10-Q 1 tssi20170930_10q.htm FORM 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q  

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  

For the quarterly period ended September 30, 2017

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 001-33627

 


 

TSS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

20-2027651

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

110 E. Old Settlers Blvd

Austin, Texas

78664

(Address of principal executive offices)

(Zip Code)

 

(512) 310-1000

(Registrant's telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

 

Indicate by check mark whether each registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes     No 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer  (Do not check if a smaller reporting company) ☐

Smaller reporting company ☒

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Number of shares of common stock outstanding as of November 13, 2017              15,557,130

 

 

 

 

TSS, INC.

 

QUARTERLY REPORT ON FORM 10Q

 

For the Quarterly Period Ended September 30, 2017

 

"SAFE HARBOR" STATEMENT

ii

PART I-FINANCIAL INFORMATION

1

Item 1.    Financial Statements

1

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

15

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

19

Item 4.    Controls and Procedures

19

PART II-OTHER INFORMATION

21

Item 1.    Legal Proceedings

21

Item 6.    Exhibits

22

 

 

 

 

"SAFE HARBOR" STATEMENT

UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

 

From time to time, we make oral and written statements that may constitute "forward-looking statements" (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission (the "SEC") in its rules, regulations and releases, including Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We desire to take advantage of the "safe harbor" provisions in the Private Securities Litigation Reform Act of 1995 for forward looking statements made from time to time, including, but not limited to, the forward- looking statements made in this Quarterly Report on Form 10-Q (the "Form 10-Q"), as well as those made in other filings with the SEC.

 

Forward looking statements can be identified by our use of forward looking terminology such as "may," "will," "expect," "anticipate," "estimate," "believe," "continue," "forecast," "foresee" or other similar words. Such forward looking statements are based on management's current plans and expectations and are subject to risks, uncertainties and changes in plans that could cause actual results to differ materially from those described in the forward-looking statements. Important factors that could cause actual results to differ materially from those anticipated in our forward-looking statements include, but are not limited to, those described under Risk Factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

We expressly disclaim any obligation to release publicly any updates or any changes in our expectations or any changes in events, conditions or circumstances on which any forward-looking statement is based.

 

As used herein, except as otherwise indicated by the context, the terms "TSS," "Company," "we", "our" and "us" are used to refer to TSS, Inc. and its subsidiaries.

 

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

TSS, Inc.

Consolidated Balance Sheets

(in thousands except par values)

 

   

September 30,

   

December 31,

 
   

2017

   

2016

 
   

(unaudited)

         

Current Assets:

               

Cash and cash equivalents

  $ 970     $ 2,152  

Contract and other receivables, net

    1,988       2,389  

Costs and estimated earnings in excess of billings on uncompleted contracts

    105       539  

Inventories, net

    246       59  

Prepaid expenses and other current assets

    269       252  

Total current assets

    3,578       5,391  

Property and equipment, net

    420       544  

Goodwill

    1,907       1,907  

Intangible assets, net

    597       704  

Other assets

    112       30  

Total assets

  $ 6,614     $ 8,576  
                 

Current Liabilities:

               

Long-term borrowings, current portion, net

  $ -     $ 246  

Borrowings under receivables factoring agreement

    -       737  

Accounts payable and accrued expenses

    2,758       5,319  

Billings in excess of costs and estimated earnings on uncompleted contracts

    3,149       2,818  

Total current liabilities

    5,907       9,120  

Long-term borrowings, less current portion

    1,411       825  

Other liabilities

    36       62  

Total liabilities

    7,354       10,007  
                 

Commitments and Contingencies

    -       -  
                 

Stockholders' Equity (Deficit):

               

Preferred stock, $.0001 par value; 1,000 shares authorized at September 30, 2017 and December 31, 2016; none issued

    -       -  

Common stock, $.0001 par value; 49,000 shares authorized at September 30, 2017 and December 31, 2016; 16,316 and 16,370 issued; 15,557 and 15,622 outstanding at September 30, 2017 and December 31, 2016, respectively

    2       2  

Additional paid-in capital

    68,687       68,522  

Treasury stock 759 and 748 shares at cost at September 30, 2017 and December 31, 2016, respectively

    (1,533 )     (1,532 )

Accumulated deficit

    (67,896

)

    (68,423

)

Total stockholders' equity (deficit)

    (740

)

    (1,431

)

Total liabilities and stockholders' equity (deficit)

  $ 6,614     $ 8,576  

 

See accompanying notes to the consolidated financial statements.

 

1

 

 

TSS, Inc.

Consolidated Statements of Operations

(in thousands, except per-share amounts; unaudited)

 

   

Three Months Ended September 30

   

Nine Months Ended September 30

 
   

2017

   

2016

   

2017

   

2016

 

Results of Operations:

                               

Revenue

  $ 4,898     $ 5,416     $ 13,485     $ 20,120  

Cost of revenue

    2,818       3,955       7,792       15,186  

Gross profit

    2,080       1,461       5,693       4,934  

Selling, general and administrative expenses

    1,578       1,970       4,876       6,299  

Depreciation and amortization

    109       161       372       459  

Gain on sale of business component

    -       (910

)

    (321

)

    (910

)

Total operating costs

    1,687       1,221       4,927       5,848  

Income (loss) from operations

    393       240       766       (914

)

Other income (expense):

                               

Interest expense, net

    (82

)

    (72

)

    (233

)

    (263

)

Other income (expense), net

    -       (3

)

    (3

)

    6  

Income (loss) from operations before income taxes

    311       165       530       (1,171

)

Income tax expense

    13       -       3       -  

Net income (loss)

  $ 298     $ 165     $ 527     $ (1,171

)

Basic and diluted income (loss) per share:

                               

Income (loss) per common share

  $ 0.02     $ 0.01     $ 0.03     $ (0.07

)

 

See accompanying notes to the consolidated financial statements.

