Note 1 – Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements of TSS, Inc. and its subsidiaries (“TSS” or the “Company” or “we”) have been prepared
in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial
information and according to instructions from the Securities and Exchange Commission (“SEC”) for Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial
statements and should be read in conjunction with the audited financial statements included in the Company’s Annual Report
on Form 10-K (“Form 10-K”) for the fiscal year ended December 31, 2012.
The information included herein is not necessarily indicative
of the annual results that may be expected for the year ended December 31, 2013, but does reflect all adjustments (which are normal
and recurring in nature) considered, in the opinion of management, necessary for a fair presentation of the results for the interim
periods presented. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions
that affect the amounts reported in the financial statements. Actual results may differ from these estimates and assumptions.
Recently Issued Accounting Pronouncements
In September 2011, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standard Update 2011-08,
Intangibles-Goodwill and Other (Topic 350) Testing
Goodwill for Impairment
(“ASU 2011-08”)
.
ASU 2011-08 gives entities testing goodwill the option of performing
a qualitative assessment before calculating the fair value of a reporting unit in step 1 of the goodwill impairment test. For those
entities that determine, on the basis of qualitative factors, that the fair value of a reporting unit is more likely than not less
than its carrying amount, an entity is not required to perform step 2 of the goodwill impairment test. ASU 2011-08 is effective
for fiscal years, and interim periods within those years, beginning after December 15, 2011. ASU 2011-8 was effective for the Company’s
fiscal year ending December 31, 2012, and the adoption did not have an impact on the Company’s consolidated financial statements.
Note 2 – Acquisitions
On May 20, 2013, VTC, L.L.C. (the “Purchaser”), a wholly owned subsidiary of TSS entered into
an Asset Purchase Agreement (the “Purchase Agreement”) pursuant to which the Purchaser agreed to acquire certain assets
and assume certain specified liabilities from arvato digital services LLC (the “Seller”) related to Seller’s
data center integration business (the “Systems Integration business”) operated at its Round Rock, Texas facility.
The preliminary purchase price paid by the Purchaser under the Purchase Agreement is approximately $1,469,243,
which included a negative purchase price adjustment of $5,757 to reflect the value of the purchased inventory and certain vendor
prepaid amounts. A payment of $725,000 was paid in cash at closing, $375,000 was set aside in an escrow account for the purposes
of satisfying any indemnification claims under the Purchase Agreement, and the balance of the purchase price of $369,243 was paid
on July 1, 2013. During the three months ended June 30, 2013, the Company incurred $243,733 in acquisition costs associated with
the purchase of the Systems Integration business. These costs were included in selling, general and administrative expenses in
the accompanying unaudited condensed consolidated statements of operations.
The purchased assets include all inventory, furniture, fixtures,
equipment, identified customer contracts, intellectual property (including certain proprietary software) and other assets used
in the Systems Integration business. The Company also offered employment to certain employees of the Systems Integration business
and assumed the Seller’s lease at the Round Rock, Texas facility for the remaining term.
The Purchaser and the Seller also entered into a Transition
Services Agreement and a Software License Agreement whereby the Purchaser will license the purchased proprietary software back
to the Seller on a non-exclusive, perpetual, royalty-free basis, with certain territorial limitations.
The purchase price is allocated to underlying assets and liabilities on their estimated fair values at
the date of acquisition. The preliminary purchase price allocation includes goodwill and other intangible assets. Recognition of
goodwill is largely attributable to the assembled workforce acquired and other factors. Goodwill is currently recognized in the
Company’s only reportable segment for the quarter ended June 30, 2013 as the acquisition did not result in the creation of
a second reportable segment. The Company is in the process of identifying potential adjustments to the fair value of assets acquired.
The Company anticipates finalizing the purchase price as soon as practicable but no later than one year from the acquisition date
of May 20, 2013.
The following table summarizes the preliminary purchase price allocation:
|
|
May 20,
|
|
|
|
2013
|
|
Cash paid at acquisition date
|
|
$
|
725,000
|
|
Additional installments of preliminary purchase price
|
|
|
744,243
|
|
Preliminary acquisition consideration
|
|
$
|
1,469,243
|
|
|
|
|
|
|
Inventories
|
|
$
|
282,497
|
|
Other current assets
|
|
|
10,976
|
|
Fixed assets
|
|
|
53,315
|
|
Goodwill
|
|
|
61,455
|
|
Intangible assets
|
|
|
1,061,000
|
|
Preliminary net assets acquired
|
|
$
|
1,469,243
|
|
The amount of revenue and net loss of the Systems Integration business included in the Company’s
unaudited condensed consolidated statement of operations for the three months ended June 30, 2013 were $652,122 and $2,041, respectively.
Intangible assets included approximately $827,000 and $234,000
attributable to customer relationships and a technology-based asset, respectively, which are being amortized on a straight-line
basis over 10 and 5 years, respectively. Customer-related intangible assets represent the underlying relationships and agreements
with the Seller’s existing customers. The technology-based asset represents internally developed software acquired.
