TSS, Inc.: Form 10-K for the period ended Dec 31, 2023

Company Overview

TSS, Inc. provides a broad and specialized range of integration technology services that enable enterprises and users to successfully implement, operate, and maintain their Information Technology systems. As a provider of technology services built on a platform of experienced program management, we have expertise in delivering complex, end-to-end IT technology solutions cost-effectively. These IT solutions can be deployed in various physical settings such as data centers, co-location facilities, server rooms, modular or edge-based solutions, security operations, and communications facilities. Our services include rack and systems integration, configuration services, data center and modular data center facility management integration, deployment and maintenance services, strategic procurement services, project management and technology consulting, and design and engineering services.

TSS was incorporated in Delaware in December 2004. Our headquarters and our systems integration and configuration services facility are located in Round Rock, Texas.

We support a broad range of enterprise customers who utilize our services to deploy solutions in their own data centers, in modular data centers (MDC), in colocation facilities or at the edge of the network. This market remains highly competitive and is subject to constant evolution as new computing technologies or applications drive continued demand for more computing and storage capacity. In 2023 these enterprises shifted their investment priorities towards artificial intelligence (AI) and accelerated computing infrastructure initiatives. Enterprises and data center operators face immense pressure to integrate and deploy the latest AI equipment and graphic processing units (GPUs). They must adopt these next-generation servers and custom rack-scale architectures to compete in the market successfully and quickly. Ensuring adequate power and thermal management systems are implemented to support these new technologies while meeting increasingly stringent sustainability requirements is critical to a successful deployment. TSS exists to assist these operators in achieving these benefits over the life cycle of their IT investments.

Over the last ten years, we have focused our business on providing world-class integration services to our customer base. As computing technologies evolve, and as we currently see new power and cooling technologies emerge, including direct liquid-cooled IT solutions and the rapid adoption of AI computing solutions, we will continue to adapt our rack and systems integration businesses to support these new products. We will also continue to offer expanded services to enable the integration, deployment, support, and maintenance of these new IT solutions. We compete in expanding market segments, often against larger competitors who have extensive resources. We rely on several large relationships and one US-based OEM customer to win contracts and to provide business to us under “Master Service Agreements”. The loss of this customer could have a material negative effect on our results. Our operational focus is to ensure this doesn’t happen.

Most of the components used in our systems integration business are consigned to us by our original equipment manufacturer (OEM) or their end-user customers, thus our revenues reflect only the services we perform, and the consigned components are not reflected in our balance sheet. We also offer our customers strategic procurement services whereby we procure third-party hardware, software, and services on their behalf. Our configuration and integration service businesses integrate these components to deliver a complete system to our customers.

In some cases, we also act as an agent and arrange for the purchase of third-party hardware, software, or services that are to be provided to our customers by another party. However, we have no control over the goods or services before they are transferred to the customer. In these instances, we are acting as an agent in the transaction. These procurement activities allow us to develop relationships with new hardware, software, and professional service providers and allow us to generate higher margins on integration projects by broadening our revenue and customer base.

Service Offerings

We have developed a unique set of solution offerings where we provide a range of services that enable our customers and partners to efficiently plan, develop, build, deploy, and maintain their IT hardware and software solutions. These solutions begin with strategies for the care of information technology assets that are housed in the facility or modular data centers, including power, cooling, and heat rejection, as well as disaster recovery backup systems. Our operating expenses are not exclusively aligned to each service offering, as shared resources such as sales, marketing, and general and administrative expenses support all services. Our solutions involve all aspects of the life cycle of both traditional and modular data centers and their related assets which are described in more detail below.

Systems Integration Services:

To assist our customers with ITequipment deployment in their data centers we provide what we call “systems integration” services. We provide integrated technology services and software tools designed to accelerate the assembly and delivery of complex information technology solutions. These services include custom configuration of a broad scope of information technology products including client products, enterprise products, clusters, and modular containers. The integration of this equipment at both a rack-level or facility or modular data center level is performed to our customer specifications and test criteria and may include imaging of software onto the hardware as well. We are generally not responsible for the performance of the related IT equipment in the field. In addition, we provide warehousing of high-value equipment such as servers, switches, and other information technology hardware that are generally provided on a consignment basis to us by our OEM and end-user customers.

We also provide second-touch configuration services for our OEM and end-user customers, such as adding software, hardware, or other features to end-user devices, bundling such devices with peripherals, pre-loading customer-determined application software, tagging, asset capture, and other fulfillment services.

We have added two new service offerings to assist customers with the ongoing management of their IT systems. These include services to move or relocate equipment between locations, and specialized cabling solutions to link or integrate rack-level products and customer cabling and labeling services.

Facilities Services:

Consulting:

During the initial phase of a data center project, we provide project development-related services that typically include establishing project goals and a preliminary budget and schedules, setting technical parameters and requirements, and determining project team members and the overall requirements of the team.

Design and engineering consulting services typically include critical power and mechanical load calculations, mechanical design and engineering, high and medium voltage electrical design and engineering, communications and security systems design and engineering, physical vulnerability assessments, force protection design and bomb blast analyses, fire protection system design and engineering, facility systems equipment selection and facility commissioning and testing. These offerings also include post-commissioning support for ongoing operations.

Our strategy is to increase the number of customers and modular data centers under contract so that we can increase the amount of recurring revenues from ongoing design, maintenance, and support contracts. Our mission-critical facilities experience and our personnel skills position us as trusted advisors to our customers and allow us to work on new opportunities as our customers grow or as their facilities mature and as partners introduce us to new client opportunities. We also intend to increase our efforts at establishing direct selling and business relationships within the market.

Deployment:

In connection with the deployment of a solution within a customer’s existing data center, modular data center or related equipment requirements, our capabilities include project management, value engineering and design management, bid negotiation support, subcontractor pre-qualification, and selection, long-lead equipment procurement, issuance of equipment and construction contracts, and refinement and management of project budgets and schedules. Our project managers mobilize the required expertise for the project, utilizing project superintendents, quality control and safety professionals, as well as qualified subcontractors and support personnel. Project managers supervise work by project team members, including subcontracted parties, including all aspects of the following: architecture and construction, electric power systems, heat rejection and cooling, energy management, and controls, cooling tower systems, security systems, voice, data and network cabling, fire and life safety systems, and process piping and plumbing systems. The project manager remains responsible for managing all aspects of the project until project completion and customer delivery.

In addition, this installation portion of a project has the largest number of outside influences that can impact project goals and objectives, such as weather, non-performance of subcontractors, equipment deliveries, unexpected project changes from the owner, and influence from local authorities and utility providers. Therefore, management experience, skill, and mission focus are critical during the project installation period.

Maintenance and management:

We provide a comprehensive maintenance and service offering designed to ensure that the multiple systems critical to sustaining online applications in enterprise data centers and modular data centers remain operational and functional. Typical facilities management services include overall management of the post-construction facility maintenance program, and on-site staffing of technical engineering positions (e.g., electricians, HVAC mechanics, control technicians, and voice/data technicians). Increasingly, data centers are being constructed in a modular format, whereby information technology, power, and other related assets are deployed in pre-integrated solutions. Modular data centers may have lower overall cost of delivery, lower energy consumption, and shorter deployment schedules compared to traditional data centers. Our on-site maintenance services provide additional project revenue for us and position us for involvement in any new facility planning, design, and construction initiatives that the customer undertakes.

In addition, we provide 24x7 network operations support from our Round Rock, Texas facility which has the capability of remotely monitoring our data center service contract customers’ facilities for systems operations and emergency events that could lead to outages. Temperature levels, humidity, electrical connectivity, power usage, and fire alarm conditions are among the items monitored. The system maintains all site documentation for repairs and maintenance performed on each critical piece of equipment covered under our services. The information is useful to our customers in assessing operational efficiency and causes of failure and enables them to make critical decisions on repair or replacement strategies based on the operating history of the monitored systems.

Our facilities maintenance service contracts can be tailored to customer requirements and typically span one to three years in duration with cancellation clauses for nonperformance and are typically billed annually in advance. Our service contracts take different forms including fixed-price equipment maintenance with an optional comprehensive warranty to fix failures in key components such as uninterruptible power supplies or batteries, ticket-based service provided at contracted rates in a master service agreement, comprehensive facility services agreements that include on-site staffing, scheduled equipment maintenance and nontechnical facility services, and direct job-specific contracts for additional moves, add, refresh, refurbishment and change work within a facility.

As computer density increases and data centers evolve into the use of modular form factors, we found that we could leverage our facilities' maintenance experience and infrastructure by offering maintenance services for modules being deployed into new data centers. The number of modular units under our service contracts has continued to expand. Our design services continue to evolve to support changing data center requirements including installation and maintenance of systems deployed on the edge. Ultimately, we started working with IT vendors to help them in the design and integration of their IT equipment into modular data centers, which typically leads to ongoing maintenance contracts as these modular systems deploy.