 

2

 

 

TSS, Inc.

Consolidated Statements of Changes in Stockholders' Equity (Deficit)

For the Nine Months Ended September 30, 2017

(in thousands, except share amounts, unaudited)

 

                   

 

                           

Total

 
   

Common Stock

   

Additional

   

Treasury Stock

   

 

   

Stockholders'

 
   

Shares

   

Amount

   

Paid-in

Capital

   

Shares

   

Amount

   

Accumulated

Deficit

   

Equity (Deficit)

 

Balance January 1, 2017

    16,370     $ 2     $ 68,522       (748 )   $ (1,532

)

  $ (68,423

)

  $ (1,431

)

Stock-based compensation

    -       -       61       -       -       -       61  

Treasury stock repurchased

    -       -       -       (11

)

    (1

)

    -       (1

)

Warrants issued with debt

            -       104       -       -       -       104  

Cancellation of restricted stock

    (54 )     -       -       -       -       -       -  

Net income

    -       -       -       -       -       527       527  

Balance at September 30, 2017

    16,316     $ 2     $ 68,687       (759 )   $ (1,533

)

  $ (67,896

)

  $ (740

)

 

See accompanying notes to the consolidated financial statements.

 

3

 

 

TSS, Inc.

Consolidated Statements of Cash Flows

(in thousands; unaudited)

 

   

Nine Months Ended September 30,

 
   

2017

   

2016

 

Cash Flows from Operating Activities:

               

Net income (loss)

  $ 527     $ (1,171

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

               

Depreciation and amortization

    372       459  

Provision for doubtful accounts

    (2

)

    (5 )

Amortization of debt discount

    22       49  

Non-cash interest

    22       -  

Stock-based compensation

    61       167  

Gain on sale of business component

    (321

)

    (910

)

Changes in operating assets and liabilities:

               

Contract and other receivables

    403       3,828  

Costs and estimated earnings in excess of billings on uncompleted contracts

    434       577  

Inventories, net

    (187

)

    -  

Prepaid expenses and other assets

    (96

)

    (65

)

Accounts payable and accrued expenses

    (2,557

)

    (1,583

)

Billings in excess of costs and estimated earnings on uncompleted contracts

    331       (37

)

Other liabilities

    (26

)

    3  

Net cash provided by (used in) operating activities

    (1,017

)

    1,312  
                 

Cash Flows from Investing Activities:

               

Capital expenditures

    (141

)

    (242

)

Proceeds from sale of business component

    314       546  

Net cash provided by investing activities

    173       304  
                 

Cash Flows from Financing Activities:

               

Payment on long-term borrowings

    (250

)

    (225

)

Repayment of bank line of credit

    -       (2,150

)

(Repayment) borrowings under receivables factoring agreement

    (737

)

    605  

Proceeds from issuance of new long-term debt

    650       -  

Repurchase of treasury stock

    (1

)

    -  

Net cash used in financing activities

    (338

)

    (1,770

)

Net decrease in cash and cash equivalents

    (1,182

)

    (154

)

Cash and cash equivalents at beginning of period

    2,152       1,132  

Cash and cash equivalents at end of period

  $ 970     $ 978  

Supplemental disclosure of cash flow information:

               

Cash paid for interest

  $ 181     $ 210  

Cash paid for taxes

  $ 42     $ 44  

Supplemental non-cash financing information:

               

Issuance of warrants in connection with debt

  $ 104     $ -  

 

See accompanying notes to the consolidated financial statements.

 

4

 

 

TSS, Inc.

Notes to Consolidated Statements

(unaudited)

 

Note 1 - Significant Accounting Policies

  

Description of Business

 

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 they are housed in. 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 and facilities management. Our corporate offices are in Round Rock, Texas, and we also have facilities in Dulles, Virginia, and Los Altos, California.

 

The accompanying consolidated balance sheet as of December 31, 2016, which has been derived from audited consolidated financial statements, and the unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("US GAAP") for interim financial statements and pursuant to the rules and regulations of the SEC for interim reporting, and include the accounts of the Company and its consolidated subsidiaries. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring items) necessary to present fairly the consolidated financial position of the Company and its consolidated results of operations, changes in stockholders' equity (deficit) and cash flows. These interim financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.

 

The accompanying consolidated financial statements have also been prepared on the basis that the Company will continue to operate as a going concern. Accordingly, assets and liabilities are recorded on the basis that the Company will be able to realize its assets and discharge its liabilities in the normal course of business. Our history of annual operating losses, declining current ratio, and total stockholders' deficit cause substantial doubt about our ability to continue to operate our business as a going concern. We have reviewed our current and prospective sources of liquidity, significant conditions and events as well as our forecasted financial results and concluded that we have adequate resources to continue to operate as a going concern. Our operating results have improved since the second half of 2016. In September 2016, we sold a portion of our facilities maintenance business for a purchase price of $950,000. During the fourth quarter of 2016, we elected to outsource multiple services that we had previously performed internally, allowing us to further reduce our level of operating expenses. During the first quarter of 2017, we sold certain identified assets and liabilities used in a portion of our construction management business for $350,000. These actions, along with other cost reductions we made, provided additional capital for our business, lowered our total operating costs, improved our operating profits, and allowed us to focus our business activities on systems integration and modular data center build and maintenance activities. In July 2017, we modified and extended the term of our long-term debt and we also borrowed an additional $650,000 in long-term debt to help us improve our liquidity and manage our working capital. We believe that there are further adjustments that could be made to our business if we were required to do so.