The unaudited financial information in the table below summarizes
the combined results of continuing operations of the Company and the Systems Integration business, on pro forma basis, as though
the acquisition had occurred as of the first date of the twelve months ended December 31, 2012. The pro forma financial information
is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if
the acquisition had taken place on that date or of results that may occur in the future. The unaudited pro forma financial information
for the three and six months ended June 30, 2013 and 2012 combines the historical results for the Company and the historical results
for the Systems Integration business for the three and six months ended June 30, 2013 and 2012.
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
Revenue
|
|
$
|
11,374,109
|
|
|
$
|
17,799,366
|
|
|
$
|
34,976,460
|
|
|
$
|
33,848,671
|
|
Net income (loss) from continuing operations
|
|
$
|
(308,088
|
)
|
|
$
|
(2,358,972
|
)
|
|
$
|
(185,715
|
)
|
|
$
|
(3,647,573
|
)
|
Basic income (loss) per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.17
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.26
|
)
|
Diluted income (loss) per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.17
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.26
|
)
|
Basic weighted average number of common shares outstanding
|
|
|
14,385,713
|
|
|
|
14,147,049
|
|
|
|
14,368,354
|
|
|
|
14,124,380
|
|
Diluted weighted average number of common shares outstanding
|
|
|
14,385,713
|
|
|
|
14,147,049
|
|
|
|
14,368,354
|
|
|
|
14,124,380
|
|
The pro forma net income (loss) presented does not include non-recurring
acquisition costs of $243,733 incurred during the three months ended June 30, 2013.
Note 3 – Goodwill and Intangible Assets
The following tables highlight the Company’s intangible
assets and accumulated amortization as of June 30, 2013 and December 31, 2012:
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
Intangible assets not suject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
1,830,316
|
|
|
|
-
|
|
|
$
|
1,768,861
|
|
|
|
-
|
|
Tradename
|
|
$
|
60,000
|
|
|
|
-
|
|
|
$
|
60,000
|
|
|
|
-
|
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
827,000
|
|
|
$
|
(7,080
|
)
|
|
|
-
|
|
|
|
-
|
|
Acquired software
|
|
$
|
234,000
|
|
|
$
|
(4,007
|
)
|
|
|
-
|
|
|
|
-
|
|
Non-compete
|
|
$
|
50,600
|
|
|
$
|
(50,600
|
)
|
|
$
|
50,600
|
|
|
$
|
(50,600
|
)
|
|
|
Three Months Ended
|
|
|
Six months Ended
|
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
Amortization expense
|
|
$
|
11,087
|
|
|
|
-
|
|
|
$
|
11,087
|
|
|
|
-
|
|
Amortization expense for intangible assets for the year ended
December 31, 2013 is expected to be approximately $75,837. Amortization expense for each year ended December 31 for 2014 through
2017 is expected to be approximately $129,500.
Note 4 – Inventories
Inventories at June 30, 2013 consisted of the following:
|
|
June 30, 2013
|
|
Work in process
|
|
$
|
19,533
|
|
Raw materials
|
|
|
295,202
|
|
Inventories
|
|
$
|
314,735
|
|
The Company values its inventories at cost with cost determined on a first-in, first-out basis. Obsolete
inventory or inventory in excess of its estimated usage is reserved to its estimated market value less cost to sell, if less than
its cost. There was no inventory reserve as of June 30, 2013.
Note 5 – Convertible notes payable
On May 21, 2013, the Company and Gerard J. Gallagher, the
President and Chief Operating Officer of the Company, agreed to restructure the promissory note held by Mr. Gallagher. As
part of this restructuring, Mr. Gallagher agreed to reduce the outstanding principal amount by $307,301, which is reflected
as a non-cash item in the accompanying unaudited condensed consolidated statements of cash flows, $1,900,000 in exchange for
an immediate payment of $900,000 at the time of closing. The Amended and Restated Convertible Promissory Note provides for
eight quarterly principal payments of $25,000 beginning July 1, 2013, a principal payment of $100,000 on January 3, 2014, and
the remaining outstanding balance due on July 1, 2015. All amounts due under the note are immediately due and payable upon
the occurrence of a “change in control” of the Company (as defined in the promissory note) or the death of Mr.
Gallagher. If the Company fails to pay any amount due under the promissory note within five days after the date due,
the Company must pay Mr. Gallagher a late charge equal to 5% of the amount due and unpaid. The Company’s obligations
under the promissory note held by Mr. Gallagher are subordinated to the obligations under a credit facility with Bridge
Bank, National Association (see
Note 6 – Credit Facility).
Upon an “event of default” (as defined in the promissory
note) that the Company fails to cure within a period of 60 days following the date of such event of default, Mr. Gallagher will
have the right to convert any amount equal to not less than $25,000 but up to an amount equal to the unpaid amount due under the
promissory note into that number of shares of the Company’s common stock obtained by dividing the amount being converted
by a conversion price equal to 125% of the fair market value per share of the Company’s common stock. For purposes of the
promissory note, the fair market value of a share of the Company’s common stock equals the average of the high and low bid
prices of the Company’s common stock reported daily on the OTCQB marketplace during the twenty day period ending on the date
Mr. Gallagher elects to make such conversion. Notwithstanding these conversion rights, the aggregate number of shares of the Company’s
common stock that may be issued as a result of converting amounts due under the promissory note upon an event of default may not
exceed 12% of the issued and outstanding shares of the Company’s common stock as of the date Mr. Gallagher initially elects
to make such conversion.