Strategic Procurement Services:

We generate revenues from fees we charge our customers to procure third-party hardware, software, and professional services on their behalf that are used in our integration services as we integrate these components to deliver a completed system to our customers. These procurement services enable highly customizable solutions for our OEM and end-user customers and enable us to expand our revenues and profits and our customer base. We recognize our procurement services revenue upon completion of the procurement activity. In some cases, we arrange for the purchase of third-party hardware, software, or professional services that are to be provided directly to our customers by another party, and we have no control of the goods before they are transferred to the customer. In these instances, we are acting as an agent in the transaction and recognize revenue as the amount of any fee or commission that we expect to be entitled to after paying the other party for the goods or services provided to the customer.

Customers

Our customers include IT OEM equipment, technology and service companies, and private-sector businesses that in some cases are the end users of the facility, or in other cases are providing a facility to a government or commercial end user.

Sales and Marketing

A key part of our selling strategy is entering into master service agreements with multiple partners and co-selling our range of services to our partners’ end-user customers, leveraging their customer relationships and broadening the scope of potential customers for us. Our go-to-market approach formerly relied on business generated by one major OEM customer. While this business was and remains valued, it has been difficult to forecast resulting in inconsistent and fluctuating quarterly results. This approach relied on expertise in information technology hardware systems, energy consumption, real estate matters, and facilities planning and operation from this primary demand source. This marketing approach allowed the end–user customer to contract for comprehensive facilities services or to contract separately for each project phase such as integration or fulfillment services.

Our updated go-to-market strategy is designed to capitalize on our investment in direct selling personnel and leveraging our OEM partner’s capabilities at the same time. Our ability to be involved in sales engagements earlier in the cycle and with end-users will allow us to positively impact demand and provide greater visibility into the integration schedules and future pipeline. This impacts our ability to better manage personnel schedules and ultimately optimize our production capacity. We also seek to enhance our name recognition using improved web marketing, trade shows, technical seminars, direct mailings, and social media.

Our headcount in sales and marketing has been very selective and targeted to align the skill sets with our evolving service offerings, leverage partner relationships and increase the consultative capability of our sales organization.

Maintaining key alliances and creating new partnerships is an important part of our sales development and growth plan. These alliances reside with various information technology consulting firms, specialty mission-critical engineering firms, application service providers, and internet service providers. Key alliance opportunities also reside in other firms within the market sector such as equipment manufacturers, product suppliers, property management firms, developers, information technology system integrators, and firmware providers. We are focused on expanding our strategic alliances with information technology corporations to provide engineering, design, construction management services, systems integration, modular solutions, and facility management services. As we expand our configuration services business, we expect this will help us establish alliances with new hardware and software providers who operate in the IT infrastructure market.

Competition

The mission-critical information technology solutions market is large, fragmented, and highly competitive. We compete for contracts based on the strength of our customer relationships, successful past performance, significant technical expertise, specialized knowledge, and broad service offerings. Our strength lies in our ability to deliver quality solutions on time and with high quality at a competitive price. These solutions can be complex or simple. We have gained traction by providing complex AI solutions utilizing GPU and advanced thermal management technology. We often compete against channel re-sellers and divisions of large information technology service and equipment providers. In some cases, because of diverse requirements, we collaborate with these and other competitors for projects. We respect competition in the information technology services sector, and we embrace what we need to do to compete and win to continue to increase in the future.

Strategy

Our goal is to profitably grow our existing businesses and to identify expanded service offerings to further our value add to our customers as we become a recognized leader in the life-cycle management of complex IT solutions. At a high level, the strategy we intend to use to accomplish this goal include:

• Expand our ability to drive demand with direct and selling resources and to co-sell with our customers and partners. We believe we can expand our services portfolio penetration within these new, as well as existing customers.
• Maintain intense customer focus: We intend to strengthen and deepen our customer relationships. We believe that continued focus on cost-effective systems integration, deployment, and ongoing life-cycle management is important, and will help to increase our net sales, operating performance, and market share. To accomplish this, we intend to continue our close collaboration with our OEM partner to assist them in identifying demand for our services and design new services that allow them to meet new customer requirements and leverage innovations and technical developments. Additionally, we will continue to expand our sales force and field service technicians and add additional technical expertise.
• Continue to deliver operational excellence and cost competitiveness and enhance our manufacturing capability. A key element of our success is our ability to leverage and optimize our systems integration facility. We will continue to invest in our integration processes and technology to achieve additional cost efficiencies and enhance our existing capabilities. We are expanding to a hybrid integration model which allows us to generate revenues from within our facility and externally at customer locations. This allows more flexibility to support our customers’ requirements while continuing to enhance our cost-effectiveness.
• Pursue selective strategic partnerships and acquisitions: As part of our strategy to expand our service offerings and to maximize our market opportunities, we may partner with or acquire technologies, services, or product lines to accelerate our growth and to enhance our portfolio.

Employees

On December 31, 2023, we had 81 full-time employees. Our future success will depend on our continued ability to attract, retain, and motivate qualified personnel. We are not a party to any collective bargaining agreement, and we have not experienced any strikes or work stoppages. We consider our relationship with our employees to be very satisfactory.

Available Information

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements relating to our annual stockholders’ meeting with the Securities and Exchange Commission (“SEC”). Copies of these filings, including amendments to such filings are available, free of charge, on our website, www.totalsitesolutions.com (http://www.totalsitesolutions.com), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Information contained on our website is not and should not be deemed to be a part of this Annual Report or a part of any other report or filing with the SEC. All reports that we file with the SEC are available to read and copy at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site at www.sec.gov (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Our business involves a number of risks, some of which are beyond our control. The risks and uncertainties described below are not the only ones we face. Such factors could have a significant impact on our business, operating results and financial condition. We believe the most significant of these risks and uncertainties are as follows:

We derive a significant portion of our revenues from one customer.

We currently derive and believe that we will continue to derive in the near term a significant portion of our revenues from one OEM customer. We provide a range of different services and generate revenue from multiple business units and divisions of this OEM customer. To the extent that any significant business unit or division of this OEM customer uses less of our services or terminates its relationship with us, or this OEM reorganizes its business units and divisions in such a way that directly impacts the level of business with us, our revenues would decline significantly, which would have a material adverse effect on our financial condition and the results of our operations. Revenues from this OEM customer comprised 96% of our total revenues for each of the years ended December 31, 2023 and 2022.

Supply chain challenges have and will likely negatively affect our integration business by slowing the supply of parts needed to perform integration services, requiring us to hold greater quantities of inventory for longer periods and/or delaying completion of services for our customers.

Since the COVID 19 pandemic began in 2020, due to its impact on global production and distribution we have experienced ongoing impacts from shortages of components needed to complete integration and procurement services, delaying our ability to recognize revenue for these projects and negatively impacting our profitability. In addition to delaying our services, this has also resulted in us having to hold onto greater quantities of customer inventory for longer time periods while we wait for the missing components to be delivered. Due to our fixed storage capacity, holding customer-owned inventory for longer periods has negatively impacted our ability to perform other services and added cost and risk, including custodial risk, into our integration business. The supply chain disruptions have also directly impacted vendors and other third parties from whom we procure goods and services for our reseller and procurement business, causing delays in completing procurement services for our customers. This has the potential to materially harm our operating results by delaying recognition of revenue. This can also harm our liquidity position if we are forced to pay vendors for products and services before we have the ability to invoice and receive payment from our customers, which could also prevent us from performing additional procurement services for our customers or cause other liquidity concerns.

Changes in labor market conditions are causing increases in our labor costs, and if we are unable to adequately recover these costs from our customers, our business will be negatively impacted.

At times we experience higher levels of attrition, increasing compensation costs, and more intense competition for talent. We believe that our future success will be dependent upon retaining the services of our key personnel, developing their successors and certain internal processes to reduce our reliance on specific individuals, and on properly managing the transition of key roles when they occur. As a small company we are particularly susceptible to negative impacts if critical and experienced personnel leave. Hiring and retaining qualified executives and other employees is therefore critical to our business. During 2022 and 2023 we had a number of changes to our executive leadership team, and we experienced increased wage pressure and challenges in hiring people in the Austin, Texas market. We have had to pay higher wages to attract new employees and retain our existing employees. If our total compensation programs, employment benefits, and overall workplace culture are not viewed as competitive and inclusive, our ability to attract, retain and motivate employees could be compromised. To the extent we experience significant attrition or the loss of critical employees and are unable to replace employees in a timely manner, we could experience a loss of critical skills and reduced employee morale, potentially resulting in business disruptions or increased expenses to address any disruptions. We have recently increased the prices we charge for our integration services to recover these higher costs. To the extent that we are unable to promptly pass higher labor costs on to our customers, our business will be negatively impacted. Our inability to attract, retain and motivate employees or manage succession of key roles may inhibit or ability to maintain or expand our business operations.

