TSS, Inc. (TSSI) FY 2024 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 comprehensive suite of services for the planning, design, deployment, maintenance, refresh and take-back of end-user and enterprise systems, including the mission-critical facilities in which they are housed. We provide a single source solution for enabling technologies in data centers, operations centers, network facilities, server rooms, security operations centers, communications facilities and the infrastructure systems that are critical to their function. Our services consist of technology consulting, design and engineering, project management, systems integration, systems installation, facilities management and IT procurement services. Our systems integration services have recently been enhanced to include integration of Artificial Intelligence (AI) enabled data center server racks. TSS was incorporated in Delaware in December 2004. Our corporate offices and our integration 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 (MDCs), 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 advanced computing and storage capacity. In 2023, these enterprises shifted their investment priorities towards AI and accelerated computing infrastructure initiatives. Enterprise and data center operators are facing immense pressure to rapidly integrate and deploy the latest generative AI equipment and GPUs (Graphics Processing Units) and will need to adapt these next-generation servers and custom rack-scale architectures to quickly and successfully compete in the market. 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 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 business 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 (original equipment manufacturer) customer to win contracts and to provide business to us under a Master Relationship Agreement.  The loss of or material decline in volume of business from this OEM customer would have a material 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 largest OEM customer or its 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 procurement services whereby we procure third-party hardware, software and services on their behalf. Our configuration and integration service businesses often integrate these components to deliver a complete system to our customers.

In some cases, in the performance of procurement services, 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 of 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 services allow us to develop relationships with new hardware, software and professional service providers and allow us to generate higher profits on integration projects by broadening our revenue and customer base.

In October 2024, we signed a multi-year agreement with our largest customer to provide systems integration services for AI-enabled computer racks at an expected minimum monthly volume.  To support this level of production, and to be able to provide increased volumes over our existing facility, we are moving our headquarters and production facility to a new location in early 2025 and anticipate capital expenditures of approximately $25 million to $30 million for improvements to that facility, primarily to significantly increase the available electrical power and related cooling capabilities for both air-cooled and direct liquid cooled (“DLC”) computer racks.  We are financially responsible for all fixed and variable costs related to this activity, including debt service requirements related to the planned capital expenditures, direct and indirect labor related to this activity, and all facility and related costs for the portion of our facility allocated to this activity.  While there may be some variability in the number of racks built in any given period, we believe the structure of the agreement with our customer provides reasonable assurance to us that absent our material breach of the agreement or our termination of the agreement, the revenues we earn from this arrangement will consistently be sufficient to cover the aforementioned costs we expect to incur in fulfilling our obligations.  Our customer could terminate the agreement if we were to materially breach the agreement, leaving us with the financial obligations of the lease and debt service regardless of whether we had revenues sufficient to cover those costs.  Likewise, if we were to terminate the agreement other than due to the other party’s material breach of the agreement, the other party would be relieved of any further obligation. Funding sources for the build-out costs at the new facility include approximately $6.8 million contributed by our landlord, $20 million from a construction loan from Susser Bank, and cash on hand for the remainder of the costs.  The construction loan is expandable up to $25 million with bank approval.

The volume of transactions we engaged in with our strategic procurement services grew substantially in 2023 and again in 2024. 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 reflect only our fees earned in the transaction (“net deals”). If the procurement activities include integration services or other value-add work beyond just the procurement activity, the transactions is recorded at its gross value (“gross deals”), and revenue and costs are allocated to the procurement and systems integration segments based on the value created in each and the effort involved to fulfill the contracts.  Overall, we were able to increase our recorded revenues from procurement transactions, representing only the revenues allocated to the procurement segment, by $79.0 million or 205%, compared to 2023. The aggregate gross value of all procurement transactions, regardless of whether they were recorded as gross deals or net deals increased from $123.2 million in 2023 to $169.1 million in 2024. Integration work related to these procurement activities is recorded separately in the systems integration segment.

Our total revenues in 2024 were $148.1 million, a $93.7 million or 172% increase from our 2023 revenues of $54.4 million. Improvement was seen in all three of our major revenue streams, with the majority of this increase coming from $79.0 million (205%) growth in our procurement business and $13.8 million (157%) growth in our systems integration businesses.  The systems integration business growth was driven primarily by the significant increase in rack integration of AI-enabled computer racks.  Our efforts in this were rewarded by winning a multi-year agreement with our largest OEM customer to continue AI rack integration for them at an expected minimum weekly volume.  We also saw a 13% growth in revenues from the facilities management segment, from $7.1 million to $8.0 million in 2024.