 

Our business plans and our assumptions around the adequacy of our liquidity are based on estimates regarding expected revenues and future costs and our ability to secure additional sources of funding if needed. However, our revenue 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 expectation of cash usage in 2017 or significantly affect our level of liquidity, which may require us to take measures to reduce our operating costs or obtain funding 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. These consolidated financial statements do not include any adjustments that might result from the Company not being able to continue as a going concern.

 

5

 

 

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 facility service and maintenance contracts, product shipments, time-and-materials contracts, fixed price contracts, and cost-plus-fee contracts (including guaranteed maximum price contracts).

 

Revenue from facility service and maintenance contracts are usually performed under master and other service agreements billed on a fixed fee basis. 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 integration of 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.

 

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.

 

Revenue from fixed price contracts is recognized on the percentage of completion method. We apply Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("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 estimated 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 our 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, systems 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.

 

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.

 

Concentration of Credit Risk

 

We are currently economically dependent upon our relationship with a large US-based IT Original Equipment Manufacturer (OEM). If this relationship is unsuccessful or discontinues, our business and revenue would suffer. The loss of or a significant reduction in orders from this customer or the failure to provide adequate products or services to it would significantly reduce our revenue. As our business evolves we are establishing relationships with additional IT OEM customers and resellers

 

6

 

 

The following customers accounted for a significant percentage of our revenues for the periods shown: 

 

   

Three months ended

September 30,

   

Nine Months Ended

September 30,

 
   

2017

   

2016

   

2017

   

2016

 

US-based IT OEM

    65 %     37 %     63 %     35 %

US-based data center company

    -       - %     -       18 %

US-based retail company

    -       6 %             24 %

Global IT services company

    1 %     20 %     6 %     12 %

US-based IT services company

    11 %     4 %     8 %     3 %

 

No other customers represented more than 10% of our revenues for any periods presented. Our US-based IT OEM customer represented 45% and 10% of our accounts receivable at September 30, 2017 and December 31, 2016, respectively. A US-based IT services company represented 23% and 17% of our accounts receivable at September 30, 2017 and December 31, 2016, respectively. A US-based electrical equipment company represented 11% of our accounts receivable at September 30, 2017. A US-based retail customer represented 25% of our accounts receivable at December 31, 2016. No other customer represented more than 10% of our accounts receivable at September 30, 2017 or at December 31, 2016.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers. ASU 2014-09 supersedes the revenue recognition requirements of FASB ASC Topic 605, Revenue Recognition and most industry-specific guidance throughout the ASC, resulting in the creation of FASB ASC Topic 606, Revenue from Contracts with Customers. ASU 2014-09 requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. This ASU provides alternative methods of adoption. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers, Deferral of the Effective Date. ASU 2015-14 defers the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017 and interim periods within those reporting periods beginning after that date, and permits early adoption of the standard, but not before the original effective date for fiscal years beginning after December 15, 2016.

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) clarifying the implementation guidance on principal versus agent considerations. Specifically, an entity is required to determine whether the nature of a promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for the good or service to be provided to the customer by the other party (that is, the entity is an agent). The determination influences the timing and amount of revenue recognition. In May 2016, the FASB issued ASU No. 2016-12 Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which clarifies guidance in certain narrow areas and adds a practical expedient for certain aspects of the guidance. The amendments do not change the core principle of the guidance in ASU 2014-09. In July 2015, the FASB issued ASU 2015-14, which delayed the effective date of ASU 2014-09. As a result, this guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Management is still evaluating disclosure requirements under the new standard and will continue to evaluate the standard as well as additional changes, modifications or interpretations which may impact current conclusions. We are continuing to assess the impact that these standards will have on our financial position and results of operations. Management expects to adopt the new standard using the modified retrospective method.

 

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)". Under ASU 2016-02, an entity will be required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. ASU 2016-02 offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. For public companies, ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period, and requires a modified retrospective adoption, with early adoption permitted. We are currently evaluating the future impact of ASU 2016-02 on our consolidated financial statements

 

In May 2017, the FASB issued ASU No. 2017-09, which amends the scope of modification accounting for share-based payment arrangements. The ASU provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. ASU 2017-09 will be applied prospectively to awards modified on or after the adoption date. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is not permitted. We do not expect this new guidance to have a material impact on our consolidated financial statements.

 

7

 

 

Note 2 - Supplemental Balance Sheet Information

 

Receivables

 

Contract and other receivables consisted of the following (in '000's):

 

   

September 30,

2017

   

December 31,

2016

 

Contract and other receivables

  $ 1,994     $ 2,393  

Allowance for doubtful accounts

    (6 )     (4

)

    $ 1,988     $ 2,389  

 

Inventory

 

We state inventories at the lower of cost or market, using the first-in-first-out-method (in '000's):

 

   

September 30,

2017

   

December 31,

2016

 

Raw materials

  $ 248     $ 61  

less: Reserve

    (2

)

    (2

)

Inventories, net

  $ 246     $ 59  

 

Goodwill and Intangible Assets

 

Goodwill and Intangible Assets consisted of the following (in '000's):    

 

   

September 30, 2017

   

December 31, 2016

 
   

Gross

           

Gross

         
   

Carrying

   

Accumulated

   

Carrying

   

Accumulated

 
   

Amount

   

Amortization

   