We have a history of operating losses, and we may experience net losses in the future.

Although we recorded operating income in 2023 and 2022 and net income in 2023, we had a net loss in 2022 and we recorded operating and net losses in both 2021 and 2020. We have a history of recurring net annual losses in prior years and at December 31, 2023 we had an accumulated deficit of approximately $66.3 million. We believe that changes we have made to the business in recent years, including the addition of procurement and reseller services and changes to our operating cost structure have improved our operating results and allowed us to achieve multiple profitable quarters in each of the last several years, but we do have a history of fluctuating operating results. Our efforts to align costs with sales and gross margin volume have reduced our level of overhead, but there can be no guarantee that we will be successful in sustaining or increasing profitability in 2024 or beyond. The uncertainty of a rapidly changing marketplace and ongoing global supply challenges have created a volatile and challenging business climate, which may continue to negatively impact our customers and their spending and investment decisions. We may not be able to generate the level of revenue necessary to achieve and maintain sustainable profitability. Any failure to maintain and grow our revenue volumes would adversely affect our business, financial condition and operating results.

We are attempting to diversify our customer base but there is no guarantee that we will be successful in doing so.

After the sale of certain components of our business in 2018 and 2017, our customer concentration increased and revenue from our three largest customers comprised 99% of our total revenues for each of the years ended December 31, 2023 and 2022. We are continuing our efforts to add new revenue streams such as our strategic procurement services that we began offering in 2019, as well as targeting other vendors in the data center infrastructure market, including Value Added Resellers and systems integrators who have the need for IT integration services. We are also targeting other vendors in the modular data center market to leverage our expertise and capabilities in this marketplace. We are also trying to stay ahead of emerging trends in the IT market space such as liquid-cooled product offerings, AI computing, immersion technology and edge-based solutions so that we can develop service offerings to leverage growth opportunities for these new markets. While we believe our efforts will allow us to broaden our customer base and reduce our customer concentration, there can be no guarantee that we will be successful at these endeavors, or of the time that it will take for these efforts to be successful.

We are partially through the implementation of a new enterprise resource IT system and have yet to fully deploy this new system across all of our business units. Any challenges, delays, difficulties, or errors during the implementation of this new system may negatively impact our business operation and harm our operating results.

We rely on computerized inventory and management systems to coordinate and manage the activities in our integration business, as well as to communicate inventory and shipment information to our vendors and customers. Our ability to rapidly process incoming deliveries, track inventory through the integration process, and process shipments in a timely manner are essential to the operations of our integration business. As we introduce a new ERP system to perform these functions including our financial reporting and accounting functions, any challenges in the implementation of the system, changes to processes or errors in functionality where such systems fail to adequately perform as designed, could adversely affect our business and harm our operating results. We began to use this new enterprise system as our system of record with effect from October 1, 2022. We are still working to deploy the system across all of our business units and integrate it into our financial reporting systems.

Our procurement services business is still evolving, and the level of this business may fluctuate significantly on a quarterly basis, requiring additional working capital in order to grow.

We began providing procurement services to our customers in 2019. We do not yet have a history of stable and ongoing contracts with customers for our procurement services and, as a result, we have experienced material fluctuations in our quarterly revenues from these services, which has had a material impact on our quarterly and annual revenues and profits. We have been able to structure our procurement activities in such a way as to minimize their overall impact on our liquidity by using trade creditors as the primary way to finance these activities. However, depending on the size of potential procurement and reseller contracts, we may be required to procure material amounts of hardware, software, and professional services from other third parties and there can be no guarantee that our existing sources of liquidity or available trade finance will be sufficient to enable us to finance these transactions.

As the age of modular data centers increases and customers look to shut or replace such units, our recurring maintenance revenues could be negatively impacted, and this could adversely affect our operating results.

Modular Data Centers (MDCs) typically have a lifespan of 6-10 years unless they are updated with new IT equipment. As they near the end of their useful life, customers can either perform maintenance to extend the MDCs' lifespan or terminate maintenance contracts for those MDCs. If customers terminate their annual maintenance contracts, it could negatively impact our maintenance revenues and profitability unless they replace the units with new MDCs immediately. While our history suggests that customers will replace MDCs with new modules subject to annual maintenance contracts, the time period between these two events could result in a decrease in our maintenance and overall revenue in our facilities business.

We have substantial amounts of goodwill, and changes in future business conditions could cause these assets to become impaired, requiring substantial write-downs that would adversely affect our operating results.

We have substantial amounts of goodwill resulting from prior acquisitions of businesses. Under generally accepted accounting principles, we do not amortize goodwill and intangible assets acquired in a purchase business combination that are determined to have indefinite useful lives, but instead review them annually (or more frequently if impairment indicators arise) for impairment. To the extent we determine that such assets have been impaired, we will write-down their carrying value on our consolidated balance sheet and book an impairment charge in our consolidated statement of operations. At December 31, 2023 and 2022, we conducted such analyses that resulted in no impairment. The net carrying value of goodwill totaled $0.8 million at December 31, 2023 and 2022, respectively.

We operate in a highly competitive industry, which could reduce our growth opportunities, revenue and operating results.

The mission-critical information technology industry in which we operate is highly competitive and continues to become more competitive. We often compete against divisions of large information technology consulting and integration companies, including several large domestic companies that may have financial, technical and marketing resources that exceed our own. These larger competitors have an infrastructure and support greater than ours, and accordingly, we continue to experience some price pressure as some companies are willing to take on projects at lower margins. Our competitors may develop the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services, and we may not be able to maintain or enhance our competitive position. Our size often prevents us from bidding on larger, more profitable projects, which significantly reduces our growth opportunities. Although our customers currently outsource a significant portion of these services to us and our competitors, we can offer no assurance that our existing or prospective customers will continue to outsource specialty contracting services to us in the future.

Most of our contracts may be canceled on short notice, so our revenue and potential profits are not guaranteed.

Most of our contracts are cancelable on short notice by the customer either at its convenience or upon our default. If one of our customers terminates a contract at its convenience, then we typically are able to recover only costs incurred or committed, settlement expenses and profit on work completed prior to termination, which could prevent us from recognizing all of our potential revenue and profit from that contract. If one of our customers terminates the contract due to our default, we could be liable for excess costs incurred by the customer in re-procuring services from another source, as well as other costs. Many of our contracts, including our service agreements, are periodically open to bid. We may not be the successful bidder on our existing contracts that are re-bid. We also provide a portion of our services on a non-recurring, project-by-project basis. We could experience a reduction in our revenue, profitability and liquidity if our customers cancel a significant number of contracts, we fail to win a significant number of our existing contracts upon re-bid, or we complete the required work under a significant number of our non-recurring projects and cannot replace them with similar projects. In addition, we provide services under certain master service agreements. If these agreements are terminated, we would be unable to provide ongoing services to those customers.

We submit change orders to our customers for work we perform beyond the scope of some of our contracts. If our customers do not approve these change orders, our results of operations could be adversely impacted.

We typically submit change orders under some of our contracts for payment of work performed beyond the initial contractual requirements. The applicable customers may not approve or contest these change orders and we cannot assure you that these claims will be approved in whole, in part or at all. If these claims are not approved, our results of operations could be adversely impacted.

We may not accurately estimate the costs associated with services provided under fixed-price contracts, which could impair our financial performance.

Approximately 90% of our revenue is derived from fixed-price contracts. Under these contracts, we set the price of our services and assume the risk that the costs associated with our performance may be greater than we anticipated. Our profitability is therefore dependent upon our ability to estimate accurately the costs associated with our services. These costs may be affected by a variety of factors, such as lower than anticipated productivity, conditions at the work sites differing materially from what was anticipated at the time we bid on the contract, and higher than expected costs of materials and labor. Certain agreements or projects could have lower margins than anticipated or losses if actual costs for contracts exceed our estimates, which could reduce our profitability and liquidity.

We warranty customer equipment against failure in some of our fixed price contracts, and a major equipment failure could have a material impact on our financial performance.

Under some of our maintenance contracts we provide limited warranties for the continued performance of equipment, including batteries and actuators used in modular data centers. We estimate the anticipated failure or replacement rate of this equipment, but if a customer location experienced a failure rate of equipment greater than we anticipated, we would incur higher equipment replacement costs and incur a loss on that maintenance contract, and potentially this could have a material negative impact on our profitability and liquidity.

We may choose, or be required, to pay our subcontractors even if our customers do not pay or delay paying us for the related services.

We use subcontractors to perform many portions of our services and to manage workflow. In some cases, we pay our subcontractors before our customers pay us for the related services. If we choose, or are required, to pay our subcontractors for work performed for customers who fail to pay, or delay paying us for the related work, we could experience a decrease in profitability and liquidity.

