let me walk through a few of the highlights for the second quarter. We achieved record year-over-year revenue growth of 262%, highlighting the accelerating demand for our solutions, the depth of our customer relationships, and the strength of the market environment we are operating in. Adjusted EBITDA increased more than 100% to $4 million in Q2 of 2025. We also generated positive cash flow from operations for the first 6 months of the year, further strengthening our financial foundation and reinforcing the durability of our business model. The exceptional performance was driven by growth in our two largest service offerings, procurement and systems integration. So let me break this down by segment. Starting with procurement services, where we source and resell third-party hardware, software, and services, revenue grew more than 572% year-over-year to $33 million in the quarter, driven by increased infrastructure investments to support AI workloads. The growth continues to underscore both our value as a strategic sourcing partner and the strong execution of our operational team. While the business may experience quarter variability, the overall trajectory remains positive, and we remain very optimistic about the contribution from this segment. Systems integration, which includes AI RAC integration, delivered another strong quarter with revenue growth increasing 91%, fueled by growing demand for AI-enabled infrastructure. This growth reflects the accelerating momentum behind AI deployments as enterprises begin to modernize and expand their compute environments, while hyperscalers remain in rapid expansion investment mode. We believe we are still in the early stages of the AI infrastructure build-out cycle, and we expect continued robust growth as customers scale investments to meet evolving compute requirements in the quarters and years ahead. I'll speak more to this in a minute. In our facilities management business, which primarily includes our modular data center business, revenues declined 35%. While this segment represents a smaller portion of our overall business, approximately 3% of the total revenue in the quarter, it has historically delivered stable high-margin contributions. The modular market is evolving. Modular data centers are no longer used solely to augment traditional data centers, but are increasingly viewed as prefabricated solutions for delivering dense computing capacity more efficiently. Additionally, edge computing, an emerging AI-driven segment, is well suited to modular deployment. As the adoption of AI technologies accelerates, we expect modular data centers to play a growing role in our strategy through 2025 and beyond. So it's clear to me that we're still in the early days of AI and demand for high-performance computing. That demand is growing, our capabilities and partnerships are expanding, and our pipeline continues to strengthen. Importantly, we're successfully executing our business strategy and delivering substantial growth while scaling our operations and positioning the company to capture a meaningful share of the rapidly growing and complex AI infrastructure market. So let me turn the call over to Danny for a more detailed conversation and discussion of our financial results. Danny?

