TSS, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a standalone fourth-quarter filing. Financial amounts below are in U.S. dollars; “million” is abbreviated as “m.”
Business context
TSS provides data-center and mission-critical-facility services, including systems integration, installation, maintenance, and engineering. During 2016–2017, it shifted away from larger, lower-margin design, procurement, and project-management work toward systems integration and modular-data-center maintenance. It sold a Maryland facilities-maintenance business in 2016 and a customer contract in 2017, outsourced some services, reduced staffing, and closed the Maryland facility. Management says the changes lowered overhead and working-capital needs, while concentrating the business on fewer customers and markets.
Financial results and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Revenue | $18.316m | $27.373m |
| Gross profit / margin | $7.725m / 42% | $7.208m / 26% |
| Operating income (loss) | $1.106m | $(0.633)m |
| Net income (loss) | $0.766m | $(1.023)m |
| Net income (loss) per diluted share | $0.05 | $(0.07) |
| Cash from (used in) operations | $(0.045)m | $2.232m |
| Cash and cash equivalents at year-end | $2.268m | $2.152m |
- Revenue fell 33%, primarily because 2016 included $13.6m from activities later sold or discontinued. Facilities revenue was $12.254m, down from $21.751m; systems-integration revenue rose to $6.062m from $5.622m.
- Gross profit increased despite lower revenue, reflecting the shift to higher-margin services and lower overhead. SG&A declined to $6.459m from $8.149m. The 2017 operating result included a $0.321m gain on the sale of a customer contract.
- Management reported quarterly 2017 revenue of $4.2m–$4.9m and a 42% gross margin in each quarter, with operating profit in each quarter.
- Operating cash flow was slightly negative despite net income; management attributed the year-over-year cash-flow decline chiefly to $2.1m of working-capital changes as the company collected receivables and paid vendors while exiting businesses.
- At year-end, current assets were $3.729m and current liabilities $5.335m, implying negative working capital of about $1.606m and a current ratio of about 0.70. Stockholders’ equity remained deficient at $(0.305)m, improved from $(1.431)m.
- Long-term borrowings had a $1.656m carrying value, net of discounts and issuance costs; disclosed future principal repayments total $2.042m, due in 2022. 2017 financing included $1.05m of new borrowing. Receivables-factoring borrowings were repaid, leaving none outstanding at year-end.
- Some debt is related-party financing, secured by substantially all company assets. The 12% MHW/MHW Partners notes provide for 6% cash interest and 6% payment-in-kind interest; separate $400,000 loans from two lenders bear no interest. Warrants issued in connection with financing create potential dilution.
- The company reported a $9,000 income-tax provision and a full valuation allowance against net deferred tax assets. It disclosed substantial net operating loss carryforwards, but their future usability is uncertain.
Outlook, risks, and unusual items
- Management said projected cash flows, if achieved, should provide adequate resources for at least the next 12 months. This assessment depends on revenue, cost, working-capital, and financing assumptions; the filing states that additional financing or cost reductions may be needed if results fall short.
- The independent auditor’s report includes a going-concern explanatory paragraph, citing the history of operating losses and net capital deficiency. The company also identifies negative working capital and stockholders’ deficit as sources of substantial doubt. The financial statements contain no adjustments for a failure to continue as a going concern.
- Customer concentration is a key risk: the largest IT OEM accounted for 67% of 2017 revenue, compared with 39% in 2016. Loss or reduced orders from this customer could materially affect results. The filing also warns that most contracts can be canceled on short notice and that about 85% of revenue comes from fixed-price contracts, exposing margins to cost overruns.
- Other cited risks include competition and pricing pressure, reliance on subcontractors and qualified personnel, equipment-warranty costs, technological change, cybersecurity, and reliance on discretionary receivables factoring. Factoring advances carry a prime-plus-7% financing cost and are subject to the factor’s discretion.
- Minimum future operating-lease payments were $3.186m; open purchase-order commitments were approximately $0.5m, mostly expected to be fulfilled in the first half of 2018. The company reported no material litigation and no dividends paid or anticipated in the foreseeable future.
- The 2017 contract sale generated $0.321m of reported gain. The 2016 Maryland business sale generated a $0.910m gain, affecting the prior-period comparison. Management did not expect adoption of the new revenue-recognition standard in 2018 to have a material impact.
Important facts for investors to verify
- Reconcile the filing’s customer-concentration disclosures: the business overview says three customers represented 82% of 2017 revenue, while the risk discussion identifies the largest customer at 67%, and the customer table lists the other named customers at 4% and 0% and says no other customer exceeded 10%.
- Assess whether recurring operating cash generation can support obligations, given negative working capital, negative 2017 operating cash flow, and the auditor’s going-concern warning.
- Review the full debt and warrant terms, related-party relationships, collateral, interest burden, maturity, and potential share dilution.
- Test the durability of 2017 margins and profitability against customer concentration, fixed-price contract exposure, and lower post-transition revenue levels.
- Confirm the amount and availability of factoring or alternative financing and the assumptions underlying management’s 12-month liquidity outlook.
- Consider the shares’ OTCQB quotation, low trading volume, and limited marketability; insiders beneficially owned approximately 38% of outstanding shares as of March 30, 2018.