The industries we serve have experienced and may continue to experience rapid technological, structural and competitive changes that could reduce the need for our services and adversely affect our revenues.

The mission-critical information technology industry is characterized by rapid technological change, intense competition and changing consumer and data center needs. We generate a significant portion of our revenues from customers in the mission-critical information technology industry. New technologies, or upgrades to existing technologies by customers, could reduce the need for our services and adversely affect our revenues and profitability. Improvements in existing technology may allow companies to improve their networks without physically upgrading them. Reduced demand for our services or the loss of a significant customer or end-user could adversely affect our results of operations, cash flows and liquidity.

We may be unable to hire and retain sufficient qualified personnel, and the loss of any of our key executive officers may adversely affect our business.

We believe that our future success will depend in large part on our continued ability to attract and retain highly skilled, knowledgeable, sophisticated and qualified managerial, professional, and technical personnel. Our business involves the development of tailored solutions for customers, a process that relies heavily upon the expertise and services of employees. Accordingly, our employees are one of our most valuable resources. Competition for skilled personnel is intense in our industry. Recruiting and training these personnel require substantial resources particularly when seeking qualified staff in remote locations where a number of our customers operate their data centers. Our failure to attract and retain qualified personnel could increase our costs of performing our contractual obligations, reduce our ability to efficiently satisfy our customers’ needs, limit our ability to win new business and constrain our future growth.

If we are unable to engage appropriate subcontractors or if our subcontractors fail to perform their contractual obligations, our performance as a prime contractor and ability to obtain future business could be materially and adversely impacted.

Our contract performance may involve subcontracts with other companies upon which we rely to perform all or a portion of the work we are obligated to deliver to our customers. Our inability to find and engage appropriate subcontractors or a failure by one or more of our subcontractors to satisfactorily deliver on a timely basis the agreed-upon supplies and/or perform the agreed-upon services may materially and adversely affect our ability to perform our obligations as a prime contractor.

In extreme cases, a subcontractor’s performance deficiency could result in the customer terminating the contract for default with us. A default termination could expose us to liability for excess costs of procurement by the customer and have a material adverse effect on our ability to compete for future contracts and task orders.

Security breaches and attacks on our computer systems could lead to significant costs and disruptions that could harm our business, financial results and reputation.

We are reliant upon a number of third-party and internally developed software programs to operate our business. We store and transmit our own as well as customer information and data, including individual data of and about their end-user customers. Maintaining the security and availability of our services, network and internal IT systems and the security of information we hold is a critical issue for us and our customers. Any software failure or corruption, including cyber-based attacks or network security breaches, could lead to the dissemination of proprietary information or sensitive, personal or confidential data about us, our employees, customers and end-user customers, could threaten our ability to provide services to our customers, generate negative publicity about us, result in litigation and increased legal liability or costs or lead to government inquiry or oversight. The occurrence of any of these events could harm our business or damage our brand and reputation, lead to the loss of customers and higher expenses, and possibly impede our present and future success in retaining and attracting new customers.

A successful assault on our infrastructure damage to our reputation and could adversely affect our financial condition. Similar security risks exist with respect to our business partners and the third-party vendors we rely on for aspects of our information technology infrastructure, support services and administrative functions. As a result, we are subject to the risk that the activities of our business partners and third-party vendors may adversely affect our business even if an attack or breach does not directly impact our systems.

Because we do not currently intend to pay dividends on our common stock, stockholders will benefit from an investment in our common stock only if it appreciates in value.

We have never declared or paid any cash dividends on our common stock. We currently intend to retain all future earnings, if any, for use in the operations and expansion of our business. As a result, we do not anticipate paying cash dividends in the foreseeable future. Any future determination as to the declaration and payment of cash dividends will be at the discretion of our board of directors and will depend on factors our board of directors deems relevant, including, among others, our results of operations, financial condition and cash requirements, business prospects, and the terms of our credit facility and other financing arrangements. Accordingly, realization of a gain on stockholders’ investments will depend on the appreciation of the price of our common stock. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders purchased their shares.

Our insiders beneficially own a significant portion of our outstanding common stock. Future sales of common stock by these insiders may adversely affect the market price of our common stock.

Our officers, directors or their affiliates beneficially own approximately 6.9 million shares of common stock or approximately 30% of our outstanding common shares as of March 28, 2024. Stock sales by our directors and officers are subject to compliance with our Code of Conduct and the preapproval process from the Chief Financial Officer. Sales of a substantial number of these shares in the public market could decrease the market price of our common stock. In addition, the perception that such sales might occur may cause the market price of our common stock to decline. Future issuances or sales of our common stock could have an adverse effect on the market price of our common stock.

Our shares are thinly traded and may not be readily marketable.

Our shares are not widely traded, and daily trading volume is generally very low compared with most publicly traded companies. As a result, you may not be able to readily resell your shares in the company.

Our common stock may be characterized as a “penny stock” under applicable SEC regulations.

Our common stock may be characterized as “penny stock” under SEC regulations. As such, broker-dealers dealing in our common stock may be subject to the disclosure rules for transactions involving penny stocks, which generally require that, prior to a purchase, the broker-dealer determine if purchasing the common stock is suitable for the applicable purchaser. The broker-dealer must also obtain the written consent of the applicable purchasers to purchase the common stock and disclose the best bid and offer prices available for the common stock and the price at which the broker-dealer last purchased or sold the common stock. These additional burdens imposed upon broker-dealers may discourage them from effecting transactions in our common stock, which could make it difficult for an investor to sell his, her or its shares at any given time.

We have developed and implemented a cybersecurity risk management program intended to protect the confidentiality, integrity, and availability of our critical systems and information.

We design and assess our program based on the National Institute of Standards and Technology Cybersecurity Framework (NIST CSF). This does not mean that we meet any particular technical standards, specifications, or requirements, but only that we use the NIST CSF as a guide to help us identify, assess, and manage cybersecurity risks relevant to our business.

As part of our cybersecurity risk management system, our IT management team tracks and logs privacy and security incidents across our OEM partners, Microsoft and Oracle and other IT system providers, our vendors, and other third-party service providers to remediate and resolve any such incidents. Any significant incidents are reviewed regularly by a cross-functional working group to determine whether further escalation is appropriate. Any incident assessed as potentially being or potentially becoming material is immediately escalated for further assessment, and then reported to designated members of our senior management. We would consult with outside counsel as appropriate, including on materiality analysis and disclosure matters, and our senior management makes the final materiality determinations and disclosures and other compliance decisions. Our management is tasked with apprising TSS’s independent public accounting firm of matters and any relevant developments.

Our Board considers cybersecurity risk as part of its risk oversight function and has delegated to the Audit Committee oversight responsibility for risks and incidents relating to cybersecurity threats, including compliance with disclosure requirements, cooperation with law enforcement, and related effects on financial and other risks. The Audit Committee oversees management’s implementation of our cybersecurity risk management program, and it reports any findings and recommendations, as appropriate, to the full Board for consideration. Senior management regularly discusses cyber risks and trends and, should they arise, any material incidents with the Audit Committee. The Company’s IT department regularly uses specialist firms to independently test our cybersecurity controls. The IT management team is informed about and monitors the prevention, detection, mitigation and remediation of cybersecurity risks and incidents through various means, which may include, among other things, briefings with security personnel, threat intelligence and other information obtained from government, public or private sources, including external consultants engaged by us, and alerts and reports produced by security tools deployed in our IT environment.

At this time, we have not identified risks from known cybersecurity threats, including as a result of any prior cybersecurity incidents, that have materially affected us, including our operations, business strategy, results of operations, or financial condition. We face certain ongoing risks from cybersecurity threats that, if realized, are reasonably likely to materially affect us, including our operations, business strategy, results of operations, or financial conditions. See “Risk Factors - Security breaches and attacks on our computer systems could lead to significant costs and disruptions that could harm our business, financial results and reputation”.

We lease a production facility, warehouse and office space in Round Rock, Texas and in 2021 renewed a 7-year lease for this space. We believe that our current facilities are adequate for our operations and additional or replacement facilities would be available if necessary.

We are not a party to any material litigation in any court, and we are not aware of any contemplated proceeding by any governmental authority against us. From time to time, we are involved in various legal matters and proceedings concerning matters arising in the ordinary course of business such as employment-related matters. We believe that any potential liability arising out of these matters and proceedings will not have a material adverse effect on our financial position, results of operations or cash flows.

The following discussion contains statements that are forward-looking. These statements are based on expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of, among other reasons, factors discussed in Item 1A – Risk Factors and elsewhere in this Annual Report. The commentary should be read in conjunction with the consolidated financial statements and related notes and other statistical information included in this Annual Report.