Amount

   

Amortization

 

Intangible assets not subject to amortization:

                               

Goodwill

  $ 1,907       -     $ 1,907       -  

Intangible assets subject to amortization:

                               

Customer relationships

  $ 906     $ (395 )   $ 906     $ (327 )

Acquired software

  $ 234     $ (204 )   $ 234     $ (169 )

Trade name

  $ 60       (4 )   $ 60       -  

 

We recognized amortization expense related to intangibles of approximately $36,000 and $34,000 for the three-month periods ended September 30, 2017 and 2016, respectively. We recognized amortization expense related to intangibles of approximately $107,000 and $103,000 for the nine-month periods ended September 30, 2017 and 2016, respectively

 

We have elected to use December 31 as our annual date to test goodwill and intangibles for impairment. As circumstances change that could affect the recoverability of the carrying amount of the assets during an interim period, the Company will evaluate its indefinite lived intangible assets for impairment. We performed a quantitative analysis of our goodwill and intangibles at December 31, 2016 as part of our annual testing for impairment. We used a combination of valuation methodologies including income and market-based valuation methods, with increased weighting on the income-based approaches and subject company stock-price methods as we felt these options more accurately captured the operations of our reporting units. Although there were events and circumstances in existence at December 31, 2016 that suggest substantial doubt about our ability to continue as a going concern, 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 at December 31, 2016 for our goodwill and other long-lived intangible assets. There were no identified triggering events or circumstances that occurred during the three or nine-month periods ended September 30, 2017 that would have required an interim impairment analysis of our goodwill and other long-lived intangible assets.

 

8

 

 

Property and Equipment

 

Property and equipment consisted of the following (in $'000):

  

    Estimated Useful     September 30,     December 31,  
   

Lives (years)

   

2017

   

2016

 

Vehicles

    5       $ 32     $ 32  

Trade equipment

    5         162       162  

Leasehold improvements

  2 - 5       340       292  

Furniture and fixtures

    7         18       16  

Computer equipment and software

    3         1,414       1,324  
                1,966       1,826  

Less accumulated depreciation

              (1,546

)

    (1,282

)

Property and equipment, net

            $ 420     $ 544  

 

Depreciation of property and equipment and amortization of leasehold improvements and software totaled $76,000 and $125,000 the three-month periods ended September 30, 2017 and 2016, respectively, and $265,000 and $340,000 for the nine-month periods ended September 30, 2017 and 2016, respectively.

 

Accounts Payable and Accrued Expenses

 

Accounts payable and accrued expenses consisted of the following (in $'000):

 

   

September 30,

2017

   

December 31,

2016

 

Accounts payable

  $ 1,741     $ 3,652  

Accrued expenses

    610       1,053  

Compensation, benefits & related taxes

    387       576  

Other accrued expenses

    20       38  

Total accounts payable and accrued expenses

  $ 2,758     $ 5,319  

 

Note 3 - Long term borrowings

   

Long-term borrowings consisted of the following (in $'000):   

 

   

September 30,

2017

   

December 31,

2016

 

Convertible notes payable

  $ -     $ 250  

Less unamortized discount

    -       (4

)

                 

Notes Payable due Feb. 2020

    1,618       945  

Less unamortized discount and debt issuance costs

    (207

)

    (120

)

      1,411       1,071  

Current portion of long-term borrowing

    -       (246

)

Non-current portion of long-term borrowing

  $ 1,411     $ 825  

 

We repaid the remaining principal of our convertible note payable to Gerard J. Gallagher, a director, senior technical advisor and founder of the Company in July 2017.

 

In February 2015, we entered into a multiple advance term loan agreement and related agreements with MHW SPV II, LLC (''MHW''), an entity affiliated with the Chairman of our Board of Directors, for a loan in the maximum amount of $2 million. We borrowed $945,000 under this loan agreement on February 3, 2015 and executed a promissory note to evidence this loan and the terms of repayment which requires interest-only payments until maturity.

 

In July 2017, we amended and restated the terms of this multiple advance term loan agreement whereby we increased the maximum principal amount of loans to $2.5 million for up to sixty days, and $2 million thereafter. The term of the loan was modified to be five years from the date of modification, thereby extending the term of the $945,000 loan to July 19, 2022. As part of this modification, the interest rate on the $945,000 loan remains at a fixed annual rate of 12%, however it was changed so that 6% is paid in cash monthly in arrears, and 6% is payable in kind, to be evidenced by additional promissory notes having an aggregate principal amount equal to the accrued but unpaid interest. We can prepay the loan at any time, subject to a prepayment fee of (a) 4% if the prepayment is made prior to July 20, 2018, (b) 2% if the prepayment is made between July 20, 2018 and July 19, 2019, and (c) 1% if the prepayment is made between July 20, 2019 and July 19, 2020.

 

9

 

 

The obligations under the loan are secured by substantially all of our assets pursuant to the terms of a security agreement. In connection with the receivables financing agreement described below, MHW executed a subordination agreement to evidence their agreement that their security interest is subordinated to the security interest of RTS Financial Services, Inc. in all of the Company's present and future accounts receivable and all proceeds thereof.