The restructured note was recorded at fair market
value resulting in a discount of $137,735. The discount is being amortized over the period from the date of issuance to the date the
note is due using the effective interest method.
The balance of the notes payable at June 30, 2013 and December
31, 2012 were as follows:
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
Convertible, unsecured promissory note, due 2015 (4.0%), net
|
|
$
|
871,343
|
|
|
$
|
2,457,301
|
|
Less: current portion, net
|
|
|
129,000
|
|
|
|
500,000
|
|
Convertible notes payable, long-term, net
|
|
$
|
742,343
|
|
|
$
|
1,957,301
|
|
The unamortized discount at June 30, 2013 was $71,000 and $57,657
in convertible notes payable – current and convertible notes payable – long term, respectively.
Scheduled principal repayments on the convertible, unsecured
promissory note at June 30, 2013 are as follows:
|
|
June 30, 2013
|
|
2013
|
|
$
|
50,000
|
|
2014
|
|
|
200,000
|
|
2015
|
|
|
750,000
|
|
Total
|
|
$
|
1,000,000
|
|
Note 6 – Credit Facility
On November 8, 2011, the Company and its subsidiaries Innovative
Power Systems, Inc., VTC, L.L.C., Total Site Solutions Arizona, LLC, and Alletag Builders, Inc. (together with the Company, collectively,
“2011 Borrowers”) obtained a credit facility (the “2011 Credit Facility”) from Wells Fargo Bank, National
Association (“WF, NA”) pursuant to a Credit Agreement by and among 2011 Borrowers and WF, NA (the “Credit Agreement”).
The 2011 Borrowers’ obligations under the 2011 Credit Facility were joint and several. The maximum amount of the 2011 Credit
Facility was $2,000,000. The 2011 Credit Facility was subject to a borrowing base of 80% of eligible accounts receivable. Borrowings
under the 2011 Credit Facility incurred interest at the London interbank offered rate plus 2.25% per annum.
The 2011 Credit Facility would have matured on November 1, 2012.
During the three months ended March 31, 2012, however, the Company failed to comply with the financial covenants requiring (a)
a maximum ratio of total liabilities to tangible net worth as set forth in the Credit Agreement; and (b) a minimum debt service
coverage ratio as set forth in the Credit Agreement. The 2011 Credit Facility was terminated effective June 28, 2012.
On May 21, 2013, the Company and its subsidiaries Innovative Power Systems, Inc., VTC L.L.C., Total Site
Solutions Arizona, LLC, and Alletag Builders, Inc. (together with the Company, collectively, “2013 Borrowers”), obtained
a revolving credit facility (the “2013 Credit Facility”) from Bridge Bank, National Association (“Lender”)
pursuant to a Business Financing Agreement by and among Borrowers and Lender (the “Financing Agreement”). The 2013
Borrowers’ obligations under the 2013 Credit Facility are joint and several. The obligations under the 2013 Credit Facility
are secured by substantially all of the 2013 Borrowers’ assets. The maximum amount of the 2013 Credit Facility is $6,000,000.
The 2013 Credit Facility is subject to a borrowing base of 80% of eligible accounts receivable, subject to customary exclusions
and limitations. Borrowings under the 2013 Credit Facility will bear interest at (1) the greater of (a) the prime rate published
by the Lender, which was 3.25% at June 30, 2013 or (b) 3.25%, plus (2) 2.0% per annum. In addition to interest payable on the principal
amount of indebtedness outstanding from time to time under the 2013 Credit Facility, the 2013 Borrowers (a) paid a commitment fee
of $30,000 to Lender and (b) are required to pay to Lender an annual fee of $30,000. The 2013 Credit Facility matures on May 21,
2015. In the event the Financing Agreement is terminated prior to May 21, 2014, 2013 Borrowers will be required to pay a termination
fee equal to $60,000 to Lender; provided that Lender will waive payment of the termination fee if the 2013 Credit Facility is transferred
to or refinanced by another facility or division of Lender unless such transfer or refinance is the result of an event of default
under the 2013 Credit Facility.
The 2013 Credit Facility requires that the 2013 Borrowers maintain
an asset coverage ratio of at least 1.5 to 1.0. The asset coverage ratio is determined by dividing the Borrowers’ unrestricted
cash on deposit with Lender and eligible accounts receivable by the 2013 Borrower’s obligations under the 2013 Credit Facility.
The 2013 Credit Facility requires all Company receivables be deposited in the Lender designated lockbox.
At June 30, 2013, there were $2,000,000 in borrowings outstanding
under the 2013 Credit Facility. Borrowing availability was $970,242 at June 30, 2013.
The Company incurred expenses of $153,567 related to obtaining
the 2013 Credit Facility. These costs are included in other assets and are being amortized over the life of the 2013 Credit Facility.