Thanks, Darryll. Consolidated total revenue increased by 262% in the second quarter of 2025 to $44 million, up from $12.2 million in the second quarter of 2024. As Darryll mentioned, the increase was driven by significant year-over-year growth in our two largest service lines, procurement and systems integration. Revenue from procurement services totaled $33 million, up 572% compared to $4.9 million in the same quarter last year, primarily driven by purchases from the federal government, along with a shift towards more gross deals versus net deals. Revenue in this segment reflects a mix of gross and net deals with revenue recognition methods that vary based on contractual terms regarding product modifications or acting as an agent in a transaction. The gross value of all procurement transactions rose 213% from the prior year quarter to $65.7 million this quarter. Based on recorded GAAP values, procurement gross margins stood at 7.7% this quarter, compared to 14.7% in the previous year quarter. When examined through the non-GAAP lens of gross value for all transactions, margins improved from 3.4% to 3.9%. This margin expansion, along with the 213% increase in gross value for procurement transactions, led to a 251% growth in gross profit from procurement services to $2.5 million, up from $700,000 in the same quarter last year. Revenue from the facilities management segment was $1.5 million, down 35% from $2.3 million in the same quarter last year. Though it remains our smallest segment, facilities management holds significant strategic potential. We're actively pursuing new opportunities and preparing to meet customer demand for modular data centers when it resumes. We've also noted some discrete projects planned for the second half of the fiscal year concerning MDCs deployed in previous years. Aside from initial revenues, new deployments generally yield multiyear maintenance contracts that enhance our earnings profile. Revenue from the systems integration segment rose to $9.5 million, a 91% increase compared to $5 million in the second quarter of 2024, mainly due to ongoing growth in AI-enabled racks integration, which began seeing significant volume in June 2024. This effort supports our multiyear agreement signed in October 2024 for our major customer. We anticipate substantial growth in systems integration revenue over the next several quarters and years. Consolidated gross margin was 17.8% this quarter, down from 37.3% in the same quarter last year but up from 9.3% in this year’s first quarter. The year-over-year decrease mainly stems from the larger share of lower-margin procurement services in total revenue compared to the previous year. Analyzing the components of consolidated margins, systems integration gross margins improved from 43% to 44%, while facilities management gross margins remained strong at 74% in both periods. As noted earlier, procurement activity gross margins rose from 3.4% to 3.9% this quarter on the gross value of transactions. The decline in blended consolidated margins results from the significant growth in the lower-margin procurement business, coupled with more procurement deals being recorded as gross deals compared to last year when more were net deals. SG&A expenses were 61% of gross profit in the second quarter, matching the 60% from the prior year. In dollar terms, SG&A expenses increased to $4.7 million from $2.7 million in the same quarter last year but decreased sequentially from $4.9 million in the first quarter of this year. The year-over-year rise was mainly due to a higher headcount and related compensation costs. This quarter's SG&A expenses included $930,000 in non-cash equity-based compensation, compared to $155,000 in the same period last year. Due to the growth of our market capitalization and revenues, we will no longer be regarded as a smaller reporting company at the end of 2025; we will transition to being an accelerated filer. As a consequence, our external auditor must conduct an integrated audit for the first time, which includes testing and assessing our internal controls over financial reporting. We are beginning to incur new higher audit and accounting costs in preparation for a more robust internal audit of these controls and a first-time external audit, as required by the Sarbanes-Oxley Act Section 404(b). Depreciation and amortization expenses climbed year-over-year to $844,000 from $117,000 in the previous year quarter, largely due to the full two months of depreciation recognized on our new facility, which became operational in May 2025. I expect quarterly depreciation to increase steadily in the third quarter as we account for a full quarter’s worth of depreciation on that facility versus just two months recorded in the current quarter. Consolidated operating income for the second quarter of 2025 was $2.2 million, a 32% rise from $1.7 million in the same quarter last year. While this shows an increase in dollar terms, it reflects a lower operating margin of 28.6% this quarter compared to 37.5% last year, as rising depreciation outpaced the growth in gross profit. As revenues ramp up at our new factory, we expect operating income in the last six months of 2025 to surpass both the comparable period of 2024 and the first half of this year. If we successfully sublease our Round Rock, Texas facility, it will further improve our operating income in future periods. We've received interest in the facility, although we anticipate no completed sublease by the end of this fiscal year. Interest expense rose to $859,000 in the second quarter of 2025, up from $378,000 in the same quarter last year. This increase stemmed from a rise in the gross value of procurement transactions and other revenues from our key customer, as well as interest on the $20 million construction loan tied to our Georgetown facility, for which we had no outstanding debt in the prior year quarter. Offsetting some of that interest expense was $175,000 in interest income earned from cash on hand, compared to $106,000 in the same quarter last year. Consequently, net income for the second quarter of 2025 was $1.5 million, a 6% increase from $1.4 million in the same quarter last year. Diluted earnings per share was $0.06 for both periods. Adjusted EBITDA, excluding interest, taxes, depreciation, amortization, and stock-based compensation, reached $4 million, up 103% from just under $2 million in the prior year quarter. Looking at year-to-date results, total revenues for the six months ended June 30, 2025, were up 410% to $142.9 million compared to $28.1 million in the same period last year. As Darryll noted, first-half 2025 revenues exceeded second-half 2024 revenues of $120.1 million, reflecting a sequential increase of 19%. By segment, procurement revenues increased by 645% and systems integration revenues rose by 140%. These gains were somewhat offset by a 37% year-to-date decline in revenues from facilities management, primarily due to the timing of discrete projects in this segment and a smaller drop in ongoing maintenance revenues. Based on our current pipeline, I expect a slight uptick in discrete projects in the latter half of the year compared to the first six months. Gross profit for the first six months of 2025 increased 135% to $17 million, and our SG&A costs improved to 57% of gross profit, down from 70% in the previous year. Year-to-date net income was $4.6 million compared to $1.5 million in the first half of last year, marking a 215% increase, with diluted EPS nearly tripling to $0.17 from $0.06 in the prior year. Regarding the balance sheet, as of June 30, 2025, we had $36.8 million in unrestricted cash and cash equivalents, along with an additional $5 million in restricted cash securing our bank loan, up from $23.2 million at year-end 2024. This increase was primarily driven by cash generated from operations and $11.3 million of current quarter bank financing proceeds supporting the construction of our new Georgetown facility. These inflows were partially offset by capital expenditures related to the facility's development. To accommodate anticipated production increases and support advanced racks, we relocated our headquarters and production facility in the second quarter of 2025. Up to the end of the second quarter, we invested about $31.6 million in upgrades to that leased facility, particularly to boost electrical power supply and cooling capabilities for both air-cooled and liquid-cooled racks. This investment exceeds our previous guidance of $20 million to $25 million due to shifts in our OEM customers' technology requirements that demand more power and cooling capacity than initially expected. We anticipate these additional capital expenditures will lead to increased future revenues. To date, funding for these investments included $20 million in bank debt, with the rest sourced from our cash reserves. The loan transitioned to a fully amortizing loan on July 5 this year, with monthly principal and interest payments scheduled through January 2030. Net working capital fell from $1.3 million at the end of 2024 to negative $16.3 million by the end of the second quarter of 2025, mainly due to capital expenditure investments. The working capital reduction, including a rise in accounts payable at the end of the period, primarily relates to procurement transactions and funding for construction expenses. Following the conversion of our debt to a term loan last month, $5 million of cash used as a loan deposit was reclassified from current asset cash to non-current asset, restricted cash. In Q3, we expect to receive $6.8 million of tenant improvement funds from our landlord, reimbursing us for CapEx invested thus far. We've also requested to activate the accordion feature on our bank loan, allowing us to borrow an additional $5 million in light of the CapEx funded with cash on hand. These funding sources will further enhance the robust cash position shown on our balance sheet. For the first six months of 2025, cash flow from operations reached $37 million, a significant improvement from the $1.7 million cash used in operations during the first half of last year. This enhancement was driven by stronger earnings and the timing of cash flows from our procurement activities. Overall, it was another great quarter, and we look forward to a strong second half of the year. I’ll now turn the call back over to Darryll for closing comments.