Overview

TSS, Inc. (“TSS”, the “Company”, “we”, “us” or “our”) provides a range of integration and technology services that enable enterprises and users to successfully implement, operate and maintain their Information Technology systems. As a provider of technology services businesses built on a platform of experienced program management, we have expertise in delivering complex, end-to-end IT technology solutions cost-effectively. These IT solutions can be deployed in a variety of physical settings such as data centers, co-location facilities, server rooms, modular or edge-based solutions, security operations, and communications facilities. Our services include rack and systems integration, configuration services, data center and modular data center facility management integrations, deployment and maintenance services, strategic procurement services, project management and technology consulting, design and engineering services. Our headquarters and our systems integration and configuration services facility are located in Round Rock, Texas

We support a broad range of enterprise customers who utilize our services to deploy solutions in their own data centers, in modular data centers (MDC), in colocation facilities or at the edge of the network. This market remains highly competitive and is subject to constant evolution as new computing technologies or applications drive continued demand for more computing and storage capacity. In 2023 these enterprises shifted their investment priorities towards artificial intelligence (AI) and accelerated computing infrastructure initiatives. Enterprises and data center operators are facing immense pressure to rapidly integrate and deploy the latest AI equipment and GPUs and will need to adopt these next-generation servers and custom rack-scale architectures to compete in the market successfully and quickly. Ensuring adequate power and thermal management systems are implemented to support these new technologies while meeting increasingly stringent sustainability requirements is critical to a successful deployment. TSS exists to assist these operators in achieving these benefits over the life cycle of their IT investments.

Over the last ten years, we have focused our business on providing world-class integration services to our customer base. As computing technologies evolve, and as we currently see new power and cooling technologies emerge, including direct liquid-cooled IT solutions and the rapid adoption of AI computing solutions, we will continue to adapt our rack and systems integration businesses to support these new products. We will also continue to offer expanded services to enable the integration, deployment, support, and maintenance of these new IT solutions. We compete in expanding market segments, often against larger competitors who have extensive resources. We rely on several large relationships and one US-based OEM customer to win contracts and to provide business to us under “Master Service Agreements”. The loss of this customer could have a material negative effect on our results. Our operational focus is to ensure this doesn’t happen.

Most of the components used in our systems integration business are consigned to us by our original equipment manufacturer (OEM) or their end-user customers. Thus our revenues reflect only the services we perform, and the consigned components are not reflected in our income statement or on our balance sheet. We also offer our customers strategic procurement services whereby we procure third-party hardware, software, and services on their behalf. Our configuration and integration service businesses integrate these components to deliver a complete system to our customers.

In some cases, we also act as an agent and arrange for the purchase of third-party hardware, software, or services that are to be provided to our customers by another party. However, we have no control over the goods or services before they are transferred to the customer. In these instances, we are acting as an agent in the transaction. These procurement activities allow us to develop relationships with new hardware, software, and professional service providers and allow us to generate higher margins on integration projects by broadening our revenue and customer base.

Our facilities business rebounded in the second half of 2022 as COVID-related supply chain conditions improved and the number of Modular Data Center (MDC) deployments that we performed increased as we satisfied the backlog that had accumulated during the COVID pandemic. This led to a $3.9 million increase in revenues from MDC deployments in our fiscal year 2022. We have since seen a $3.7 million decrease in revenue from MDC deployments in 2023 compared to 2022. This whiplash impact has altered the underlying demand and delivery of MDC deployments, and we expect the number of MDC deployments that we complete to fluctuate on a quarterly basis for the foreseeable future, causing our quarterly revenues and profits to fluctuate. To offset this, we are selectively investing in direct sales capabilities to work alongside our OEM partners to re-create demand lost during and post the pandemic period.

Our systems integration business was negatively impacted during the COVID pandemic due to logistical and supply-chain issues. Supply constraints that initially were due to disruptions caused by the pandemic have continued to occur and create obstacles that still affect component supply to us and negatively impact our integration revenues. The latter half of 2023 was characterized by supply shortages of AI chips and servers, and challenges procuring fiber-optic and high-speed cables for example. We believe that these ongoing constraints will dissipate as additional production capacity comes online, and we are optimistic that increases in demand for AI solutions will create new opportunities to grow our integration business in 2024 and beyond. As this AI technology and other computing technology evolves, including liquid-cooled solutions, we believe this will drive growth in the data center market and provide new revenue opportunities for us. Despite these ongoing challenges, there has been an improvement in supply-chain issues since the second half of 2022, which, along with pricing adjustments, has helped us grow our integration revenues by 23% in 2023 compared to 2022.

The volume of transactions we engaged in with our strategic procurement services grew substantially in 2023. Customers value our ability to source disparate hardware, software and services and provide a single-source solution for their IT needs. In some cases, we merely act as agents in these transactions, and so the reported revenues will be different and only reflect our fees earned in the transaction. Overall, we were able to increase our revenues from procurement transactions by $25.3 million or 191%, compared to 2022. The aggregate gross value of all procurement transactions increased from $73 million in 2022 to $123.1 million in 2023.

Our total revenue in 2023 was $54.4 million, a $23.8 million or 78% increase from our 2022 revenues of $30.6 million. The majority of this increase came from growth in our procurement and systems integration businesses, offset by a $3M decrease in our facilities revenues as the number of MDC deployments decreased compared to 2022.

Our gross profits increased by $2 million or 23% compared to 2022, mainly due to the higher volumes of activity in our procurement and integration businesses. Our gross profit margin as a percentage of sales decreased to 20% in 2023 from 29% in 2022. The primary cause of the decrease in gross profit margin percentage was the increase in volume of our procurement business as a proportion of our total revenue, where we generally earn much lower margins on product purchase/resell services than we do with our traditional maintenance and integration services. Absent this business, the margins on our core integration and maintenance operations decreased to 36% in 2023 from 37% in 2022 due to the lower volume of maintenance business during 2023.

Our selling, general and administrative expenses of $8.9 million were 16% higher than the $7.7 million we recorded in selling, general and administrative expenses in 2022. The increase was primarily due to higher labor costs as we made a number of strategic investments during 2023 in our sales, marketing, production and support organizations, to enable us to expand our capabilities and to position us to capitalize on future growth opportunities.

Because of the higher overall gross profits, even with higher selling, general and administrative expenses, we were able to improve our operating profit by $0.8 million or 91% from 2022, recording operating income of $1,750,000 in 2023 compared to an operating profit of $914,000 that we recorded in 2022.

Our interest expense increased by $0.7 million compared to 2022. This was due to a combination of higher interest rates during 2023 and higher levels of activity in our procurement business compared to the prior year. During 2023 we transacted approximately $123.1 million in transactions in this business activity, although $84.5 million of this was for agent-type transactions. With the receivable-financing program that we have with a third-party banking partner, all of these procurement transactions are financed via this program, and we incur interest costs on the gross value of these transactions. As the gross volume increases in these procurement activities, our interest cost will increase. This increase in volume was exacerbated by the increase in interest rates during 2023. By comparison, we transacted approximately $72.8 million in such transactions in 2022.

We ended 2023 with $11.8 million of cash on hand, a decrease of $8.6 million from the balance at the end of 2022. This decrease was primarily due to the timing of cash flows connected with our procurement activities. The volume of procurement activities in progress was lower at the end of 2023 compared to the end of 2022. These activities resulted in a large increase in our accounts payable at the end of 2022 which were paid in the first quarter of 2023. The procurement activities drive large quarterly fluctuations in our accounts receivables, inventory and deferred revenues, depending on the timing of particular transactions. We were able to generate $14.7 million of cash flows from operations during 2022 but as the transactions completed, we used $8.3 million in operating activities during 2023. We have been able to structure our procurement activities in such a way as to minimize their overall impact on our liquidity by using trade creditors as the primary way to finance these activities.

Critical Accounting Policies and Estimates

We consider an accounting policy to be critical if:

• the accounting estimate requires us to make assumptions about matters that are highly uncertain or require the use of judgment at the time we make that estimate; and
• changes in the estimate that are reasonably likely to occur from period to period or use of different estimates that we could have reasonably used instead in the current period, would have a material impact on our financial condition or results of operations.

Management has reviewed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed these disclosures. In addition, there are other items within our financial statements that require estimation but are not deemed critical as defined above. Changes in these and other items could still have a material impact on our financial statements.

Revenue Recognition

We recognize revenues when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

Some of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations based on relative standalone selling prices.

Maintenance services

We generate maintenance services revenues from fees that provide our customers with as-needed maintenance and repair services on modular data centers during the contract term. Our contracts are typically one year in duration, are billed annually in advance, and are non-cancellable. As a result, we record deferred revenue (a contract liability) and recognize revenue from these services on a ratable basis over the contract term. We can mitigate our exposure to credit losses by discontinuing services in the event of non-payment. However, our history of non-payments and bad debt expense has been insignificant.

