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, 2013.
The information included herein is not necessarily indicative
of the annual results that may be expected for the year ended December 31, 2014, 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 July 2013, the FASB issued Accounting
Standards Update 2013-11 (“ASU 2013-11”),
Income Taxes (Topic 740) Presentation of an Unrecognized Tax Benefit When
a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues
Task Force)
. ASU 2013-11 is effective for the Company starting the fiscal year and interim period beginning on January 1, 2014.
The Company does not expect the adoption of ASU 2013-11 to have a material impact on its 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 purchase price paid by the Purchaser
under the Purchase Agreement was $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.
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 purchased proprietary software back to the
Seller on a non-exclusive, perpetual, royalty-free basis, with certain territorial limitations.
The Company accounted for this transaction as a business combination
using the acquisition method in accordance with Accounting Standards Codification 805,
Business Combinations
(“ASC
805”). Under the acquisition method, the purchase price is allocated to underlying assets and liabilities based on their
estimated fair values at the date of acquisition. The 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 recognized in
the Company’s only reportable segment as the acquisition did not result in the creation of a second reportable segment.
The following table summarizes the purchase price allocation:
|
|
May 20,
|
|
|
|
2013
|
|
Cash paid at acquisition date
|
|
$
|
725,000
|
|
Additional installments of preliminary purchase price
|
|
|
744,243
|
|
Acquisition consideration
|
|
$
|
1,469,243
|
|
|
|
|
|
|
Inventories
|
|
$
|
132,307
|
|
Other current assets
|
|
|
10,976
|
|
Fixed assets
|
|
|
48,133
|
|
Goodwill
|
|
|
137,827
|
|
Intangible assets
|
|
|
1,140,000
|
|
Net assets acquired
|
|
$
|
1,469,243
|
|
Intangible assets included approximately $0.9 million and $0.2
million attributable to a customer-related intangible asset and a technology-based asset, respectively. The intangible assets attributable
to the customer-related intangible asset are being amortized on a straight-line basis over ten years. The intangible assets attributable
to the technology-based asset are being amortized on a straight-line basis over five years. The customer-related intangible asset
represents the underlying relationships and agreements with the Seller’s existing customers. The technology-based asset represents
internally developed software.
Inventories, fixed assets and other assets were valued at cost
which approximates fair value. Intangibles were valued using Level 3 inputs, which results in management’s best estimate
of fair value from the perspective of a market participant.
The unaudited financial information in the table below summarizes
the combined results of continuing operations of the Company and the Systems Integration business as though the acquisition had
occurred as of the first day of the three months ended March 31, 2013. The unaudited pro forma financial information for the three
months ended March 31, 2013 combines the historical results for the Company and the historical results for the Systems Integration
business for the three months ended March 31, 2013. 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.
|
|
Three Months Ended
|
|
|
|
March 31, 2014
|
|
|
March 31, 2013
(pro forma)
|
|
Revenue
|
|
$
|
7,059,423
|
|
|
$
|
23,602,351
|
|
Net (loss) income from continuing operations
|
|
$
|
(891,855
|
)
|
|
$
|
207,511
|
|
Basic (loss) income per share
|
|
$
|
(0.06
|
)
|
|
$
|
0.01
|
|
Diluted (loss) income per share
|
|
$
|
(0.06
|
)
|
|
$
|
0.01
|
|
Basic weighted average number of common shares outstanding
|
|
|
14,467,280
|
|
|
|
14,356,551
|
|
Diluted weighted average number of common shares outstanding
|
|
|
14,467,280
|
|
|
|
14,356,551
|
|
Note 3 – Goodwill and Intangible Assets
The following tables highlight the Company’s intangible
assets and accumulated amortization as of March 31, 2014 and December 31, 2013:
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Gross
Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
Intangible assets not subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
1,906,688
|
|
|
|
-
|
|
|
$
|
1,906,688
|
|
|
|
-
|
|
Tradename
|
|
$
|
60,000
|
|
|
|
-
|
|
|
$
|
60,000
|
|
|
|
-
|
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
906,000
|
|
|
$
|
(77,935
|
)
|
|
$
|
906,000
|
|
|
$
|
(55,285
|
)
|
Acquired software
|
|
$
|
234,000
|
|
|
$
|
(40,258
|
)
|
|
$
|
234,000
|
|
|
$
|
(28,558
|
)
|
The Company recognized amortization expense related to intangibles
of approximately $34,000 and $0 for the three months ended March 31, 2014 and 2013, respectively.