Thanks, Danny. I appreciate it. I commented earlier that our Georgetown facility is a strategic asset, and I'd like to expand on that before turning the call over to questions. I've described in previous calls how the amount of compute power in each rack is growing as a result of advancements in chip technologies such as GPUs from leading providers. Our close relationship with the leading IT OEM provides us an operational view of the road map ahead for chips and resulting rack densities. As a couple of years ago, a rack might have required 30 kilowatts of power. We are now preparing to integrate racks with 300 kilowatts of power on our way to a megawatt of power, possibly within the next year. The layout and capabilities of our facility that integrates 300 kilowatt racks is very different from a facility that integrates 30 kilowatt. We have invested in a new facility beyond our initial expectation because racks of greater density are approaching faster than we expected. More availability of electrical power is certainly the case, and we're targeting in a year more than double the current availability of electricity. We have also invested in cooling infrastructure, including direct liquid processing required to address racks of dramatically higher power. The point to all of this is we are seeing great growth opportunity as the new facility comes online. Looking out over the next 12 to 24 months, our facility will become more and more critical for IT OEMs to deliver the product road map. Interestingly, we also expect to see more investment in the enterprise marketplace as the AI rollout continues and small, very dense compute resources are located closer to the end user. In summary, we expect continued strong performance for the remainder of this year. Given the strength of our first half and our increasing visibility into the second half of the year, we are raising our full year 2025 adjusted EBITDA outlook, as we've said previously, from at least 50% growth to at least 75% growth compared to 2024. We remain focused on driving long-term profitable growth and delivering lasting shareholder value. So with that, let's open up the line for Q&A.

