TSS, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter report. Financial comparisons are with FY2017 unless otherwise stated. Amounts below are in U.S. dollars.
Business context
TSS provides data-center facilities services and systems integration, including deployment, maintenance, and integration of IT equipment. The company continued its strategic shift away from large, lower-margin construction and project-management work toward modular data-center services, facilities maintenance, and systems integration. In December 2018 it sold its Virginia-based critical power and cooling business, completing the transition described by management. TSS operates in the United States and reported 67 full-time employees at year-end.
Financial performance and position
| Metric | FY2018 / Dec. 31, 2018 | FY2017 / Dec. 31, 2017 |
|---|---|---|
| Revenue | $22.335 million | $18.316 million |
| Gross profit; gross margin | $8.483 million; 38% | $7.725 million; 42% |
| Operating income | $2.866 million | $1.106 million |
| Net income | $2.437 million | $0.766 million |
| Basic / diluted earnings per share | $0.16 / $0.13 | $0.05 / $0.05 |
| Cash from operating activities | $1.900 million | $(0.045) million |
| Cash and cash equivalents | $6.178 million | $2.268 million |
| Current assets / current liabilities | $7.433 million / $4.571 million | $3.729 million / $5.335 million |
| Long-term borrowings, carrying value | $1.838 million | $1.656 million |
| Stockholders’ equity (deficiency) | $2.481 million | $(0.305) million |
Revenue rose 22%, with facilities services up approximately 24% and systems integration up approximately 18%. Facilities revenue growth was led by deployment and other services; maintenance revenue increased more modestly. Gross profit increased 10%, but the gross margin fell four percentage points. Management attributed the decline to uneven systems-integration facility utilization and lower deployment-project margins. SG&A was $6.372 million, down slightly; depreciation and amortization was $0.385 million.
Operating income included a $1.140 million gain on the business sale. Interest expense, net, was $0.403 million and income tax expense was $0.026 million. Operating cash flow improved to $1.900 million. Investing activities provided $1.902 million, principally from the business sale, while financing activities provided $0.108 million. Cash increased by $3.910 million during the year. Year-end working capital was approximately $2.862 million, versus a deficit in 2017.
Material changes and unusual items
- The Virginia power and cooling business was sold for stated gross consideration of $2.5 million. TSS reported $2.325 million paid at closing after escrow and assumed assets, and $2.144 million of sale proceeds in the cash-flow statement. The sale generated a reported $1.140 million gain after write-offs and transaction costs.
- The buyer, Innovative Power, LLC, was managed by the board chairman, who was also affiliated with entities holding TSS promissory notes. The filing says the transaction was negotiated at arm’s length and approved by the board excluding the chairman.
- The divested business was profitable: the filing reports $1.332 million of pre-tax profit related to it in 2018. The company cautions that its remaining operations must grow or be supplemented to replace the sold business’s contribution. Pro forma results assuming the dispositions occurred at the start of 2017 show 2018 operating income of $0.429 million and a net loss of $0.035 million.
- TSS adopted the new revenue-recognition standard in 2018; management said adoption had no material effect. It adopted the new lease standard on January 1, 2019 and recorded approximately $2 million of lease-related assets and liabilities.
Liquidity, debt and outlook
TSS entered a two-year, asset-based revolving credit facility of up to $1.5 million with Texas Capital Bank on December 31, 2018. It is secured by substantially all assets, bears interest at LIBOR plus 3%, and includes financial covenants and a $500,000 minimum-liquidity requirement. No amount was outstanding at year-end; eligible borrowing availability was approximately $100,000. The facility matures December 31, 2020.
Separate notes had $1.995 million of principal outstanding, carry 12% interest (partly paid in kind), and mature in July 2022. They are affiliated with the board chairman and secured by company assets, subordinated to the bank facility. Management stated it expected available resources to fund operations for at least 12 months, conditional on meeting its revenue and cost projections. It provided no specific numerical earnings or revenue guidance.
Management expects the narrower business model to produce lower revenue than historical levels, with less quarterly volatility, but acknowledged increased customer concentration. It intends to pursue higher-margin recurring services and improve integration-facility utilization. Risks include customer concentration, contract cancellations and rebids, fixed-price cost overruns, subcontractor and equipment-warranty exposure, competition, staffing, technology change, liquidity and financing needs, and possible loss of maintenance revenue as modular data centers age. The company reported no material litigation and said its financial statements received an unmodified audit opinion; the auditor highlighted customer concentration as an emphasis matter. Management reported effective disclosure controls and internal control over financial reporting.
Most important facts for investors to verify
- Customer dependence: One OEM accounted for 66% of 2018 revenue (67% in 2017); the three largest customers represented 80%. The OEM also accounted for 75% of year-end trade receivables.
- Underlying profitability after the divestiture: Separate the $1.140 million sale gain and the sold unit’s earnings from continuing operations; reconcile the filing’s reported pro forma results and differing descriptions of the divested business’s profit contribution.
- Liquidity and borrowing capacity: Confirm the borrowing-base availability, covenant headroom, and working-capital needs; year-end availability under the new facility was only about $100,000 despite its $1.5 million stated maximum.
- Debt and related-party arrangements: Review the 12% secured notes, warrant terms, chairman affiliations, sale transaction terms, and the facility’s priority and covenant restrictions.
- Share dilution and trading risk: Review outstanding options and warrants, restricted stock, and the thinly traded OTCQB listing. The filing reports 17,217,919 common shares outstanding on March 21, 2019.
- Financial statement details: Confirm the basic and diluted EPS figures against the audited statements; the MD&A also gives a rounded 2018 per-share figure that differs from the audited basic EPS.