Annual amortization expense for the customer-related intangible
asset will be approximately $91,000 during each year through 2022 and $35,000 in 2023. Annual amortization expense for the acquired
software intangible asset will be approximately $47,000 during each year through 2017 and $18,000 in 2018.
There was no impairment of goodwill or intangible assets during
the three months ended March 31, 2014.
Note 4 – Inventories
Inventories at March 31, 2014 and December 31, 2013 consisted
of the following:
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
Work in process
|
|
$
|
45,548
|
|
|
$
|
46,162
|
|
Raw materials
|
|
|
144,954
|
|
|
|
176,013
|
|
Less: Reserve
|
|
|
(2,397
|
)
|
|
|
(5,499
|
)
|
Inventories, net
|
|
$
|
188,105
|
|
|
$
|
216,676
|
|
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.
Note 5 – Convertible notes payable
On May 21, 2013, the Company and Gerard J. Gallagher, the Chief
Technical 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. After the reduction, the new principal amount due
was $1.9 million, which bears interest at an annual rate of 4%. This reduction in the principal amount was agreed upon in exchange
for an immediate payment of $0.9 million at the time of closing, leaving an outstanding principal balance of $1.0 million. In addition,
the Amended and Restated Convertible Promissory Note provided for eight quarterly principal payments of $25,000 beginning July
1, 2013, a principal payment of $0.1 million on January 3, 2014, and the remaining outstanding balance due on July 1, 2015. The
promissory note remains convertible into shares of the Company’s common stock at a conversion price of $7.50 per share. 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) and during the continuance of the event of default, the outstanding principal indebtedness under the promissory note will
bear interest at an annual rate of 7%. If the Company fails to cure an event of default 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 Company incurred approximately $40,000 related to the restructuring
of the note. These costs are included in other assets and are being amortized over the life of the note on a straight-line basis.
Approximately $5,000 was recorded as amortization expense during the three months ended March 31, 2014.
The restructured note was recorded at fair market value resulting
in a discount of approximately $138,000. 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 March 31, 2014 and December
31, 2013 were as follows:
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
Convertible, unsecured promissory note, due 2015 (4.0%), net
|
|
$
|
751,343
|
|
|
$
|
859,843
|
|
Less: current portion, net
|
|
|
39,000
|
|
|
|
137,000
|
|
Convertible notes payable, long-term, net
|
|
$
|
712,343
|
|
|
$
|
722,843
|
|
The unamortized discount at March 31, 2014 and December 31,
2013 was approximately $74,000 and $90,000, respectively. As of March 31, 2014 and December 31, 2013, approximately $61,000 and
$63,000, respectively, was recorded as a contra account to convertible notes payable-current, and approximately $13,000 and $27,000,
respectively, was recorded as a contra account to convertible notes payable, long-term.
Scheduled principal repayments on the convertible, unsecured
promissory note at March 31, 2014 are as follows:
2014
|
|
$
|
75,000
|
|
2015
|
|
|
750,000
|
|
Total
|
|
$
|
825,000
|
|
Note 6 – Credit Facility
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,
“Borrowers”), obtained a revolving credit facility (the “Credit Facility”) from Bridge Bank, National Association
(“Lender”) pursuant to a Business Financing Agreement by and among Borrowers and Lender (the “Financing Agreement”).
The Borrowers’ obligations under the Credit Facility are joint and several. The obligations under the 2Credit Facility are
secured by substantially all of the Borrowers’ assets. The maximum amount of the Credit Facility is $6.0 million. The Credit
Facility is subject to a borrowing base of 80% of eligible accounts receivable, subject to customary exclusions and limitations.