Note 7 – Loss Per Share
Set forth in the table below is the reconciliation by quarter
of the numerator (net loss) and the denominator (shares) for the computation of basic and diluted net loss per share:
|
|
Numerator
Income (Loss)
|
|
|
Denominator
Shares
|
|
|
Per Share
Amount
|
|
Three months ended June 30, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net loss
|
|
$
|
(964,679
|
)
|
|
|
14,385,713
|
|
|
$
|
(0.07
|
)
|
Effect of dilutve securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Stock Options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Unsecured convertible note
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Diluted net loss
|
|
$
|
(964,679
|
)
|
|
|
14,385,713
|
|
|
$
|
(0.07
|
)
|
Three months ended June 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net loss
|
|
$
|
(2,268,914
|
)
|
|
|
14,147,049
|
|
|
$
|
(0.16
|
)
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Stock Options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Unsecured convertible note
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Diluted net loss
|
|
$
|
(2,268,914
|
)
|
|
|
14,147,049
|
|
|
$
|
(0.16
|
)
|
Six months ended June 30, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net loss
|
|
$
|
(987,831
|
)
|
|
|
14,368,354
|
|
|
$
|
(0.07
|
)
|
Effect of dilutve securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Stock Options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Unsecured convertible note
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Diluted net loss
|
|
$
|
(987,831
|
)
|
|
|
14,368,354
|
|
|
$
|
(0.07
|
)
|
Six months ended June 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net loss
|
|
$
|
(3,521,003
|
)
|
|
|
14,124,380
|
|
|
$
|
(0.25
|
)
|
Effect of dilutve securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Stock Options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Unsecured convertible note
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Diluted net loss
|
|
$
|
(3,521,003
|
)
|
|
|
14,124,380
|
|
|
$
|
(0.25
|
)
|
For the three and six months ended June 30, 2013 and 2012, potentially
dilutive shares of 3,150,204 and 2,372,169 were excluded from the calculation of dilutive shares because their effect would have
been anti-dilutive.
Note 8 – Income Taxes
The Company has made no provision for income taxes for the quarters
ended June 30, 2013 and 2012 due to the net losses incurred in the periods.
The Company maintains a full valuation allowance on all of the
net deferred tax assets due to the significant negative evidence in regards to future realization of these net deferred tax assets
as of June 30, 2013 and 2012.
The Company currently has U.S. net operating loss carryforwards.
Upon examination, one or more of these net operating loss carryforwards may be limited or disallowed.
Note 9 – Incentive Compensation Plan
The Company’s 2006 Omnibus Incentive Compensation Plan
(the “Incentive Plan”) is designed to optimize the profitability and growth of the Company through incentives that
are consistent with its goals and align the personal interests of plan participants with an incentive for individual performance.
The Incentive Plan is further intended to assist the Company in motivating, attracting and retaining plan participants and allowing
them to share in successes of the Company. The Incentive Plan permits the Company to award eligible persons nonqualified stock
options, restricted stock and other stock-based awards, which will cause the Company’s stockholders to experience dilution
if and when such shares are ultimately issued.
On January 16, 2013, the Company issued
100,000 stock options to an employee under the Incentive Plan. The options expire 10 years from the grant date and become exercisable
when the fair market value of a share of the Company’s common stock is $2.00 or more for 20 consecutive business days.
On March 14, 2013, the Company issued 30,000
stock options to an employee under the Incentive Plan. The options expire 10 years from the grant date and vest in equal annual
installments on March 31, 2014, 2015, and 2016.
On March 26, 2013, the Company issued 36,667
shares of restricted stock to one of its employees under the Incentive Plan. 16,667 shares vested on March 31, 2013, 6,666 shares
vested on July 1, 2013, 6,667 shares will vest on each of July 1, 2014 and 2015, subject to the employee’s continued service
through the vesting dates.
On May 20, 2013, in connection with the
acquisition of the Systems Integration business, the Company granted 604,000 stock options to employees hired by the Company in
connection with that acquisition. The options expire 10 years from the grant date and vest ratably over three years following the
grant date, subject to the employees’ continued service through the vesting dates. These grants were not made under the Incentive
Plan.
On May 20, 2013, pursuant to the terms
of an employment agreement, the Company issued 200,000 options to its Chief Financial Officer. The options expire 10 years from
the grant date. 50,000 options vest each of the first two anniversary dates of the grant and 100,000 options vest on the third
anniversary of the grant date, subject to the Chief Financial Officer’s continued service through the vesting dates. These
grants were not made under the Incentive Plan.
For the three months ended June 30, 2013 and June 30, 2012,
the Company recorded non-cash compensation expense included in selling, general and administrative expenses of $0.1 million and
$0.1 million, respectively and cost of revenue included $26,438 and $9,462, respectively. For the six months ended June 30, 2013
and 2012, the Company recorded non-cash compensation expense included in selling, general and administrative expenses of $0.2 million
and $0.1 million, respectively and cost of revenue included $58,571 and $19,083, respectively.
Note 10 – Related Party Transactions
The Company participates in transactions with the following
entities affiliated through common ownership and management. The Audit Committee in accordance with its written charter reviews
and approves in advance all related party transactions greater than $25,000 and follows a pre-approved process for contracts with
a related party for less than $25,000.