Integration services

We generate integration services revenues from fees that provide our customers with customized system and rack-level integration services. We typically recognize revenue upon shipment to the customer of the completed systems as this is when we have completed our services and when the customer obtains control of the promised goods. We typically extend credit terms to our integration customers based on their creditworthiness and generally do not receive advance payments. As such, we record accounts receivable at the time of shipment, when our right to the consideration becomes unconditional. Accounts receivable from our integration customers are typically due within 30-105 days of invoicing. An allowance for doubtful accounts is provided based on a periodic analysis of expected credit losses based on current estimates, which also includes a review of individual account balances, including an evaluation of days outstanding, payment history, recent payment trends, and our assessment of our customer’s creditworthiness. As of December 31, 2023 and 2022, our allowance for doubtful accounts was $7,000.

Equipment sales

We generate revenues under fixed price contracts from the sale of data center and related ancillary equipment to customers in the United States. We typically recognize revenue when the product is shipped to the customer as that is when the customer obtains control of the promised goods. Typically, we do not receive advance payments for equipment sales, however, if we do, we record the advance payment as deferred revenue. Normally we record accounts receivable at the time of shipment when our right to the consideration has become unconditional. Accounts receivable from our equipment sales are typically due within 30-45 days of invoicing.

Deployment and Other services

We generate revenues from fees we charge our customers for other services, including repairs or other services not covered under maintenance contracts, installation and servicing of equipment including modular data centers that we sold, and other fixed-price services including repair, design and project management services. In some cases, we arrange for a third party to perform warranty and servicing of equipment, and in these instances, we recognize revenue as the amount of any fees or commissions that we expect to be entitled to. Other services are typically invoiced upon completion of services or completion of milestones. We record accounts receivable at the time of completion when our right to consideration becomes unconditional.

Procurement services

We generate revenues from fees we charge our customers to procure third-party hardware, software and professional services on their behalf that are then used in our integration services as we integrate these components to deliver a completed system to our customer. We recognize our procurement services revenue upon completion of the procurement activity. In some cases, we arrange for the purchase of third-party hardware, software or professional services that are to be provided to our customers by another party and we have no control of the goods before they are transferred to the customer. In these instances, we are acting as an agent in the transaction and recognize revenue as the amount of any fee or commissions that we expect to be entitled to after paying the other party for the goods or services provided to the customer. Accounts receivable from our procurement activities are typically due within 30-60 days of invoicing.

Judgments

We consider several factors in determining that control transfers to the customer upon shipment of equipment or upon completion of our services. These factors include that legal title transfers to the customer, we have a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment or completion of the services.

Sales taxes

Sales (and similar) taxes that are imposed on our sales and collected from customers are excluded from revenues.

Shipping and handling costs

Costs for shipping and handling activities, including those activities that occur subsequent to transfer of control to the customer, are recorded as cost of sales and are expensed as incurred. We accrue costs for shipping and handling activities that occur after control of the promised good or service has transferred to the customer.

The following table shows our revenues disaggregated by reportable segment and by product or service type (in $’000):

Remaining Performance Obligations

Remaining performance obligations include deferred revenues and amounts we expect to receive for goods and services that have not yet been delivered or provided under existing, non-cancellable contracts. For contracts that have an original duration of one year or less, we have elected the practical expedient applicable to such contracts and we do not disclose the transaction price for remaining performance obligations at the end of each reporting period and when we expect to recognize this revenue. As of December 31, 2023, current deferred revenue of $3,370,000 consists of $2,404,000 representing our remaining performance obligations for our maintenance contracts, all of which are expected to be recognized within one year, and $966,000 relating to procurement and integration services where we have yet to complete our services for our customers as of December 31, 2023, all of which are expected to be recognized within one year.

Intangible Assets

We recorded goodwill and intangibles with definite lives, including customer relationships and acquired software, in conjunction with the acquisition of various businesses. Intangible assets with finite lives are amortized based on their estimated economic lives. Goodwill represents the excess of the purchase price over the fair value of net identified tangible and intangible assets acquired and liabilities assumed, and it is not amortized.

We perform an impairment test of goodwill on an annual basis with a measurement date of December 31, or whenever events or circumstances make it more likely than not that impairment of goodwill may have occurred. Our goodwill impairment test involves comparing the fair value of a reporting unit with its carrying amount. If that fair value exceeds the carrying amount, no impairment charge is required to be recorded. If the carrying value exceeds the reporting unit’s fair value, an entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the impairment losses recognized cannot exceed the total amount of goodwill allocated to that reporting unit. If necessary, the fair value of a reporting unit will be determined using a discounted cash flow, which requires the use of estimates and assumptions. Significant assumptions that may be required include forecasted operating results, and the determination of an appropriate discount rate. Actual results may differ from forecasted results, which may have a material impact on the conclusions reached.

We also review intangible assets with definite lives for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset, a loss is recognized for the difference between the fair value and carrying value of the intangible asset.

Allowance for Doubtful Accounts

We estimate an allowance for doubtful accounts based on factors related to the specific credit risk of each customer. Historically our credit losses have been minimal. We perform credit evaluations of new customers and may require prepayments or use of bank instruments such as trade letters of credit to mitigate credit risk. We monitor outstanding amounts to limit our credit exposure to individual accounts. We continue to pursue collection even if we have fully provided for an account balance.

Stock Based Compensation

We account for stock-based compensation using a fair-value based recognition method. Stock-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized ratably over the requisite service period of the award. Determining the appropriate fair-value model and calculating the fair value of stock-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. We develop our estimates based on historical data and market information that can change significantly over time. A small change in estimates used can have a relatively large change in the estimated valuation.

We use the Black-Scholes option valuation model to value employee stock option awards that are not performance-based awards. We estimate stock price volatility based upon our historical volatility. Estimated option life and forfeiture rate assumptions are derived from historical data. For restricted stock awards, we use the quoted price of our common stock on the grant date as the fair value of the award. For stock-based compensation awards with graded vesting, we recognize compensation expense using the straight-line amortization method. For performance-based stock awards, if applicable, we may use third-party valuation specialists and a Monte-Carlo simulation model to ascertain the fair value of the award at grant date.

Results of Operations

Comparison of 2023 to 2022

Revenue

Revenue consists of fees earned from the planning, design and project management of mission-critical facilities and information infrastructures, as well as fees earned from providing maintenance services on these facilities. We also earn revenue from providing system configuration and integration services, including procurement services, to IT equipment vendors. Currently we derive all our revenue from the U.S. market.

We contract with our customers under five primary contract types: fixed-price service and maintenance contracts, time and material contracts, cost-plus-fee, guaranteed maximum price and fixed-price contracts. Cost-plus-fee and guaranteed maximum price contracts are typically lower-risk arrangements and thus yield lower profit margins than time-and-materials and fixed-price arrangements, which generate higher profit margins generally, relative to their higher risk. Certain of our service and maintenance contracts provide comprehensive coverage of all of the customer’s equipment (generally excluding IT equipment) at a facility during the contract period. Where customer requirements are clear, we prefer to enter comprehensive fixed-price arrangements or time-and-materials arrangements rather than cost-plus-fee and guaranteed maximum price contracts.

Most of our revenue is generated based on services provided either by our employees or subcontractors. To a lesser degree, the revenue we earn includes reimbursable travel and other costs to support the project. Since we earn higher profits from the labor services that our employees provide compared with use of subcontracted labor and other reimbursable costs, we seek to optimize our labor content on the contracts we are awarded to maximize our profitability.

We have been concentrating our sales efforts towards maintenance and integration services where we have traditionally earned higher margins. Historically we performed design, construction and project-management services in a concentrated number of high-value contracts for the construction of new data centers, but we have transitioned our business away from this market. We have also focused on providing maintenance services for modular data center applications as this market matures. We continue to focus on increasing our systems integration revenues through more consistent revenue streams that will better utilize the assets in that business, and through adding additional services such as procurement services and data center moves, to help drive volume through the facility. This includes adapting our integration services to stay abreast of emerging technologies such as immersion computing, liquid-cooled computing, and edge-based technology, so that we can help our customers succeed in these new markets.

Our total revenue in 2023 was $54.4 million, a $23.8 million or 78% increase from our 2022 revenues of $30.6 million. The majority of this increase came from growth of $25.3 million in our procurement business and from growth of $1.6 million in our systems integration business, offset by a $3.1 million decrease in our facilities revenues as the number of MDC deployments decreased compared to 2022.

Our procurement business involves us procuring third-party hardware, software and services on our customers’ behalf that are then typically used in our integration services as we integrate those components to deliver a completed system to our customer. The volume and timing of revenues from our procurement business has been unpredictable and subject to large fluctuations, especially on a quarterly basis. Most transactions are for discrete projects that do not recur, and the time to complete most projects is usually less than six months. In some cases, we also act as an agent and arrange for the purchase of third-party hardware, software or services that are to be provided to our customer by another party, and we have no control over the goods or services before they are transferred to the customer. In these instances, we are acting as an agent in the transaction and recognize revenue as the amount of any fee or commission that we expect to be entitled to after paying the other party for the goods or services provided to the customer. We had a substantial increase in the number of procurement transactions we completed in 2023 compared to 2022, including a large increase in agent-type transactions, that allowed us to increase revenues from procurement activities from $13.2 million in 2022 to $38.5 million in 2023.