 

In conjunction with entering into the loan agreement, the Company and MHW also entered into a warrant granting MHW the right to purchase up to 1,115,827 shares of the Company's common stock. As part of the July 2017 modification, we also modified the warrant to change the exercise price of the shares and to extend the term of the warrant to July 19, 2022. The warrant is now exercisable for a period of five years from July 19, 2017 at an exercise price of $0.10 for the first 390,539 shares, $0.20 for the next 390,539 shares and $0.30 for the final 334,749 shares. The exercise price and number of shares of common stock issuable on exercise of the warrant will be subject to adjustment in the event of any stock split, reverse stock split, recapitalization, reorganization or similar transaction. The fair value of the modified warrant was determined to be approximately $167,000 and the incremental value of the warrant compared to the original warrant was approximately $6,000. This amount was added to the remaining unamortized value of the original warrant such that approximately $93,000 will be amortized using the straight-line method (which approximates the effective interest rate method) over the term of the loan. $5,000 and $8,000 was amortized during each of the three-month periods ended September 30, 2017 and 2016, respectively, and $21,000 and $24,000 was amortized during each of the nine-month periods ended June 30, 2017 and 2016, respectively for this warrant.

 

On July 19, 2017, we also borrowed an additional $650,000 from MHW Partners, an entity affiliated with MHW. This loan ranks parri passu with the $945,000 promissory notes held by MHW and is subject to the same loan agreement. Similar to the notes held by MHW, this note issued to MHW Partners bears interest at 12% per annum payable in cash monthly in arrears at a rate of 6% per annum and payable in kind at a fixed rate of 6% per annum, and has a maturity date of July 19, 2022. We can prepay the note issued to MHW Partners at any time, subject to a prepayment fee of (a) 4% if the prepayment is made prior to July 20, 2018, (b) 2% if the prepayment is made between July 20, 2018 and July 19, 2019, and (c) 1% if the prepayment is made between July 20, 2019 and July 19, 2020.

 

The obligations under the loan agreement and this promissory note are secured by substantially all of the Company's assets pursuant to the terms of an amended and restated security agreement. This security agreement amends and restates the security agreement entered into with MHW in February 2015.

 

In conjunction with entering into this new loan, we entered into a warrant granting MHW Partners the right to purchase up to 767,500 shares of our common stock. The warrant is exercisable for a period of 5 years from July 19, 2017, at an exercise price of $0.10 for the first 268,625 shares, $0.20 for the next 268,625 shares and $0.30 for the final 230,250 shares. The exercise price and number of shares of common stock issuable upon exercise of this warrant will be subject to adjustment in the event of any stock split, reverse stock split, recapitalization, reorganization or similar transactions. The fair value of the warrant granted was approximately $115,000. Using the relative-fair value allocation method, the debt proceeds were allocated between the debt value and the fair value of the warrants, resulting in a recognition of a discount on the loan of approximately $98,000 and a corresponding increase to additional paid-in capital. This discount will be amortized using the effective interest rate method over the term of the loan. Approximately $5,000 was amortized during the three-month period ended September 30, 2017.

 

Peter H. Woodward, the Chairman of our Board of Directors, is a principal of MHW Capital Management LLC, which is the investment manager of MHW and MHW Partners. MHW Capital Management LLC is entitled to a performance related fee tied to any appreciation in the valuation of the common stock in excess of the applicable strike price under the warrant.

 

10

 

 

Note 4 - Receivables Factoring Agreement

 

In May 2016, we entered into a receivables-factoring agreement with RTS Financial Service, Inc. ("RTS"). Under the terms of this agreement, we may offer for sale, and RTS in its sole discretion may purchase our eligible receivables (the "Purchased Accounts"). Upon purchase RTS becomes the absolute owner of the Purchased Accounts, which are payable directly to RTS, subject to certain repurchase obligations by us.

 

RTS's fee for each Purchased Account is computed daily until the amount of the Purchased Account is paid to RTS, and such fee equals the amount of the Purchased Account multiplied by the sum of the prime rate then in effect plus 7%, divided by 360. RTS will pay us 80% of the amount of the Purchased Accounts upon purchase and the balance (less fees) is paid to us upon collection of the Purchased Account by RTS.

 

Our obligations under the receivables factoring agreement are secured by all present and future accounts receivable (provided, however that accounts for one customer are excluded) and all chattel paper, instruments, general intangibles, securities, contract rights, insurance, proceeds, property rights and interests associated therewith, as well as all equipment, inventory and deposit accounts of the Company.

 

RTS may require us to repurchase a Purchased Account if we breach any warranty or otherwise violate or default on any of our obligations under the factoring agreement or if the Purchased Account is not paid in full on or before the payment due date of such Purchased Account or within 120 days after the invoice date of such Purchased Account.

 

The receivables factoring agreement has an initial term of 12 months and automatically renews for successive 12-month renewal periods unless terminated pursuant to the terms of the agreement. We may terminate the agreement at the end of the initial term upon 60 days' notice and payment of an early termination fee to RTS in the amount of $10,000. We may also terminate the agreement at any time during the first 24 months upon 30 days' notice and payment of an early termination fee based on the average monthly amount purchased during the term of the agreement. RTS may terminate the agreement upon 90 days' notice to us or immediately upon the occurrence of certain events.

 

Note 5 - Sale of Business Component

 

On January 31, 2017, we completed the sale of certain identified assets and liabilities associated with a specific customer contract from our project management business for $350,000 pursuant to an Asset Purchase Agreement ("APA") dated December 12, 2016 with Tech Site Services, LLC, a privately held Maryland company. The sale price was subject to certain post-closing adjustments relating to working capital and obtaining the consent of the customer as a condition of closing. Tech Site Services, LLC also must pay us an earn-out payment equal to 10% of all revenue generated under the customer contract in excess of $2.5 million in each 12-month period during the two-year period after the closing of this transaction.