Chesapeake Mission Critical, L.L.C.
(Chesapeake MC) is 10.32% owned by Thomas P. Rosato, the Company’s former Chief Executive Officer, a former member of the
Board of Directors and the holder of approximately 12.2% of the Company’s outstanding common stock. Chesapeake MC is a manufacturers’
representative reselling and servicing mechanical and electrical equipment from original equipment manufacturers.
TPR Group Re Three, LLC
(TPR Group Re Three) is 50%
owned by Mr. Rosato and Gerard G. Gallagher, the Company’s President and Chief Operating Officer and a member of the
Board of Directors. TPR Group Re Three leases office space to the Company under the terms of a real property lease to
TSS/Vortech. The original lease term expired at December 31, 2011. Prior to expiration, the lease was renegotiated to a full
service lease, excluding utilities, at $24 per square foot or an aggregate annual rate of $0.3 million, representing an
annual reduction of approximately $0.2 million. The lease is cancellable by either the Company or TPR Group Re Three with six
months written notice. The Company obtained an independent appraisal of the original lease, which determined the lease to be
at fair value. In May 2013 this lease was extended for an additional three years, at terms consistent with the
original lease. Although the Company has not obtained a new independent appraisal covering the renewal terms, the Company
believes the terms of the lease renewal to be at fair value on the renewal date.
RF Realty Investments, LLC (“RF
Realty”)
is owned by Mr. Rosato and his family. RF Realty leases office and warehouse space to the Company. The
Company obtained an independent appraisal of the lease, which determined the lease to be at fair value. In May 2013 the lease
of the office space was cancelled effective July 31, 2013.
The following table sets forth transactions the Company has
entered into with the above related parties for the three and six months ended June 30, 2013 and 2012. Cost of revenue
represents costs incurred in connection with related parties which provide services to us on contracts for our customers.
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
|
June 30, 2013
|
|
|
June 30, 2012
|
|
Cost of Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chesapeake Mission Critical, LLC
|
|
|
-
|
|
|
|
116,017
|
|
|
|
-
|
|
|
|
116,017
|
|
Total
|
|
$
|
-
|
|
|
$
|
116,017
|
|
|
$
|
0
|
|
|
$
|
116,017
|
|
Selling, general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office rent paid to RF Realty Investments, LLC
|
|
|
37,998
|
|
|
|
37,998
|
|
|
|
76,376
|
|
|
|
75,996
|
|
Office rent paid to TPR Group Re Three, LLC
|
|
|
69,156
|
|
|
|
69,156
|
|
|
|
139,004
|
|
|
|
163,397
|
|
Total
|
|
$
|
107,154
|
|
|
$
|
107,154
|
|
|
$
|
215,380
|
|
|
$
|
239,393
|
|
Note 11 – Commitments and Contingencies
The Company is from time to time involved in other litigation
incidental to the conduct of the business, none of which is expected to be material to its business, financial condition or operations.
Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
Overview
TSS, Inc. was incorporated in Delaware on
December 20, 2004 as a special purpose acquisition company formed under the name “Fortress America Acquisition
Corporation” for the purpose of acquiring an operating business that performs services in the homeland security
industry. On January 19, 2007, we acquired all of the outstanding membership interests of each of VTC,
L.L.C., doing business as “Total Site Solutions” (“TSS”), and Vortech, L.L.C. (“Vortech”
and, together with TSS, “TSS/Vortech”) and simultaneously changed our name to “Fortress International
Group, Inc.” The acquisition fundamentally transformed the Company from a special purpose acquisition company to an
operating business. After our initial acquisition of TSS/Vortech, management continued an acquisition strategy to expand our
geographic footprint, add complementary services and diversify and expand our customer base. We acquired 100% of the
outstanding and issued capital stock of Innovative Power Systems, Inc. and Quality Power Systems,
Inc. (“Innovative”) on September 24, 2007. On May 20, 2013, we acquired an existing data center services
integration business from arvato digital services, LLC. On June 5, 2013, we changed our corporate name to TSS, Inc.
TSS provides comprehensive services for the planning, design,
development and maintenance of mission-critical facilities and information infrastructure. We also provide a single source solution
for highly technical mission-critical facilities such as data centers, operation centers, network facilities, server rooms, security
operations centers, communications facilities and the infrastructure systems that are critical to their function. Our services
include technology consulting, engineering and design management, construction management, system installations and integration,
operations management, and facilities management and maintenance.
Our industry has been and may be further adversely impacted
by the current economic environment and tight credit conditions. We have seen larger competitors seek to expand their
services offerings including a focus in the mission-critical market. These larger competitors have an infrastructure and
support greater than ours, and accordingly, we have experienced some price pressure as some companies are willing to take on projects
at lower margins. With certain customers, we have experienced a delay in spending, or deferral of projects to an indefinite
commencement date, due to the economic uncertainty or lack of access to capital. Additionally, we rely on certain customers
to win contracts and provide business to us under “Master Service Agreements.” We cannot be assured they will continue
to win contracts and their loss of contracts could have a negative effect on our results.