Our gross profits increased by $11.4 million or 103% compared to 2023, mainly due to the higher volumes of activity in our procurement and systems integration businesses, including our AI rack integration activity. In addition to earning revenue for completing AI rack integrations, our multi-year agreement includes weekly volume commitments as well as certain fixed fees, which we believe will be sufficient to cover our fixed and variable costs incurred in fulfilling our obligations under the agreement.  Specifically, we believe the fees received under this agreement will be sufficient to cover all of our direct labor, labor training, power consumption and other variable costs, as well as indirect labor, rent and related facility costs for the portion of our factory allocated to this activity, debt service for the assets added to support this business, and other smaller fixed costs that we will incur to perform our obligations under this agreement.  If we experience periodic lulls in demand or if our customer has extended periods of inability to secure parts, we have agreed to seek opportunities to scale back a portion of our direct labor and temporary employees used in this activity, primarily in positions that can be refilled and retrained fairly quickly as demand or supply chain issues are resolved, and to in turn reduce the variable fees charged to our customer under this agreement.  We believe this structure demonstrates our desire to help control the customer’s costs while protecting our financial results by reducing our fee to them only if our own internal labor costs also are reduced.  Our gross profit margin as a percentage of sales decreased to 15% in 2024 from 20% in 2023. 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. As more fully discussed below, we saw improvements in the margins for both the facilities management line of business and the systems integration businesses, and when viewed on a gross value basis, also improved our margins in the procurement business.  The driver of the decrease in the overall blended margin was the fact that a greater portion of our procurement activity in 2024 was “gross deals” whereas the majority of the 2023 procurement activity was from “net deals.”

With all expense lines growing at a rate slower than the growth in revenues, we leveraged the 172% growth in consolidated revenues in 2024 into a 386% increase in operating income and 7,976% growth in net income compared to 2023.

We ended 2024 with $23.2 million of cash on hand, an increase of $11.4 million from the balance at the end of 2023. This increase was driven by the $6.0 million net income during 2024 and timing differences stemming from the procurement business increasing near year-end, due to us being paid more quickly than we must pay our vendors.  These inflows were somewhat offset by $4.5 million of cash used to repurchase shares from employees as a means for them to satisfy tax withholding requirements or pay the exercise price upon the vesting of restricted stock and exercise of stock options.  The taxes due on such activities increased significantly in 2024 in direct relation to the increase in our prevailing stock price.

Critical Accounting Policies and Estimates

We consider an accounting policy to be critical if:

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 upon 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 contract terms typically are 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 expenses has been insignificant.

Integration services

We generate integration services revenues by providing our customers with customized systems and rack-level integration services. We 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.

In 2024, we signed a multi-year agreement to maintain a facility and trained staffing levels to integrate AI-enabled racks for a key customer. In addition to the fixed monthly fees to which we are entitled under that agreement, we also receive payments that scale depending on the volume of AI racks integrated and for which we are prepared to integrate. To mitigate the impact of demand fluctuations and supply-chain issues on our growing AI-enabled rack integration business that are largely out of our control, our customer has committed to pay us for maintaining staffing levels to support an agreed minimum weekly quantity of racks. To the extent we cannot meet the minimum weekly volume due to our inefficiency, such as production down time or labor shortages compared to agreed-upon levels, we will reduce the fee and bill only for the quantity of racks that we actually configured or could have configured, given the actual staffing levels. We contractually agreed to use commercially reasonable efforts to mitigate our customer’s costs for under-utilized staff, including during periods of extended lulls in demand or supply chain issues experienced by our customer. Under this agreement, we recognize revenue monthly for maintaining the facility and trained staffing levels to support the weekly quantity of racks our customer has contractually requested we be ready to integrate, with the staffing fees reduced for any intentional or unintentional under-staffing. The fee for staffing is not variable consideration because the customer’s usage is known weekly and is not contingent on the occurrence of any future events or subject to any estimation.

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 individual account balances, including an evaluation of days outstanding, payment history, recent payment trends, and our assessment of our customers’ creditworthiness. As of December 31, 2024, and 2023, our allowance for doubtful accounts was $7,000.

Equipment and Material sales

We generate revenues under fixed price contracts from the sale of data center and related ancillary equipment or materials to customers in the United States. We recognize revenue when the product is shipped to the customer as that is when the customer obtains control of the promised goods and when we have completed our contractual obligations. Typically, we do not receive advance payments for equipment or material sales; however, if we do, we record the advance payment as deferred revenues. Normally we record accounts receivable at the time of shipment, when our right to the consideration has become unconditional. Accounts receivable from our equipment and material 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; and other fixed-price services including repair, design and project management services, or the moving of equipment to a different location. 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.