Cost of Revenue

Cost of revenue includes the cost of component parts for our products, labor costs expended in the production and delivery of our services, subcontractor and third-party expense, equipment and other costs associated with our test and integration facilities, excluding depreciation of our manufacturing property and equipment, shipping costs, and the costs of support functions such as purchasing, logistics and quality assurance. The cost of revenue as a percentage of revenue was 80% for the year ended December 31, 2023, compared to 71% for 2022. This increase is primarily due to the higher proportion of our total revenue that is from procurement services in 2023. Absent the procurement business, the cost of revenue as a percentage of revenue on our traditional integration and maintenance businesses was 64% in 2023 compared to 63% in 2022.

Our procurement revenues were 71% of total revenue in 2023 compared to 43% of total revenues in 2022. We earn much lower margins from our procurement services, unless we are acting as an agent in the transaction, than we do with our traditional maintenance and integration services. As the percentage of revenues derived from procurement services increases, we would anticipate that cost of revenue as a percentage of sales will also increase, and result in lower gross profit margins.

Since we earn higher profits when using our own labor services, we expect gross margins to improve when our labor service mix increases relative to the use of subcontracted or third-party labor. Our direct labor costs are relatively fixed in the short-term, and the utilization of direct labor is critical to maximizing our profitability. As we continue to bid and win contracts that require specialized skills that we do not possess, we would expect to have more third-party subcontracted labor to help us fulfill those contracts. In addition, we can face hiring challenges in internally staffing larger contracts. While these factors could lead to a higher ratio of cost of services to revenue, the ability to outsource these activities without carrying a higher level of fixed overhead allows us to increase income, broaden our revenue base and have a favorable return on invested capital. As we increase the level of procurement and reseller services in the future, we anticipate that our overall gross margin will decrease as the normal margins on reseller activities are lower than the margins from our traditional facilities and systems integration services.

A large portion of our revenue is derived from fixed price contracts. Under these contracts, we set the price of our services and assume the risk that the costs associated with our performance may be greater than we anticipated. Our profitability is therefore dependent upon our ability to estimate accurately the costs associated with our services. These costs may be affected by a variety of factors, such as lower than anticipated productivity, conditions at the work sites differing materially from what was anticipated at the time we bid on the contract, and higher than expected costs of materials and labor. Certain agreements or projects could have lower margins than anticipated or losses if actual costs for contracts exceed our estimates, which could reduce our profitability and liquidity.

Gross Profit

Our gross profit margin for the year ended December 31, 2023 was 20% compared to a gross profit margin of 29% for the year ended December 31, 2022. This decrease in gross profit margin as a percentage of revenue compared to 2022 was primarily from the higher percentage of our total revenue in 2023 that came from procurement services. As the percentage of total revenue from procurement services increases, our gross profit margin will decrease as the cost of sales is higher for this revenue than our traditional integration and facilities revenues. Absent the impact from our procurement services, the gross profit margin on our traditional integration and facilities revenues was 36% in 2023 compared to 37% in 2022.

The growth in our total revenues in 2023 compared to 2022 allowed us to increase our overall gross profit by 23% or $2 million to $11 million in 2023 compared to gross profit of $9 million in 2022.

Our ability to maintain and to further improve gross profits will depend, in part, upon our ability to continue increasing sales of our higher-margin services including maintenance and integration services, improve our service margins by passing our higher operating costs on to our customers through increasing pricing, improving the operating efficiency of the integration business including utilization of our direct labor, and increasing the total revenues to a level that will allow us to increase and improve the utilization of our integration and service operations. Our gross profit margin is also likely to fluctuate based on the proportion of our total revenues that comes from our procurement activities.

Selling, General and Administrative Expenses

Selling, general and administrative expenses primarily consist of compensation and related expenses, including variable sales and incentive compensation, for our executive, administrative, sales and marketing personnel, as well as related travel, selling and marketing expenses, professional fees, facility costs, insurances and other corporate costs. For the year ended December 31, 2023, our selling, general and administrative expenses of $8.9 million increased by $1.2 million, or 16%, compared to 2022. The increase was primarily due to higher labor costs as we made a number of strategic investments during 2023 in our sales, marketing, production and support organizations, to enable us to expand our capabilities and to position us to capitalize on future growth opportunities.

Operating income

Because of the higher absolute gross profits, even with the higher level of selling, general and administrative expenses, we were able to improve our operating profit by $0.8 million or 91% from 2022 and record an operating income of $1,750,000 in 2023 compared to operating income of $914,000 that we recorded in 2022.

Interest expense, net

For the year ended December 31, 2023 we recorded interest expense, net of interest income, of $1,616,000. This compares to interest expense, net of interest income, of $931,000 for the year ended December 31, 2022. The increase in interest expense was due to both higher interest rates in 2023 compared to 2022 and to an increase in the value of transactions that were factored, which was approximately $137 million in 2023 compared to approximately $87.8 million in 2022. The increase in amounts factored was because of the higher number of procurement projects, including agent-type transactions, that we processed in 2023. This increase in interest expense attributable to factoring was partially offset in 2023 when there was no interest expense for related party debt which was extinguished in July 2022. We were also able to offset this increase with an additional $322,000 of interest income during 2023 as we managed cash flows from our procurement transactions and were able to invest surplus funds until required.

Income tax expense

Due to a history of consolidated net operating losses, we have not recorded any income tax expenses, other than minimum or statutory costs. As of December 31, 2023, our accumulated net operating loss carry-forward was $40 million. We anticipate that these loss carry-forwards may offset future taxable income that we may achieve and future tax liabilities. However, because of uncertainty regarding our ability to use these carry forwards and the potential limitations due to ownership changes, we have established a valuation allowance for the full amount of our net deferred tax assets.

Net income (loss)

After net interest and income taxes, we recorded net income of $74,000, or $0.00 per share for the year ended December 31, 2023. This compares to a net loss of $73,000, or $(0.00) per share we recorded for the year ended December 31, 2022.

Comparison of 2022 to 2021

Revenue

Our total revenue in 2022 was $30.6 million, a $3.2 million or 12% increase from our 2021 revenues of $27.4 million. Our facilities revenues increased by $3.1 million or 44% to $10.2 million, driven by an increase in deployments of MDCs as customer projects delayed by the COVID-19 pandemic during 2021 were now able to be completed. Our systems integration revenues grew by $1.5 million or 27% compared to 2021 as supply-chain issues attributable to the COVID-19 pandemic dissipated, and because of stronger demand from our OEM partner. Our procurement revenues decreased by $1.4 million or 10% compared to 2021 because we completed more agent-type transactions in 2022 than we did in 2021, resulting in lower recorded revenue but higher profits from this line of business.

Cost of revenue

Cost of revenue includes the cost of component parts for our products, labor costs expended in the production and delivery of our services, subcontractor and third-party expense, equipment and other costs associated with our test and integration facilities, excluding depreciation of our manufacturing property and equipment, shipping costs, and the costs of support functions such as purchasing, logistics and quality assurance.

The cost of revenue as a percentage of revenue was 71% for the year ended December 31, 2022, compared to 77% for 2021. This decrease in margin percentage from 2021 reflects the lower proportion of our total revenues that come from our procurement activities. Our procurement revenues were 43% of total revenue in 2022 compared to 54% of total revenues in 2021. We earn much lower margins on product purchase/resell services, unless we are acting as an agent in the transaction, than we do with our traditional maintenance and integration services. As the percentage of revenues derived from procurement services decreases, we would anticipate that cost of revenue as a percentage of sale will decrease.

Gross Profit

Our gross profits increased by $2.6 million or 41% compared to 2021, mainly due to the higher volume of activity across all our business units, and our gross profit margin as a percentage of sales increased to 29% in 2022 from 23% in 2021. The increase in gross profit was greater than the increase in total revenues due in part to the impact of growth in the number of agent-type transactions in our procurement business in 2022. Under these transactions we recognize as revenue the net margin we receive after paying the other party for goods or services that they deliver to the customer. Profits from our procurement services increased by $1.7 million in 2022 compared to 2021. Absent this business, the margins on our core integration and maintenance operations decreased from 44% in 2021 to 37% in 2022 despite higher revenues. This was primarily due to an increase in costs, particularly labor costs, in our integration business that reflected higher wage inflation, higher levels of employee turnover that impacted efficiency, and development and other costs incurred in developing and introducing new types of integration service during 2022.