Although we will closely monitor our proposal pricing and the
volume of our contracts, we have seen our margins decrease on certain lines of business and cannot be certain that our current
margins will be sustained. Furthermore, given the economic environment, to the extent the volume of our contracts further
decreases, we may have to take additional measures to reduce our operating costs through additional reductions in general, administrative
and marketing costs, including potential reductions in personnel and related costs.
RESULTS OF OPERATIONS
Quarterly Comparison – Three months ended June 30,
2013 and 2012
Revenue
Revenue decreased $8.6 million to
$7.0 million for the three months ended June 30, 2013 from $15.5 million for the same period last year. The decrease primarily
relates to a $8.0 million decrease in construction management services as we had a large project in process during the prior year,
a $1.0 million decrease in facilities management services due to a project start-up in the prior year, offset by the $0.7 million
in revenue from the Systems Integration acquisition in May 2013.
Gross Profit
Gross profit for the three months ended June 30, 2013 was $2.0
million compared to a gross profit of $2.3 million for the same period in the prior year. Gross profit as a percentage of revenue
increased to 28.4% in the three months ended June 30, 2013 compared to 15.0% for the same period in the prior year. The increase
in gross profit as a percentage of revenue is attributable primarily to the effect in the prior year of the large construction
management project mentioned above, and a change in composition of work towards higher margin projects.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the three months
ended June 30, 2013 was $2.9 million compared to $2.5 million for the same period in the prior year. The increase was primarily
driven by $0.3 million in selling, general and administrative expenses from the acquired Systems Integration business and
$0.2 million acquisition costs associated with its purchase in May 2013.
Impairment loss on goodwill
During the second quarter of 2012, conditions existed which
indicated that the carrying value of goodwill exceeded the current fair value of our business. We conducted an analysis of the
operations in order to identify any impairment in the carrying value of the goodwill and other intangibles related to our business.
Analyzing our business using both an income approach and a market approach determined that the carrying value exceeded the current
fair value of our business, resulting in goodwill impairment of $2.1 million for the three months ended June 30, 2012.
Year to Date Comparison - Six Months Ended June 30, 2013
and 2012
Revenue
Revenue decreased $8.8 million to
$21.1 million for the six months ended June 30, 2013 compared to $29.9 million for the same period in the prior year. The decrease
primarily relates to a $13.4 million decrease in construction management services as we had a large project in process during the
prior year offset by a $5.0 million facilities management project that occurred during the first quarter 2013 and $0.7 million
in revenue from the Systems Integration business acquired in May 2013.
Gross Profit
.
Gross profit was $4.7 million for the six months ended June
30, 2013 compared to $4.4 million for the same period in the prior year. Gross profit as a percentage of revenue was 22.5% for
the six months ended June 30, 2013 compared to $14.7% for the same period in the prior year. The increase in gross profit as a
percentage of revenue is attributable primarily to the effect in the prior year of the large construction management project mentioned
above, and a change in composition of work towards higher margin projects.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $5.6 million
for the six months ended June 30, 2013 compared to $5.5 million for the same period last year. The increase was primarily driven
by $0.3 million in selling, general and administrative expenses from our Systems Integration business and $0.2 million of
acquisition costs associated with its purchase.
Restructuring charges
Restructuring charges, consisting primarily of severance payments
and equity based expense of $0.3 million were recognized in the six months ended June 30, 2012. No such charges were recorded in
the current year.
Impairment loss on goodwill
During the second quarter of 2012, conditions existed which
indicated that the carrying value of goodwill exceeded the current fair value of our business. We conducted an analysis of the
operations in order to identify any impairment in the carrying value of the goodwill and other intangibles related to our business.
Analyzing our business using both an income approach and a market approach determined that the carrying value exceeded the current
fair value of our business, resulting in goodwill impairment of $2.1 million for the six months ended June 30, 2012.
LIQUIDITY AND CAPITAL RESOURCES
Our primary liquidity and capital requirements are to fund working
capital for current operations. Our primary source of funds to meet our liquidity and capital requirements include cash on hand,
funds generated from operations and borrowings under our revolving credit facility.
We have a $6.0 million revolving credit facility (the “Credit
Facility”) with Bridge Bank, NA (“Bridge”) subject to a borrowing base of 80% of eligible accounts receivable.
The Credit Facility matures on May 21, 2014 and is secured by substantially all of the Company’s assets. The Credit Facility
is designed to provide working capital for general corporate purposes.
On May 21, 2013, we renegotiated a note payable which reduced
the outstanding principal amount by $307,301. See Item 1. Financial Statements
Note 5 – Convertible notes payable.
At June 30, 2013, there were $2.0 million in borrowings outstanding
under the Credit Facility of the total available borrowing base of $3.0 million. This represented the highest amount of borrowings
during the quarter and six months ended June 30, 2013. At June 30, 2013, there was $970,242 available for borrowing under the Credit
Facility.
We believe our cash on hand, borrowings under the Credit Facility
and cash flow from operations will provide adequate resources to meet our capital requirements and operational needs for the next
twelve months.
OFF BALANCE SHEET ARRANGEMENTS
As of June 30, 2013, we do not have any off balance sheet arrangements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
There have been no material changes to our critical accounting
policies and estimates as set forth in the Annual Report for the year ended December 31, 2012 except as noted below. See also Item
1. Financial Statements
Note 1 – Basis for Presentation
regarding Recent Accounting Pronouncements.