Strategic Procurement services

We generate revenues from fees we charge our customers to procure third-party hardware, software and professional services on their behalf, some of which 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 revenues upon completion of the procurement activity. For any procurement activities in which we somehow transform the product, the revenues recognized on these transactions are the gross sales amount of the transaction, and we recognize offsetting costs of sales for any costs we incur to procure the related goods (“gross deals”).  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 and do not transform the product in any way. In these instances, we are acting as an agent in the transaction and recognize revenue on a net basis, recording only 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 (“net deals”). Accounts receivable from our procurement activities are typically due within 80 days of invoicing.  The majority of the procurement activities generally involve us transforming the product, and as such the majority of these transactions are recorded as gross deals.  In order to accelerate the time period in which we receive payment, we generally factor the procurement services receivables utilizing a program that we estimate has an effective annualized interest rate below the rate at which we could borrow funds.  Regardless of whether the transaction is recorded as a gross transaction or a net transaction, the interest we are charged through the factoring program is based on the gross value of the transaction.

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 presents our revenues disaggregated by reportable segment and by product or service type (in ’000’s):

Remaining Performance Obligations

Remaining performance obligations include deferred revenue 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, 2024, deferred revenue of $3,384,000 includes $1,476,000 of our remaining performance obligations for our maintenance contracts, all of which are expected to be recognized within one year, and $1,908,000 relates to procurement and integration services where we have yet to complete our services for our customers.  Of the $1,908,000 deferred revenues related to procurement and integration services, $1,137,000 is expected to be recognized within one year, and $771,000 is expected to be recognized beyond one year. Contract liabilities, consisting of deferred revenues were $3,370,000 on December 31, 2023, and $2,080,000 on December 31, 2022.

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.  The recorded goodwill is allocated to the reporting unit to which the underlying transaction relates.

We perform an impairment test of goodwill annually as of December 31, or whenever events or circumstances make it more likely than not that impairment of goodwill may have occurred. As part of the annual impairment test, we review for indicators of impairment as “Step Zero” of the annual impairment test as defined by U.S. GAAP and if any exist, we compare the fair value of the 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, we would recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the impairment loss 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.

We have elected to use December 31 as our annual assessment date. As circumstances change that could affect the recoverability of the carrying amount of the assets during an interim period, we will evaluate our indefinite lived intangible assets for impairment. The Company performed a quantitative analysis of our indefinite lived intangible assets on December 31, 2024, and 2023 and concluded there was no impairment. The valuation results indicated that the fair value of our reporting units was greater than the carrying value, including goodwill, for each of our reporting units. Thus, we concluded that there was no impairment on December 31, 2024, or 2023 for our goodwill and other long-lived intangible assets. On December 31, 2024, and 2023, the carrying value of goodwill was $0.8 million.

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 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 2024 to 2023

Unless otherwise noted, all comparisons in this section are between the twelve months ended December 31, 2024 (the “current year” or “2024”) and the twelve months ended December 31, 2023 (the “prior year” or “2023”).  Based on our current structure and ways in which the business is managed and viewed at an executive level, we determined that effective in the fourth quarter of 2024, we now have three reportable segments rather than two reportable segments as historically reported.  The new procurement reportable segment was previously aggregated with the remainder of the systems integration segment.  The systems integration segment and procurement segments are now separated into two reportable segments, with the third reportable segment remaining Facilities Management.  Prior year segment information has been recast to conform to the current year presentation.

Revenue

Revenues consist of fees earned from the planning, design and project management for mission-critical facilities and information infrastructures, as well as fees earned from providing maintenance services for these facilities. We also earn revenues from providing system configuration and integration services, as well as procurement services, to IT equipment vendors. In the quarter ended June 30, 2024, we invested approximately $1.7 million in our Round Rock facility to expand our capacity to integrate generative AI-enabled server racks, including both air cooled and direct-liquid cooled systems.  We received a reimbursement from one of our customers for the majority of those investments and are amortizing that reimbursement into service integration revenues over the expected useful life of three years.  We began integration services on AI racks in June 2024 and have continued that activity to date.  Currently we derive substantially all our revenue from the U.S. market, with an immaterial amount derived from Canada in service of a U.S. based customer.