 

The transaction closed on January 31, 2017. The APA contains representations, warranties, covenants and indemnification provisions customary for a transaction of this type. Many of the representations made by us are subject to, and qualified by materiality or similar concepts. Both parties have agreed to indemnify the other party for certain losses arising from the breach of the APA and for certain other liabilities, subject to specified limitations. In connection with the transaction both parties will provide transition services with respect to the business activities that were sold.

 

The customer contract and intellectual property sold had a net book value of $0. As a result of the sale, Tech Site Services LLC assumed liabilities of $7,000, resulting in $343,000 of cash proceeds that was paid to us upon closing. Additionally, we incurred approximately $29,000 in legal, escrow and other expenses that would not have been incurred otherwise. As a result, we recorded a net gain of approximately $321,000 in our consolidated statement of operations for the three-month period ended March 31, 2017.

 

On July 1, 2016, we adopted ASU 2014-08 regarding discontinued operations. As a result, we evaluated the sale of a portion of our project maintenance business component in light of this new standard. We concluded that the sale of a portion of our project management business component in January 2017 was not a "material shift" (as defined in ASU 2014-08) for us and therefore, is not considered a discontinued operation. In accordance with ASU 2014-08, the following information is being provided:

 

   

Three Months Ended Sept 30,

   

Nine Months Ended Sept. 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Pre-tax profit related to project management business sold

  $ -     $ 37     $ 70     $ 148  

 

11

 

 

Note 6 - Net Income (Loss) Per-Share

 

Basic and diluted income (loss) per share are based on the weighted average number of shares of common stock and potential common stock outstanding during the period. Potential common stock, for the purposes of determining diluted income per share, includes the effects of dilutive unvested restricted stock, options to purchase common stock and convertible securities. The effect of such potential common stock is computed using the treasury stock method or the if-converted method, as applicable.

 

The following table presents a reconciliation of the numerators and denominators of the basic and diluted income (loss) per share computations for income (loss) from continuing operations. The table below represents the numerator and shares represent the denominator (in thousands except per share amounts).  

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Basic net income (loss) per share:

                               

Numerator:

                               

Net income (loss)

  $ 298     $ 165     $ 527     $ (1,171

)

Denominator:

                               

Weighted-average shares of common stock outstanding

    15,497       15,652       15,507       15,659  

Basic net income (loss) per share

  $ 0.02     $ 0.01     $ 0.03     $ (0.07 )
                                 

Diluted net income (loss) per share:

                               

Numerator:

                               

Net income (loss)

  $ 298     $ 165     $ 527     $ (1,171

)

Plus interest expense on convertible debt

    -       4       -       -  
    $ 298     $ 169     $ 527     $ (1,171

)

Denominator:

                               

Weighted-average shares of common stock outstanding

    15,497       15,652       15,507       15,659  

Dilutive options and warrants outstanding

    1,538       -       1,013       -  

Effect of conversion of convertible notes

    -       43       4       -  

Number of shares used in diluted per-share computation

    17,035       15,695       16,524       15,659  
                                 

Diluted net income (loss) per share

  $ 0.02     $ 0.01     $ 0.03     $ (0.07

)

 

For the three and nine-month periods ended September 30, 2017 and 2016, potentially dilutive shares of 1,548,000 and 3,496,000, respectively, were excluded from the computation of diluted net income per share because the exercise price of these stock options and warrants was greater than the average market price of our common shares during those periods.

 

Note 7 - Related Party Transactions

 

During the three-month period ended September 30, 2017 we repaid the remaining $100,000 principal outstanding on a convertible note payable to Mr. Gallagher, a director, and our senior technical advisor and founder. The convertible note bore interest at 5% per annum and was subordinated to our borrowings to MHW and to RTS under our receivables financing agreement. Per the terms of the notes, we paid interest of $4,000 during the three-month period ended September 30, 2016, and we paid interest of $3,000 and $19,000 during the nine-month periods ended September 30, 2017 and 2016, respectively. We repaid principal against the convertible note of $100,000 and $75,000 in the three-month periods ended September 30, 2017 and 2016, respectively. We repaid principal against the convertible note of $250,000 and $225,000 in the nine -month periods ended September 30, 2017 and 2016, respectively.

 

We have $1,618,000 principal outstanding at September 30, 2017 in promissory notes payable to MHW and MHW Partners, net of remaining discount of $207,000. Per the terms of the notes, we paid interest of $45,000 and $29,000 during the three-month periods ended September 30, 2017 and 2016, respectively, and we paid interest of $101,000 and $75,000 during each of the nine-month periods ended September 30, 2017 and 2016, respectively. Peter H. Woodward, the Chairman of our Board of Directors, is a principal of MHW Capital Management, LLC which is the investment manager of MHW and MHW Partners. MHW Capital Management LLC is entitled to a performance-related fee equal to 10% of any appreciation in the valuation of the common stock in excess of the applicable strike price under the warrant issued to MHW.

 

12

 

 

 Note 8 Segment Reporting

 

Segment information reported in the tables below represents the operating segments of the Company organized in a manner consistent with which separate information is available and for which segment results are evaluated regularly by our chief operating decision-maker in assessing performance and allocating resources. Our activities are organized into two major segments: facilities and systems integration. Our facilities unit is involved in the design, project management and maintenance of data center and mission-critical business operations. Our systems integration unit integrates IT equipment for OEM vendors and customers to be used inside data center environments, including modular data centers. All of our revenues are derived from the U.S. market. Segment operating results reflect earnings before stock-based compensation, acquisition related expenses, other expenses, net, and provision for income taxes.