The first question comes from Bradley Stevenson with Breakout Investors.

I have a few questions and I'd like to know your thoughts on them. One area we haven't discussed, or at least I haven't heard you mention, is the priority of TSSI in Dell's rack integration projects. We are aware that Dell has in-house rack integration facilities, and they likely utilize other vendors in addition to you. Can you provide any insights on this?

Bradley, I would respond by saying that we aim to make it very straightforward to choose TSS as the total solution. We have prepared ourselves for a more complex future and strive to be the more cost-effective, superior, and faster option compared to anything else available in the market. Regarding our priorities, we are never satisfied; we aim to be the top choice and are working diligently towards that goal. While I can't disclose specific details or percentages, I assure you that we seek our fair share of the business and are committed to making it as easy as possible to achieve that.

Okay. You talked a little bit about growing organically in your press release and also exploring strategic alternatives. I think that comment was about expanding beyond Bill. Am I reading that correctly? And if so, can you talk a little more about that or provide any more detail on that?

Yes. Our organic growth involves maximizing what we can achieve with our current relationships, and it’s clear that we are focused on this goal. We are committed to improving each day and continuing our organic growth. Beyond that, there are various ways we can expand. We've previously mentioned opportunities such as on-site rack integration in customer facilities, but we maintain a level of respect for our existing partners and won’t disrupt those relationships in a competitive market. However, we can still have dedicated teams working on different technologies, which we are considering. Another avenue for growth is through our solutions being offered to the channel market, which resells existing customer technologies and needs firms like ours for integration. We’ve invested significant resources, in the range of $25 million to $35 million, and want to ensure these investments pay off. It shouldn’t be the responsibility of channel partners to incur such costs to meet customer needs when they can utilize our resources for integration through our facility in Round Rock. Additionally, there’s a wide range of technology available in the marketplace that we believe our current relationships would support us partnering with. While I can’t delve into specifics, we are open to any growth opportunities that are beneficial and do not jeopardize our existing partnerships, provided they are executed fairly and profitably.

Procurement is a significant amount. It's much smaller than last quarter, but considerably larger than the same quarter last year. Is there any way to relate that to other aspects of your operations? I'm trying to express that I was surprised by the $90 million last quarter; I didn't foresee such a large figure. This quarter, at $33 million, wasn't a surprise, but I still find myself uncertain about what to expect. Can you provide any guidance on that?

Well, yes, there is. We inspect our pipeline frequently. And if you were surprised by the $90 million, so were we in the respect that it was such a big number and a big quarter for us. If you recall, we did $60 million in Q3 last year, and that was an eye-opener. And we've felt, and we still feel there's a little bit of a propensity to dial closer to the federal buying cycle, which usually is the third quarter of the calendar year. I can tell you that we're optimistic about the full year. I think you'll hopefully be pleasantly surprised again someday, and we're working hard to make that happen. So the corollary to anything other than the federal buying cycle and the fact that we put more muscle behind working transactions than we ever did before, I think it's paying off. So in other words, internal resources allocated to go after opportunities that drive revenue for procurement. That also leads into business that we're driving in our configuration services business. And we've realigned our team internally to place, if you will, more attention and talent into the config services business, which really is connected to the procurement business. And eventually, and hopefully, very soon, we'll see the benefits of that.

Yes, to clarify, Bradley, while the configuration services receive a significant amount of volume from current activities, the numbers for configuration services are categorized within the Systems Integration segment.

Bradley, I've been here for almost three years now, and what Danny mentioned is something we always question. However, he is absolutely correct. They influence each other and collaborate closely. Additionally, we can grow configuration services independently of procurement, which is our goal. To achieve that, we had to make some personnel changes, and we are continuing to invest in a software platform and technology to automate the process, making it much easier to achieve the desired outcome. We are funding this with operational resources. While it's not a significant amount of money, it does require time.

Got you. And I wasn't trying to say I was disappointed in $33 million. I just didn't know what to expect. That's what I was really saying.