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 generally generate higher profit margins, relative to their higher risk. Certain of our service and maintenance contracts provide comprehensive coverage of all the customers’ equipment (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.  Occasionally, our revenues will reflect certain reimbursements received from customers for expanding our capacity, typically through capital expenditures, or for adding headcount to support specific customer requests.

Our maintenance and integration services traditionally earn higher margins and maintenance contracts typically renew annually, providing consistency and predictability of revenues. In past years, we performed design and project-management services in a concentrated number of high-value contracts for the construction of new data centers. In addition to contributing to large quarterly fluctuations in revenue depending upon project timing, these projects required higher levels of working capital and generated lower margins than our maintenance and integration services. We re-focused our design and project management services towards smaller scaled jobs typically connected with addition/move/retrofit activities rather than new construction, to obtain better margins and a more predictable pattern of earnings. We have also focused on providing maintenance services for modular data center applications as this market has expanded. We continue to focus on increasing our systems integration revenues through more consistent revenue streams that will better utilize our assets in that business, and through adding revenue streams such as procurement services to help drive volume through the integration facility.  The expansion into AI-enabled rack integration services which began in June 2024 bolstered both our revenues and our earnings, helping move the systems integration segment from a $1.0 million segment pre-tax loss in the year ended December 31, 2023 to a $5.0 million segment contribution to pre-tax income in 2024.  These amounts exclude certain corporate expenses, such as selling, general and administrative costs as well as facility costs and interest income that are not allocated to segments.

Total revenues in 2024 increased 172% to $148.1 million, with each major revenue stream contributing to the improvement.  Procurement revenues increased by $79.0 million (205%), systems integration revenues increased by $13.8 million (157%), and facilities management revenues increased by $0.9 million (13%) from 2023.

The $13.8 million (157%) increase in systems integration revenues was due primarily to the growth in integration of AI-enabled computer racks, which began with significant volume in June 2024 and continued at similar volumes throughout the remainder of 2024.  With the October signing of a multi-year agreement to continue integrating AI-enabled racks at similar volumes, we expect systems integration revenues to remain significantly above the historical trend for several years. This agreement calls for certain minimum monthly payments to us, which we believe will be sufficient to cover the majority of the costs for the facility and debt service payments tied to the build-out of that factory for which we are responsible.  While those payments are required under the terms of this agreement, our customer could terminate the agreement if we were to materially breach the agreement, leaving us with the financial obligations of the facility and debt service regardless of whether we had revenues sufficient to cover those costs.  Likewise, if we were to terminate the agreement other than due to our customer’s material breach of the agreement, they would be relieved of any further obligation.  If the customer were to terminate the agreement for convenience, they would continue to be obligated to pay us for the monthly fixed charge, but would no longer have any minimum volume commitments, as discussed below.

In addition to the fixed monthly fees to which we are entitled under that agreement, we also receive payments that scale depending on the volume of AI racks integrated and for which we are prepared to integrate.  To mitigate the impact of demand fluctuations and supply-chain issues on our growing AI-enabled rack integration business, our primary customer has committed to pay us for maintaining staffing levels to support an agreed minimum weekly quantity of racks.  To the extent we do not meet the minimum weekly volume due to our production down time or labor shortages in compared to agreed-upon levels, we will reduce the fee, billing only for the quantity of racks we actually configured or could have configured given the actual staffing levels.  We contractually agreed to use commercially reasonable efforts to mitigate our customer’s costs for under-utilized staff, including during periods of extended lulls in demand or supply chain issues experienced by our customer.  While any reduction in available staff reduces the revenues to which we are entitled under this agreement, we believe our long-term partnership with our customer is strengthened as we help them mitigate a portion of the costs for which they are responsible.  The periodic reduction of revenues has a muted impact on our overall results, as we also reduce our labor costs in line with the reduced revenues.

Our non-AI rack integration services, without such minimum commitments, may be impacted by periodic supply chain issues for certain components and lulls in demand. These supply chain disruptions periodically cause delays in the timing of systems integration revenue for us as we await delivery of required components, and our vendors and partners expect these supply-chain issues to continue for at least the next several quarters, though they appear to be improving in general.  It is not yet known the extent to which tariffs currently threatened or imposed by the United States may or may not impact these supply chain issues.

Our procurement services involve us procuring third-party hardware, software and services on our customers’ behalf, some of which are then used in our integration services as we integrate those components to deliver a completed system to our customer. Because we are receiving these goods and transforming them, we recognize revenue for the gross value of these transactions and offsetting cost of sales for the components we purchase to fulfill the requests.  We refer to these as “gross deals.”  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 and we have no control of 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 for only 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 refer to these as “net deals.”  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 most jobs are completed within six months.