Selling, General and Administrative Expenses

Selling, general and administrative expenses primarily consist of compensation and related expenses, including variable sales compensation, for our executive, administrative and sales and marketing personnel, as well as related travel, selling and marketing expenses, professional fees, facility costs, insurances and other corporate costs. For the year ended December 31, 2022, our selling, general and administrative expenses of $7.7 million increased by $1 million, or 15% compared to 2021. The increase was primarily due to higher labor costs, including approximately $0.6 million attributable to a change in our chief executive officer in the fourth quarter of 2022, and the impact of wage inflation on our workforce which was more pronounced during 2022 than in previous years.

Operating Income

Because of the higher absolute gross profits, even with the higher level of selling, general and administrative expenses, we were able to improve our operating profit by $1.7 million or 210% from 2021, and recorded operating income of $914,000 in 2022 compared to an operating loss of $831,000 that we recorded in 2021.

Interest expense

For the year ended December 31, 2022, we recorded interest expense, net of interest income, of $931,000. This compared to interest expense, net of interest income, of $401,000 for the year ended December 31, 2021. The increase in interest expense was due to the higher number of agent-type transactions that were factored in our procurement business compared to 2021. Interest expense in our procurement activities increased by $480,000 in 2022 due to the higher number of transactions and the impact of higher interest rates during 2022.

Income tax expense

Due to a history of consolidated net operating losses, we have not recorded any income tax expenses, other than minimum or statutory costs. As of December 31, 2022, our accumulated net operating loss carry forward was $41 million. We anticipate that these loss carry-forwards may offset future taxable income that we may achieve and future tax liabilities. However, because of uncertainty regarding our ability to use these carry forwards and the potential limitations due to ownership changes, we have established a valuation allowance for the full amount of our net deferred tax assets.

Net income (loss)

After interest, other income and income taxes, we recorded a net loss of $73,000, or $(0.00) per share for the year ended December 31, 2022. This compares to a net loss of $1.3 million, or $(0.07) per share we recorded for the year ended December 31, 2021.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity at December 31, 2023 are our cash and cash equivalents on hand, funds available under our bank credit facility and projected cash flows from operating activities.

As of December 31, 2023, the Company had an accumulated deficit of $66,311,000. Although we reported operating income in 2023 and 2022 and net income in 2023, we do have a history of annual operating and net losses which have been due, in part, to the effects of COVID-19 and subsequent supply chain constraints. These factors may be indicative of doubt regarding the Company’s ability to continue as a going concern. Management has evaluated the significance of these conditions in relation to its ability to meet its obligations. Our primary sources of funds to meet our liquidity and capital requirements include cash on hand, funds generated from operations, including the funds from our customer financing program, and trade credit extended to us by our vendors, or under our revolving credit facilities with our bank. If our future results do not meet expectations, management believes that we can implement reductions in selling, general and administrative expenses to better achieve profitability and therefore improve cash flows, or that we could take further steps such as the issuance of new equity or debt. We may also require additional capital if we seek to acquire additional businesses to increase the scale of our operations, or if there is a sudden increase in the level of procurement services. There can be no assurance as to the Company’s ability to scale its business operations on terms upon which additional financing might be available.

Management believes that we will be able to generate sufficient cash flows and liquidity as described above, as we have been able to grow our revenues and order backlog and seen an improvement in supply chain constraints. We believe that we will continue to be profitable on a quarterly and annual basis in 2024 and beyond. As a result, management has concluded that there is not substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern for a reasonable period of time.

As of December 31, 2023 and 2022, we had cash and cash equivalents of $11.8 million and $20.4 million, respectively.

Significant uses of cash

Operating activities:

Cash used in operating activities was $8.3 million for the year ended December 31, 2023, compared to cash provided by operating activities of $14.7 million for the year ended December 31, 2022. This change in cash from operating activities was primarily attributable to the timing and financial impacts of our procurement services. The volume of procurement activities was higher at the end of 2023 compared to the end of 2022, however, at the end of 2022 we were able to be paid for multiple large procurement projects but had yet to pay vendors for these same projects. This resulted in an increase of approximately $14 million in our outstanding accounts payable at the end of 2022. During the first quarter of 2023 we paid those vendors, and both our cash and accounts payable decreased by over $14 million. The increases in our inventory and receivables in 2023 compared to 2022 are also attributable to the timing of in-progress procurement projects. We have been able to structure our procurement activities in such a way as to minimize their overall impact on our liquidity by using trade creditors as the primary way to finance these activities. However, due to timing, it is possible to see fluctuations on a quarterly and annual basis for procurement projects that are in progress at the end of a reporting period. We believe that we will have adequate trade credit available to use to continue financing our procurement activities as we grow this business during 2024 and beyond.

Investing activities:

Cash used in investing activities was $0.3 million in 2023, primarily for the upgrading of our integration business and improvements to our facility. This compares to cash used in investing activities of $0.5 million in 2022 for the expansion and upgrading of our integration facility to support our business.

Finance activities:

Cash used in financing activities was $40,000 in 2023 compared to cash used in financing activities of $1.8 million during 2022. The cash used in financing activities during 2023 was for the purchase of stock related to tax obligations around vesting of restricted stock by our employees. In 2022 we used $134,000 for tax obligations around restricted stock vesting, and we received $41,000 in proceeds from the exercise of stock options by employees. We also received $367,000 in proceeds from the exercise of warrants by our former note holders, and we used $2.045 million to repay all of the company’s outstanding long-term debt upon its maturity in July 2022.

Future uses of cash

Our business plans and our assumptions around the adequacy of our liquidity are based on estimates regarding estimated revenues and future costs and our ability to secure sources of funding when needed. Further, our estimates may change, and future events or developments may also affect our estimates. Any of these factors may change our expectation of cash usage during 2024 and beyond or significantly affect our level of liquidity, which may require us to take other measures to reduce our operating costs in order to continue operating. Any action to reduce operating costs may negatively affect our range of products and services that we offer or our ability to deliver such products and services, which could materially impact our financial results depending on the level of cost reductions taken.

Our primary liquidity and capital requirements are to fund working capital from current operations. Our primary sources of funds to meet our liquidity and capital requirements include cash on hand, funds generated from operations including the funds from our customer financing programs, and, if needed, borrowings under our bank credit facility. We believe that if future results do not meet expectations, we can implement reductions in selling, general and administrative expenses to better achieve profitability and therefore improve cash flows, or that we could take further steps such as the issuance of new equity or debt. However, the timing and effect of these steps may not completely alleviate a material effect on liquidity. We may also require additional capital if we seek to introduce new lines of business or if we seek to acquire additional businesses as a way to increase the scale of our operations.

New Accounting Pronouncements

Recently Adopted Accounting Guidance

In March 2020, FASB issued Accounting Standards Update ASU No. 2020-04*, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, (“*ASU 2020-04”). ASU 2020-04 provides optional expedients and exceptions for applying GAAP principles to contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued due to reference rate reform. This guidance was effective beginning on March 12, 2020 and was adopted by us in the fourth quarter of 2022 and did not have any material impact on our consolidated results of operations, cash flows, financial position or disclosure.

In June 2016, FASB issued Accounting Standards Update ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): *Measurement of Credit Losses on Financial Instruments (“*ASU 2016-13”). The standard’s main goal is to improve financial reporting by requiring earlier recognition of credit losses on financing receivables and other financial assets. Among the provisions of ASU 2016-13 is a requirement that assets measured at amortized cost, which includes trade accounts receivable, be presented at the net amount expected to be collected. This pronouncement requires that an entity reflect all of its expected credit losses based on current estimates which will replace the current standard requiring that an entity need only consider past events and current conditions in measuring an incurred loss. This guidance was adopted by us in the fourth quarter of 2023 and did not have a material impact on our consolidated results of operation, cash flows, financial position or disclosure.

In May 2019, FASB issued Accounting Standards Update ASU No. 2019-15, *Financial Instruments – Credit Losses (Topic 326), (“*ASU 2019-15”). ASU 2019-15 provides final guidance that allows entities to make an irrevocable one-time election upon adoption of the new credit losses standard to measure financial assets at amortized cost (except held-to-maturity securities) using the fair value option. The effective date and transition methodology are the same as in ASU 2016-13.

Recently Issued Accounting Pronouncements

In November 2023, FASB issued Accounting Standards Update ASU No. 2023-07, *Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. (“*ASU 2023-07”). ASU 20203-07 improves reportable segment disclosure requirements for public business entities primarily through enhanced disclosures about significant segment expenses that are regularly provided to the chief operating decision-maker, and included within each reported measure of segment profit (referred to as the “significant expense principle”). ASU 2023-07 will become effective for the fiscal year 2024 annual financial statements and interim financial statements thereafter, and will be applied retrospectively for all prior periods presented in the financial statements, with early adoption permitted. We intend to adopt the standard when it becomes effective in the fiscal year 2024 annual financial statements and we are currently evaluating the impact this guidance will have on the disclosures included in the Notes to the Consolidated Financial Statements.