I was just trying to figure out where you're coming from because next time you ask a question, I might not take the answer question.

I want to address your comments regarding EBITDA guidance. Please correct me if you prefer not to refer to it as guidance. If my calculations are correct, achieving 75% more than last year would imply that we would effectively break even with the quarter we just finished over the next two quarters on average. While that is a positive figure, do you foresee any potential for exceeding that outcome?

We recently view that as the baseline. If you consider it, you may not have caught the exact phrasing we used to convey that, but we anticipate at least a 75% increase.

So last year, we did $10 million.

Okay, so if you hit $4 million in the third quarter and $4 million in the fourth quarter, that gives you about a 75% increase, I believe.

Yes. I think your math is somewhat close to the first half of this year, Danny, correct me if I'm wrong, I think the first half, we did about $8.2 million in EBITDA. Last year, we did $10 million. We're saying at least 75%.

First half of this year was $9.2 million.

$9.2 million? What's $1 million amongst friends, $9.2 million, $8.2 million, $9.2 billion. So I think that hopefully answers your question. If we consider the full year, we're raising the guidance to at least 75%.

The next question comes from Kris Tuttle with Blue Caterpillar. At half of this year, Danny, correct me if I'm wrong, I think the first half, we did about $8.2 million in EBITDA. Last year, we did $10 million. We're saying at least 75%. Daniel M. Chism, CFO, mentioned that the first half of this year was $9.2 million. Darryll E. Dewan, President and CEO, responded that $9.2 million, $8.2 million, what's $1 million amongst friends, $9.2 billion. So hopefully that answers your question. If we're looking at the full year, we're increasing the guidance to at least 75%.

I was expecting more coverage on this call. In the past, analysts would introduce companies with this level of growth and fundamentals. Anyway, I have a couple of quick questions. Regarding Georgetown, can you clarify whether you are fully operational there or at capacity? If it's not 100%, what is your timeline for reaching that level?

We are now at full capacity, Kris, good to talk to you. We started the transition in early May, and we have reached 100%. So we are operating at full production capability right now.

We are now at 100%, Kris, good to talk to you, by the way. We started the transition around the early part of May, and we segued into 100%. So we're at full capacity and full production capability right now.

Sorry, Kris, you're pixelating a little bit.

We are now at full capacity, Kris, good to talk to you. We began the transition in early May and have since achieved 100% production capability.

One quick question, and I might have missed it because I missed the prepared remarks. So if I did, excuse me for asking again, but did you address anything going on with the Round Rock facility, like any kind of movement there in terms of opportunities? Or are you just 100% concentrating in the Georgetown facility now? I just wanted to know if you addressed that at all?

The opportunity is in sublease or as in doing additional business there.

Yes. I guess both. I mean, I'm assuming too that kind of that facility allows you to maybe do stuff that's none. Also potentially as an assumption also.

You're right, Maj, it is available. We've had some interested parties for sublease as well. It's also on our agenda to expand our configuration services business. It has sufficient power and some direct liquid cooling capability, which is what we have previously implemented there. The facility is 110,000 square feet, and we are exploring ways to maximize its use. This presents us with an opportunity to grow beyond our current relationships without disrupting them. However, we don't have any specific updates to share at this time, but we are actively working on it.

This concludes the Q&A portion of our call, and I'd like to turn the floor back over to Darryll Dewan for our closing remarks.

Thank you, sir. Folks on the call, we're really grateful and glad to be in our new facility. It's been an effort and an extreme amount of work by a great team to get here. So the execution to get here is quite amazing. We're doing everything we can to position the company to scale and be ready to address these advanced technologies by the investments we're making and by the people that we've got here. I can tell you that we're focused daily and quarterly and on an annual basis to continue to execute and to produce shareholder value. In a big picture, this is an exciting space. The AI world is just amazing. We appreciate you, our investors, for your commitment and your support. We're doing everything we can to give you a good return on your investment. And my phone and my door is always open as a management team here. So I appreciate any of your feedback or questions. As we've said before and I've said before in the previous call, wish us luck. So thank you. Have a good day.

Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.