The increase in procurement revenues, which was unusually large this year, was driven primarily by an increase in purchases from the federal government including several individually large sales, combined with a mix shift with a greater proportion of the revenues coming from gross deals, as opposed to net deals.  As much of our procurement business is ultimately related to federal government buying, we believe this can contribute to some seasonality of these revenues.  As the federal government budget ends on September 30 each year, we believe this may generally lead to an increase in procurement revenues in the quarter ending September 30 each year and again in the quarter ending December 31 as federal agencies receive their budgets for the new year.  However, we cannot accurately predict when other large procurement activity will occur, such as large purchases from our customers’ enterprise clients.

Due to the lighter effort required to execute procurement transactions, the gross margins are thinner in that line of business.  As a result, increases and decreases in that business have a smaller impact on our overall margins and profitability compared to increases in the facilities management or systems integration lines of business.  The following table presents the results of our procurement activities, both in terms of the gross value of the transactions, regardless of whether they were recorded as gross deals or net deals, along with the recorded values, to aid in an analysis of the underlying economics (in thousands, except percentages):

The following table provides a reconciliation of the non-GAAP figures presented above to the most closely related GAAP figures presented. We review these non-GAAP figures not as a substitute for the GAAP figures, but to help in our internal analysis of the underlying economics of each transaction as we do not believe the GAAP figures are as useful for that purpose as are the non-GAAP measures.

The gross value of all procurement transactions increased 37% from 2023, from $123.2 million to $169.1 million in 2024.  The majority of the 2024 procurement transactions were gross deals, whereas the majority of the 2023 transactions were net deals, in which we record only our agent fee as revenues.  As a result, the recorded revenue increased from $38.5 million in 2023 to $117.5 million in 2024.  Gross profit recognized on all procurement transactions increased 49% from $5.3 million to $7.8 million before interest charges.  After netting out related interest charges, the procurement segment’s contribution to pre-tax income increased 57% from $3.5 million to $5.5 million.

Although the margins are thin, efforts required to support the business are minimal, so any incremental activity remains additive to our net income and can lead to additional cross-sales of higher yielding integration services, so we continue to view this business as a growth vehicle.  As mentioned previously, the procurement business can fluctuate widely from quarter to quarter, and the recorded revenues can fluctuate even more widely if there is a substantial shift between gross and net deals, even if the underlying economics between the two are relatively similar.

Cost of Revenue and Gross Margins

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 expenses, 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. Our consolidated gross margin was 15% for the year ended December 31, 2024 compared to 20% for 2023. The blended decrease was driven by the outsized increase in the lower margin procurement business in relation to the remainder of the organization.  Gross margins for 2024 were 7% for the procurement business, 42% for the system integration business, and 62% for the facility management activities.  In 2023, gross margins were 14% for the procurement business, 19% for the systems integration business, and 57% for the facilities management activities.  As seen in the tables above, while the recorded margins for procurement activities decreased from 14% to 7%, when viewed on a gross transaction value, they improved from 4.3% to 4.6%.  Viewed on that basis, margins improved in each line of business with the most significant improvement in the system integration activities, reflecting the impact of a significant increase in the revenues from AI rack integration.  We anticipate margins in that line of business will improve further in 2025, as 2025 will reflect a full year’s activity at more elevated levels of AI rack integration, whereas 2024 reflected that impact for roughly the last seven months of the year.

We anticipate costs allocated to the system integration business to increase in 2025 due to our new, larger integration facility with greater rent and related expenses, paired with an increase in the fees we earn from our primary AI rack integration customer in recognition of our greater expense structure.  While we began recognizing rent expense of approximately $251,000 monthly for the new facility in December 2024 in accordance with GAAP, we do not anticipate paying cash rent for the new facility until April or May 2025, at which point we will begin paying monthly cash base rent of approximately $222,000 plus related lease costs including insurance, property taxes and common area maintenance.  Until we either sublease or find another productive use for or our current facility, we will bear facility rent and related costs at two facilities.

Since we earn higher profits when using our own labor, we expect gross margins to improve when our labor mix increases relative to the use of subcontracted labor 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 improves our overall profitability by increasing income, broadening our revenue base and generating a favorable return on invested capital. In periods when we increase the level of IT procurement services, we anticipate that our overall blended gross margin percentages will be lower in those periods, even as our gross profits increase, as the normal margins on procurement 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 accurately estimate 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.