 

Revenue and operating results by reportable segment reconciled to reportable net income (loss) for the three and nine-month periods ended September 30, 2017 and 2016 and other segment-related information is as follows (in thousands):

 

   

Three Month Periods

ended Sept. 30,

   

Nine Month Periods

ended Sept 30,

 
    2017     2016     2017     2016  

Revenues:

                               

Facilities

  $ 3,249     $ 4,597     $ 8,466     $ 16,599  

System integration services

    1,649       819       5,019       3,521  

Total revenues

  $ 4,898     $ 5,416     $ 13,485     $ 20,120  
                                 
Income (loss) from operations:                                

Facilities

  $ 723     $ 831     $ 1,795     $ 338  

System integration services

    (330 )     (591 )     (1,029 )     (1,252 )

Total income (loss) from operations

  $ 393     $ 240     $ 766     $ (914 )
                                 

Depreciation expense:

                               

Facilities

  $ 8     $ 16     $ 25     $ 53  

System integration services

    68       109       240       287  

Consolidated depreciation expense

  $ 76     $ 125     $ 265     $ 40  
                                 

Interest expense

                               

Facilities

  $ 46     $ 57     $ 131     $ 210  

System integration services

    36       15       102       53  

Consolidated interest expense

  $ 82     $ 72     $ 233     $ 263  

 

   

June 30,

2017

   

Dec. 31,

2016

 
Total assets                

Facilities

  $ 3,672     $ 4,190  

System integration services

    1,586       1,938  

Other consolidated activities

    1,356       2,448  

Total assets

  $ 6,614     $ 8,576  

 

Other consolidated activities include assets not specifically attributable to each business segment including cash, prepaid and other assets that are managed at a corporate level.

 

Note 9. Subsequent Events

 

On October 6, 2017, we entered into an amendment to our multiple advance term loan agreement and the related security agreement with MHW and MHW Partners, to add new lenders to the loan and security agreements. Upon execution, Mr. Glen Ikeda and Mr. Andrew Berg became new lenders to the Company. In accordance with the terms of the Amendment, Mr. Ikeda then provided a loan in the amount of $300,000 and Mr. Berg provided a loan in the amount of $100,000 (collectively the "New Loans").

 

The New Loans have a maturity date of July 19, 2022. The New Loans do not bear interest and we are permitted to make optional prepayments at any time without premium or penalty, provided that if we prepay the outstanding principal amount of a New Loan prior to the second anniversary of the date of the applicable note, then the total amount of such prepayment will not exceed 95% of the total principal amount of the applicable note and any remaining principal amount under the note shall be fully and finally cancelled, extinguished, forgiven and terminated without further action of any party.

 

The New Loans include customary affirmative covenants for secured transactions of this type, including compliance with laws, maintenance of insurance, maintenance of assets, timely payments of taxes and notice of adverse events. The loan agreement and ancillary documents include customary negative covenants including limitations on liens on assets of the Company.

 

Concurrent with the new loans, we entered into a warrant with Mr. Ikeda granting Mr. Ikeda the right to purchase up to 954,231 shares of our common stock. This warrant is exerciseable until July 19, 2022, at an exercise price of $0.10 for the first 498,981 shares, $0.20 for the next 273,981 shares and $0.30 for the final 181,269 shares. The exercise price and number of shares of common stock issuable on exercise of this warrant will be subject to adjustment in the event of any stock split, reverse stock split, recapitalization, reorganization or similar transaction.

 

13

 

 

Concurrent with the new loans, we entered into a warrant with Mr. Berg granting Mr. Berg the right to purchase up to 318,077 shares of our common stock. This warrant is exerciseable until July 19, 2022, at an exercise price of $0.10 for the first 166,327 shares, $0.20 for the next 91,327 shares and $0.30 for the final 60,423 shares. The exercise price and number of shares of common stock issuable on exercise of this warrant will be subject to adjustment in the event of any stock split, reverse stock split, recapitalization, reorganization or similar transaction.

 

The fair value of these two warrants granted in connection with the new loans was approximately $367,000. Using the relative fair-value allocation method, the debt proceeds were allocated between the debt value and the fair value of the warrants, resulting in recognition of a discount on the new loans of approximately $191,000, with a corresponding increase to additional paid-in capital. This discount will be amortized to interest expense over the term of the loan using the effective interest rate method.

 

14

 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated financial statements and notes thereto included in Item 1 of this Form 10-Q and the consolidated financial statements and notes thereto and our Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2016 included in our 2016 Annual Report on Form 10-K. This report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties. Our expectations with respect to future results of operations that may be embodied in oral and written forward-looking statements, including any forward-looking statements that may be included in this report, are subject to risks and uncertainties that must be considered when evaluating the likelihood of our realization of such expectations. Our actual results could differ materially. The words "believe," "expect," "intend," "plan," "project," "will" and similar phrases as they relate to us are intended to identify such forward-looking statements. In addition, please see the "Risk Factors" in Part 1, Item 1A of our 2016 Annual Report on Form 10-K for a discussion of items that may affect our future results. 

 

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 they are housed in. 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 and facilities management.

 

Our headquarters are in Round Rock, Texas, and we have offices in Dulles, Virginia, and Los Altos, California.

 

Our business is concentrated on the data center infrastructure and services market. This market is becoming increasingly competitive as commerce moves to cloud-based solutions and as data storage requirements continue to escalate for many industries. We compete against many larger competitors who have greater resources than we do, which may affect our competitiveness in the market. We rely on several large customers to win contracts and to provide business to us under ''Master Service Agreements'', and the loss of such customers would have a negative effect on our results.