Borrowings under the Credit Facility will bear interest at (1) the greater of (a) the prime rate published by the Lender, which
was 3.25% at March 31, 2014 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 Credit Facility, the 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. On April 8, 2014, the Borrowers and the Lender agreed to a modification of
the Financing Agreement that, among other things, expanded the definition of eligible receivables to include certain receivables
with extended invoice terms and added a monthly maintenance fee of 0.1 percentage points of the daily account balance for the relevant
month. The Credit Facility matures on May 21, 2015. In the event the Financing Agreement is terminated prior to May 21, 2014, the
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 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 Credit Facility.
The Credit Facility requires that the 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 plus eligible accounts receivable by the Borrower’s obligations outstanding under the Credit
Facility. On March 31, 2014, the Company had an asset coverage ratio of 1.9 to 1.0.
At March 31 2014, there was $3.0 million in borrowings outstanding
under the Credit Facility. This amount represented the highest amount of borrowings during the three months ended March 31, 2014.
Additional borrowing availability was $0.6 million at March 31, 2014.
The Company incurred expenses of $0.2 million, including a commitment
fee of $30,000, related to obtaining the Credit Facility. These costs are included in other assets and are being amortized over
the life of the Credit Facility on a straight line basis. Approximately $19,000 was recorded as amortization expense for the three
months ended March 31, 2014, respectively.
Note 7 – Liquidity and Capital Resources
Our primary liquidity and capital requirements are to fund working
capital for current operations. Our primary sources of funds to meet our liquidity and capital requirements include cash on hand,
funds generated from operations and borrowings under the Credit Facility.
As of March 31, 2014 and December 31, 2013, we had cash and
cash equivalents of $1.1 million and $3.3 million, respectively. We had restricted cash, which includes amounts required as collateral
for a surety bond, of $0.2 million and $0.5 million as of March 31, 2014 and December 31, 2013, respectively.
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.
As indicated above, the Credit Facility matures on May 21, 2015.
In advance of that maturity date, the Company expects to explore one of several options to improve its liquidity, including but
not limited to renegotiating the Credit Facility under similar terms, negotiating a new credit facility with our current or a new
vendor or raising additional debt or equity capital.
Note 8 – Loss Per Share
No adjustments to net loss were necessary to calculate basic
and diluted earnings per share.
For the three months ended March 31, 2014 and 2013, potentially
dilutive shares of 2,794,333 and 2,605,346, respectively, were excluded from the calculation of dilutive shares because their effect
would have been anti-dilutive due to the net loss.
Note 9 – Income Taxes
The Company has made no provision for income taxes for the three
months ended March 31, 2014 and 2013 due to the net losses incurred in the periods.
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.
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 March 31, 2014 and 2013.
Note 10 – 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 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 granted
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, and 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, pursuant to the terms
of an employment agreement, the Company issued 200,000 stock 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.
On June 5, 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 January 14, 2014, pursuant to the terms
of an employment agreement, the Company issued 250,000 shares of restricted stock and 200,000 stock options to its Executive Vice
President, Sales and Marketing. 25,000 shares of the restricted stock vested on February 14, 2014, 125,000 shares will vest on
January 14, 2015 and 100,000 shares will vest on January 14, 2016. The options expire 10 years from the grant date. The options
will vest in installments as follows: 100,000 options will vest when the fair market value of the Company’s common stock
is at least $2.00 for 20 consecutive trading days, and 100,000 options will vest when the fair market value of the Company’s
common stock is at least $3.00 for 20 consecutive trading days. These grants were not made under the Incentive Plan.
For the three months ended March 31, 2014 and 2013, the Company
recorded non-cash compensation expense included in selling, general and administrative expenses of $129,050 and $75,480, respectively,
and cost of revenue included $4,225 and $32,314, respectively.
Note 11 – 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-approval process for contracts with
a related party for less than $25,000.
TPR Group Re Three, LLC (“TPR Group Re Three”) is
50% owned by Mr. Thomas P. Rosato, the Company’s former Chief Executive Officer, a former member of the Board of Directors
and a significant stockholder until February 28, 2014, and Gerard G. Gallagher, the Company’s Chief Technical 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.
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 amended for a new term beginning August 1, 2013 and terminating July 31, 2016. The Company paid TPR Group Re Three rents totaling
approximately $69,000 in each of the three months ended March 31, 2014 and 2013.
Note 12 – 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.
The Company is not aware of any pending litigation at March 31, 2014.