Selling, General and Administrative (SG&A) Expenses

Selling, general and administrative expenses consist primarily of compensation and related expenses, including sales commissions and other incentive compensation for our executive, administrative and sales and marketing personnel, as well as related travel, selling and marketing expenses, professional fees, facility costs, insurance and other corporate costs. As a percentage of gross profit, SG&A fees improved from 81% in 2023 to 59% in 2024, effectively leveraging this cost in relation to the overall growth in the Company’s operations.  In dollar terms, our SG&A expenses increased by $4.3 million (48%) due to higher headcount and related compensation costs to support the growing scale of the organization combined with higher accruals for incentive compensation tied directly to the improvements in sales and earnings.

Depreciation expense

Depreciation expense increased to $0.6 million in 2024 compared to $0.2 million in 2023, representing 3% of gross profit in each period.  The increase relates almost exclusively to depreciating the incremental $1.7 million of capital expenditures added in the second quarter of 2024 to support the growing AI rack integration business.  Our OEM customer that required the AI rack integration services reimbursed us for this cost, and that reimbursement is being amortized into income over the same three-year estimated life over which we are depreciating these additional assets.

Operating Income

Operating income was $8.5 million in 2024 compared to $1.8 million in 2023.  With total operating costs growing 50%, or just under half the 103% growth rate of gross profit, operating income increased by 386%, or $6.8 million due to effectively leveraging our expense structure.

Interest expense, net

In 2024, we recorded net interest expense of $2.2 million compared to $1.6 million in the prior year quarter. The increase in interest expense was due directly to the increase in the gross value of procurement transactions and other revenues from our primary customer in 2024 compared to the prior year.  The factoring charge we incur is based on the total gross value of transactions, including the gross value of procurement deals whether we account for such deals as gross or net deals.  Included in net interest expense is $562,000 of interest income earned in 2024 compared to $355,000 earned in 2023.  Interest income resulted from quickly obtaining cash under the factoring program and investing surplus funds until required to pay our vendors.  While the factoring program costs us interest expense, interest earned on excess funds helps offset that cost.

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, primarily the Texas Franchise Tax. As of December 31, 2024, our accumulated net operating loss carry-forward was $37 million. We anticipate that these loss carry-forwards may offset future taxable income and future tax liabilities. However, because of uncertainty regarding our ability to use these carry forwards, we have established a valuation allowance for the full amount of our net deferred tax assets.  We will reconsider this in 2025 and future periods, assuming we continue to report significantly improved earnings and see positive movements on other positive and negative evidence we considered in making this assessment.

Net Income

After net interest expense and income taxes, we recorded a net income of $6.0 million, or $0.24 per diluted share for 2024, compared to a net income of $0.1 million, or $0.00 per diluted share in 2023.

Comparison of 2023 to 2022

Revenue

In 2023, we concentrated our sales efforts towards maintenance and integration services where we had 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 transitioned our business away from this market. We also focused on providing maintenance services for modular data center applications as this market matures. We continued 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 management revenues as the number of MDC deployments decreased compared to 2022.

We had a substantial increase in the number of procurement transactions we completed in 2023 compared to 2022, including a large increase in net deals, that allowed us to increase revenues from procurement activities from $13.2 million in 2022 to $38.5 million in 2023.

Cost of Revenue

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.

Gross Profit

Our gross profit margin for 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 management revenues. Absent the impact from our procurement services, the gross profit margin on our traditional integration and facilities management 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 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

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 recorded an operating income of $1,750,000 in 2023 compared to operating income of $914,000 in 2022.

Interest expense, net

For 2023, we recorded net interest expense 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, primarily the Texas Franchise Tax. 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 at that point regarding our ability to use these carry forwards and the potential limitations due to ownership changes, we 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.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity on December 31, 2024 are our cash and cash equivalents on hand, funds available under our construction loan and projected cash flows from operating activities.