Accounting for Business Combinations
In accordance with the accounting standard for business combinations,
we allocate the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values.
The excess of the purchase price over the fair value of the assets acquired and liabilities assumed, if any, is recorded as goodwill.
We use all available information to estimate fair values. We
typically engage outside appraisal firms to assist in the fair value determination of identifiable intangible assets such as customer
contracts, leases and any other significant assets or liabilities and contingent consideration. We adjust the preliminary purchase
price allocation, as necessary, up to one year after the acquisition closing date if we obtain more information regarding asset
valuations and liabilities assumed.
Revenue Recognition
We recognize revenue when pervasive evidence of an arrangement
exists, the contract price is fixed or determinable, services have been rendered or goods delivered, and collectability is reasonably
assured. Our revenue is derived from fixed-price contracts, time-and-materials contracts, cost-plus-fee contracts (including guaranteed
maximum price contracts), facility service and maintenance contracts, and product shipments.
Revenue from fixed price contracts is recognized on the percentage
of completion method. We apply ASC 605-35 Construction-Type and Production-Type Contracts, recognizing revenue on the percentage-of-completion
method using costs incurred in relation to total estimated project costs. This method is used because management considers costs
incurred and costs to complete to be the best available measure of progress in the contracts. Contract costs include all direct
materials, subcontract and labor costs and those indirect costs related to contract performance, such as indirect labor, payroll
taxes, employee benefits and supplies.
Revenue on cost-plus-fee contracts is recognized to the extent
of costs incurred, plus an estimate of the applicable fees earned. Fixed fees under cost-plus-fee contracts are recorded as earned
in proportion to the allowable costs incurred in performance of the contract.
Billings in excess of costs and estimated earnings on uncompleted
contracts are classified as current liabilities. Costs and estimated earnings in excess of billings, or work in process, are classified
as current assets for the majority of the Company’s projects. Work in process on contracts is based on work performed but
not yet billed to customers as per individual contract terms.
Certain of our contracts involve the delivery of multiple elements
including design management, system installation and facilities maintenance. Revenues from contracts with multiple element arrangements
are recognized as each element is earned based on the relative selling price of each element provided the delivered elements have
value to customers on a standalone basis. Amounts allocated to each element are based on its objectively determined fair value,
such as the sales price for the service when it is sold separately or competitor prices for similar services.
Revenue and related costs for master and other service agreements
billed on a time and materials basis are recognized as the services are rendered based on actual labor hours performed at contracted
billable rates, and costs incurred on behalf of the customer. Services are also performed under master and other service agreements
billed on a fixed fee basis. Under fixed fee master service and similar type service agreements for facilities and equipment, we
furnish various unspecified units of service for a fixed price. These services agreements are recognized on the proportional performance
method or ratably over the course of the service period and costs are recorded as incurred in performance.
We recognize revenue from assembled products when the finished
product is shipped, and collection of the resulting receivable is reasonably assured. In arrangements where a formal acceptance
of products or services is required by the customer, revenue is recognized upon meeting such acceptance criteria.
Inventory Valuation
We value our inventories at cost with cost determined on a first-in,
first-out basis. We write down obsolete inventory or inventory in excess of our estimated usage to its estimated market value less
cost to sell, if less than its cost. Inherent in our estimates of market value in determining inventory valuation are estimates
related to future demand and technological obsolescence of our products. Any significant unanticipated changes in demand or technological
developments could have a significant impact on the value of our inventories and our results of operations and financial position
could be materially affected.
Intangible Assets
We recorded goodwill and intangibles with definite lives, including
customer relationships and acquired software, in conjunction with the acquisition of the Systems Integration business. These intangible
assets 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 and liabilities acquired, and is not amortized.
GAAP requires us to perform an impairment test of goodwill on
an annual basis 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 first have the option to make a qualitative assessment of goodwill for impairment. If
we are able to determine through the qualitative assessment that the fair value of a reporting unit more likely than not exceeds
its carrying value, no further evaluation is necessary. For those reporting units for which the qualitative assessment
is either not performed or indicates that further testing may be necessary, we then assess goodwill for impairment using a two-step
process. The first step requires comparing the fair value of the reporting unit with its carrying amount, including
goodwill. If that fair value exceeds the carrying amount, the second step of the process is not required to be performed, and no
impairment charge is required to be recorded. If that fair value does not exceed that carrying amount, we must perform the second
step, which requires an allocation of the fair value of the reporting unit to all assets and liabilities of that unit as if the
reporting unit had been acquired in a purchase business combination and the fair value of the reporting unit was the purchase price.
The goodwill resulting from that purchase price allocation is then compared to the carrying amount with any excess recorded as
an impairment charge.
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.
Item 3. Quantitative and Qualitative Disclosures about Market
Risk.
Not applicable.
Item 4. Controls and Procedures.