As discussed above, we have signed a multi-year agreement to integrate an expected minimum weekly volume of AI-enabled computer racks, which we expect to be equal to and possibly greater than the run rate we have integrated since June 2024.  Due to the increasing power and cooling demands expected in upcoming generations of those racks, we have leased and plan to move to a new facility which can provide sufficient power for the foreseeable future.  The new facility is almost 213,000 square feet compared to the 105,000 square foot leased facility in which we currently operate.  We are in the process of building out the new facility and expect to invest a total of $25 million to $30 million.  We had already spent approximately $8.5 million of that total by December 31, 2024 and expect to spend the remainder in the first half of 2025.  On December 31, 2024, we consummated a construction loan with Susser Bank for up to $20 million, expandable in certain circumstance to $25 million, and immediately drew down $8.7 million, with $3.4 million reimbursing us for previously spent funds and $5.0 million being placed in a money market account securing the loan, and the remainder covering loan closing costs.  Once construction is completed, the outstanding balance will be converted to a fully amortizing term loan with a maturity date roughly approximating the term of the multi-year AI rack integration agreement we signed with our OEM customer.  We anticipate receiving funds from our customer that offset the debt service for the full term of this debt and the majority of the costs to operate the new facility as most of that facility will be dedicated to that activity.  We have not yet determined whether we will be able to secure additional business to utilize both facilities.  If not, we will likely seek to sublease our existing 105,000 square foot facility in Round Rock, Texas but may incur the costs and cash demands of two facilities for some indeterminate period of time.

The majority of the Company’s receivables are from a single customer with 80-day payment terms.  We generally factor our receivables from that customer through a bank factor, so that we are paid within 2-3 days of invoicing rather than needing to wait the full term to receive funds.  We believe this is an efficient program, as we estimate the effective annualized interest rate to utilize that program is less than the rate at which we could borrow funds.  We hold excess funds in an interest-bearing account so that we can earn some interest income on the funds we receive immediately from the factoring program but do not have to pay to our vendors for 30-45 days on typical payment terms.

As of December 31, 2024, the Company had an accumulated deficit of $60.3 million. Although we reported a small net income of $0.1 million in 2023 and a significantly improved net income of $6.0 million in 2024, we do have a history of operating and net losses over the preceding several years which were due, in part, to the effects of COVID-19 and subsequent supply chain constraints. In June 2024, we began integrating AI-enabled computer racks for our largest OEM customer at a much greater volume than prior to that point, and in October 2024, signed a multi-year agreement with that customer providing for the coverage of a significant portion of our fixed costs as well as minimum commitments of volume of AI racks for the next several years, significantly enhancing our expectation of continuing our recent trend of operating profitably and reducing our accumulated deficit.  In December 2024, we also secured a new manufacturing facility and long-term bank financing for the capital investments required to fulfil that agreement.  Our procurement business, which we began in 2019, has also increased substantially in both revenues and earnings.  Management has evaluated the significance of these conditions in relation to its ability to meet its ongoing obligations and whether it indicates doubt as to our ability to continue as a going concern. 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, trade credit extended to us by our vendors, and fund available under our construction loan.  We believe these factors have combined to substantially mitigate the risks that we might not be able to continue as a going concern.  If our future results do not meet our 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. We also recently filed a shelf registration statement on Form S-3, enabling us to raise up to $150 million from the capital markets, if needed to finance our operations or growth. There can be no assurance as to the Company’s ability to continue to operate profitably or 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, as well as a significant and sustained improvement in our earnings since June 2024. We believe that we will continue to be profitable on a quarterly and annual basis in 2025. As a result, management has concluded that there is no 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 or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern for a reasonable period.

As of December 31, 2024, and 2023, we had cash and cash equivalents of $23.2 million and $11.8 million, respectively.  Of the cash held at December 31, 2024, $5.0 million is held in a money market account as collateral against our outstanding bank debt, and therefore is not immediately accessible other than to use for repayment of the debt.

Significant sources and uses of cash

Operating activities:

Cash provided by operating activities was $15.3 million in 2024, compared to $8.3 million of cash used in operating activities in 2023. This change in cash from operating activities was primarily attributable to the significant increase in contribution from the AI-rack integration services combined with the financial impacts of our procurement services and the large increase in procurement services near the end of 2024 for which we have already been paid under our factoring program but for which we have not yet had to pay our vendors. Related primarily to the lease for our new integration facility, our operating cash flows are also reflective of large increases in the lease right-of-use asset of $20.2 million, largely offset by an increase in operating lease liabilities of $20.2 million.

The prior year period included a $7.3 million decrease in accounts payable, as we paid for procurement activities that had been completed near the end of 2022 but for which we had not yet had to pay vendors.  The current period accounts payable increased $39.0 million.  Somewhat offsetting this was an increase of $12.7 million in contract and other receivables and a $15.3 million growth inventories in the current year largely related to procurement activities ongoing at year-end, and to a smaller degree to support our growth in the integration services business.  Changes in our receivables, inventory, accounts payable and deferred revenues during 2024 are attributable primarily to the timing of procurement transactions. 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 or annual basis for procurement contracts in progress at the end of a particular reporting period. We believe that we will have adequate trade credit available to us to continue financing our procurement activities as we grow this business during 2025 and beyond. These changes were further enhanced by the $6.0 million of net income during the current year vs. net income of $0.1 million in the prior year.