Our management performed an evaluation under the supervision
and with the participation of our Chief Executive Officer (principal executive officer) and our Chief Financial Officer
(principal financial officer) of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e)
of the Securities Exchange Act of 1934, as amended) as of June 30, 2013. Based upon that evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that as of June 30, 2013, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control
over financial reporting for the six months ended June 30, 2013 that have materially affected, or are reasonably likely to materially
affect, the Company’s internal control over financial reporting as such term is defined in Rule 13a-15 and 15d-15 of the
Exchange Act of 1934, as amended.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to any material litigation in any court,
and management is 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. We currently believe
that any ultimate 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.
Item 1A. Risk Factors.
In addition to the other information set forth in this Form
10-Q, you should carefully consider the factors discussed in Part I, “Item 1A: Risk Factors” in our Annual Report on
Form 10-K for the year ended December 31, 2012, which could materially affect our business, financial condition or future results.
The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition
and/or operating results. The following risk factors also could materially affect our business, financial condition, or future
results:
W
e are not curren
tly
in a position to have a registration statement declared effective by the SEC in order to issue any debt or equity securities in
the public markets.
On August 5, 2013, we failed to timely file a Form 8-K/A
containing audited historical financial statements and unaudited pro-forma financial statements related to the acquisition of
the Systems Integration business. The audited financial statements are required under Rule 3-05 of Regulation S-X and the
pro-forma financial statements are required under Rule 8-05 of Regulation S-X. Until such time as we are able to file these
financial statements for the periods required, we will not be in a position to have the SEC declare effective any
registration statement. It may take an extended period of time for us to comply with these requirements, and, during that
time, we would be unable to raise capital through the issuance of debt or equity securities in the public markets to fund our
operations and any acquisitions. Although we believe our existing cash on hand, our expected cash flows from
operations, and borrowings under our credit facility will provide adequate liquidity and working capital to support our
operations and capital requirements for the next twelve months, this inability to file a registration statement could
adversely affect our liquidity, results of operations and ability to fund any acquisitions.
Our inability to maintain sufficient availability under
our revolving credit facility or sufficient access to capital markets to replace that facility would have a significant impact
on our business.
We maintain a revolving credit facility with Bridge Bank, National
Association. Borrowings under this facility are collateralized by substantially all of our assets. The amount of available borrowings
fluctuates based on the underlying asset-borrowing base, which generally is 80% of our trade accounts receivable. In addition to
cash on hand and cash flow from operations, the facility provides us with the liquidity we require to meet our operating, investing
and financing needs. While we believe we can meet these needs from our operations and available sources of financing for the next
12 months, we can provide no assurances that we will be able to do so long-term. The loss of the use of the facility or the inability
to replace the facility when it expires would materially impair our ability to operate our business.
Our acquisition of businesses could negatively impact
our profitability and return on invested capital.
Acquisitions, including the acquisition of the Systems Integration
business involve a number of risks and financial, accounting, managerial and operational challenges,
including the following, any of which could adversely affect our growth and profitability:
|
·
|
Any acquired business, technology, service or product could under-perform
relative to our expectations and the price paid for it, or not perform in accordance with our anticipated timetable;
|
|
·
|
Acquisitions could cause our financial results to differ from expectations
in any given fiscal period, or over the long term;
|
|
·
|
Acquisition-related earnings charges could adversely impact operating
results;
|
|
·
|
Acquisitions could place unanticipated demands on our management,
operational resources and financial and internal control systems;
|
|
·
|
We may assume unknown liabilities, known contingent liabilities that
become realized or known liabilities that prove greater than anticipated, and the realization of any of these liabilities may increase
our expenses or adversely affect our financial position;
|
|
·
|
As a result of acquisitions, we have in the past recorded significant
goodwill and other identifiable intangible assets on our balance sheet, and, if we are not able to realize the value of these assets,
we may incur charges relating to the impairment of these assets;
|
|
·
|
We could experience difficulty in integrating personnel, operations
and financial and other systems and retaining key employees and customers;
|
|
·
|
We may be unable to achieve cost savings or other synergies anticipated
in connection with an acquisition; and
|
|
·
|
In connection with acquisitions, we often enter into post-closing financial arrangements such as purchase
price adjustments, earn-out obligations and indemnification obligations, which may have unpredictable financial results.
|
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds.
|
|
|
|
|
|
|
|
Total Shares
|
|
|
Approximate Dollar
|
|
|
|
|
|
|
Average
|
|
|
Purchased as Part of
|
|
|
Amount of Shares Yet
|
|
Monthly Period During the Quarter
|
|
Total Shares
|
|
|
Price Paid
|
|
|
Publically Announced
|
|
|
To Be Purchase Under
|
|
Ended June 30, 2013
|
|
Purchased
|
|
|
per Share
|
|
|
Plans
|
|
|
Plans
|
|
April 1, 2012-April 30, 2013
|
|
|
9,240
|
|
|
$
|
0.72
|
|
|
|
-
|
|
|
|
-
|
|
May 1, 2012-May 31, 2013
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
June 1, 2012-June 30, 2013
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
9,240
|
|
|
$
|
0.72
|
|
|
|
|
|
|
|
|
|
(a)
|
All of these shares were acquired from associates to satisfy tax withholding requirements upon the vesting of restricted stock.
|