Investing activities:

We invested $8.5 million in 2024 primarily in the ongoing buildout of our new leased integration facility and headquarters, as well as leasehold improvements in our current integration facility.  These costs are largely for enhancements to our electrical and cooling systems in both facilities to support our growth in AI-enabled rack integration.  Of the total investment, $1.7 million was reimbursed to us by our customer during 2024 and as discussed above, is being recognized into income over a three-year period estimating the same useful life of this equipment over which we are recording depreciation.  This compares to $0.3 million invested in capital assets in the prior year, also for purchases of property and equipment and leasehold improvements to expand and upgrade our Round Rock integration facility.

Finance activities:

Financing activities provided a net inflow of $4.6 million in 2024 compared to a use of $40,000 in 2023.  We received loan proceeds of $8.7 million upon closing our construction loan in 2024, offset by a use of $0.5 million in debt issuance costs.  With the significant increase in our stock price in 2024, employee exercises of stock options also provided $0.9 million of cash.  To minimize dilution to our shareholders, we generally allow employees to “net settle” upon the vesting of restricted stock and upon stock option exercises, allowing them to forfeit a portion of the shares sufficient to cover their tax obligation and the option exercise price, and use the Company’s cash to pay the taxes.  These transactions are represented by the $4.5 million of stock repurchases in 2024 and $40,000 in 2023.  None of these share repurchases were open market transactions, and there is no approved share buyback program in place other than allowing employees to net settle.

Future uses of cash

Our business plans and our assumptions around the adequacy of our liquidity are based on estimates regarding future revenues and costs and our ability to secure sources of funding when needed. However, our revenues may not meet our expectations, or our costs may exceed our estimates. Further, our estimates may change, and future events or developments may also affect our estimates. Any of these factors may change our expectations of cash usage during 2025 and beyond or significantly affect our level of liquidity, which may require us to take other measures to raise funds or 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 and to fund the planned investment in our new facility. Our primary sources of funds to meet our liquidity and capital requirements include cash on hand and funds generated from operations including the funds from our customer financing program, combined with the construction loan secured in December 2024 to finance the investment in our new 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 a new line of business or if we seek to acquire additional businesses, further expand our facility, or operate both facilities.

Off-Balance Sheet Arrangements

As of December 31, 2024 and December 31, 2023, we had no off-balance sheet arrangements.

New Accounting Pronouncements

Recently Adopted Accounting Guidance

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. We adopted this guidance effective January 1, 2023, and it did not have a material impact on our financial results of operations.

In May 2019, FASB issued Accounting Standards Update 2019-15, Financial Instruments – Credit Losses (Topic 326), (AASU 2019-15”). ASU 2019-15 provides guidance that allows entities to make an irrevocable one-time election upon adoption of the new credit loss 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. We adopted this guidance effective January 1, 2023, and it did not have a material impact on our financial results of operations or financial position.

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 2023-07 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”). We adopted this guidance effective for the annual period ended December 31, 2024, and it did not have a material impact on our financial results of operations or financial position. In interim periods after December 31, 2024, the new guidance will be applied retrospectively for all prior periods presented in the financial statements.

Recently Issued Accounting Pronouncements

In December 2023, FASB issued ASU No. 2023-09, Improvements to Income Tax Disclosures (“ASU 2023-09”), which requires that an entity disclose specific categories in the effective tax rate reconciliation as well as provide additional information for reconciling items that meet a quantitative threshold. Further, this ASU requires certain disclosures of state versus federal income tax expense and taxes paid. This ASU is effective for our Annual Report on Form 10-K for the year ending December 31, 2025, with early adoption permitted. We do not expect the adoption of ASU 2023-09 to have a material impact on our financial statements.

In November 2024, FASB issued ASU 2024-03, Income Statement – Reporting Comprehensive Income – Expense Disaggregation Disclosures (Subtopic 220-40) (“ASU 2024-03”), which will require that entities provide more granular footnote disclosures of the details contained in certain captions on the company’s income statement, such as “Selling, General and Administrative” expenses. This new guidance is effective for annual reporting periods beginning after December 15, 2026, and interim reporting periods beginning after December 15, 2027, which early adoption permitted. We have not yet determined all the effects that adoption of this new guidance will have on our statement of operations and related footnote disclosures. We do not expect its adoption to affect our net operating results or financial position.