    

RESULTS OF OPERATIONS

 

Revenue

 

Revenue consists of fees earned from the planning, design and project management for mission-critical facilities and information infrastructures, as well as fees earned from providing equipment and maintenance services for these facilities. We also earn revenue from providing system configuration and integration services to IT equipment vendors. Currently we derive all our revenue from the U.S. market.

 

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 generate higher profit margins generally, relative to their higher risk. Certain of our service and maintenance contracts provide comprehensive coverage of all of the customers equipment (excluding IT equipment) at a facility during the contract period. Where customer requirements are clear, we prefer to enter into 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.

 

We have been concentrating our sales efforts towards maintenance and integration services where we have traditionally earned higher margins. Historically our construction services were tied to a few, high-value contracts for the construction of new data centers at any point in time. In addition to contributing to large quarterly fluctuations in revenue depending upon project timing, these projects required additional working capital and generated lower margins than our maintenance and integration services. We have re-focused our construction services towards smaller scaled jobs typically connected with addition/move/retrofit activities rather than new construction, where we can obtain better margins. We have also focused on providing maintenance services for modular data center applications as this emerging market expands.

 

15

 

 

Revenues for the three-month period ended September 30, 2017 decreased by $0.5 million, or 10% compared to the same period in 2016. This decrease reflects a $1.3 million or 29% decrease in our facilities services revenues as our project management and design activities, including equipment procurement, decreased following our decision in 2016 to focus less on these services and to focus more on higher margin services such as facilities maintenance and systems integration. We made this decision to perform less design and project management services due to the low margins they generate and the related high working capital and headcount requirements. Revenues in our systems integration business increased by $0.8 million or 101% compared to the third quarter of 2016, primarily due to a higher level of integration services connected with modular data center integrations services and building of racks compared to 2016. Our revenue of $4.9 million in the three-month period ended September 30, 2017 was 17% or $0.7 million higher than the $4.2 million in revenue we had in the second quarter of 2017 primarily due to higher levels of modular data center deployments and higher integration service revenues.

 

Revenues for the nine-month period ended September 30, 2017 decreased by 33% or $6.6 million compared to the same period in 2016. This decrease reflects a $8.1 million or 49% decrease in our facilities services revenue primarily caused by the sale of portions of this business in 2016 and 2017, and our decision to perform less equipment procurement and data center construction-related projects. This decrease was offset by a $1.5 million or 43% increase in our systems integration business, reflecting higher demand compared to the prior year.

 

We anticipate that our quarterly revenues will be lower than historical levels over the remainder of 2017 as we concentrate our business on facilities maintenance and systems integration services. We made the decision in late 2016 to outsource multiple services that we had previously staffed directly, including consulting design, engineering and some construction project management services. This allowed us to reduce our overhead expenses. We believe that this will decrease the variability in our quarterly revenues and decrease the variability in our working capital by eliminating these large one-off projects. We believe this will also help us manage our liquidity, and contribute to improved profitability.

 

Cost of revenue

 

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 expense, 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. The cost of revenue as a percentage of revenue was 58% for the three-month period ended September 30, 2017 compared to 73% for the same period in 2016 and 58% in the second quarter of 2017. This decrease from 2016 is because of a lower level of equipment procurement costs and subcontractor expense in 2017 due to the absence of large project management activities, and from higher utilization of our systems integration facility in 2017 compared to the same period in 2016 as revenues from this business unit increased. We have higher costs and lower margins from project management activities including equipment procurement, and the decrease in this revenue in absolute value and as a percentage of our total revenues compared to the prior year, resulted in a lower cost of revenue.

 

For the nine-month period ended September 30, 2017, the cost of revenue as a percentage of revenue was 58%, compared to 76% in the same period of 2016. This decrease reflects the lower level of project management and construction services and equipment procurement revenues in 2017.

 

Since we earn higher profits on our own labor services, we expect the ratio of cost of services to revenue to decline when our labor services mix increases relative to the use of subcontracted labor or third-party material. Our systems integration activities mainly comprise labor services, so growth in this business will favorably impact the ratio of cost of services to revenue. Conversely, as subcontracted labor or third-party material purchases for customer projects increase relative to our own labor services or overall cost of services, we expect the ratio of cost of services to revenue to increase. Our direct labor costs are relatively fixed in the short-term, and the utilization of direct labor is critical to maximizing our profitability. With our decision to perform less procurement and project management activities we anticipate a lower level of third-party subcontracted labor and expect our cost of revenue as a percentage of revenue to decrease compared to historical levels.

 

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 estimate accurately 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.

 

Gross Profit

 

For the three-month period ended September 30, 2017, our gross profit was 42% of revenue, compared to a gross profit margin of 27% in the third quarter of 2016 and a gross profit margin of 42% in the second quarter of 2017. This improvement in margin compared to 2016 resulted in our gross profit being $2.1 million for the quarter, compared to a gross profit of $1.5 million in the third quarter of 2016. Our revenue mix in this current quarter was more favorable from a profit perspective as our revenue was all in our higher margin activities including facilities and systems integration activities. For the nine-month period ended September 30, 2017, our gross profit margin was 42% of revenue compared to 24% in the same period of 2016. Despite $6.6 million less revenue compared to the first nine-months of 2016, this improved gross margin allowed us to increase our gross profit by 16% or $0.8 million to $5.7 million in 2017. This largely reflects the discontinuation of design, construction management and equipment procurement activities and elimination of the associated overhead of these activities.

 

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Our ability to maintain these levels of gross margin will depend, in part, upon our ability to further increase sales of our higher-margin services including maintenance and integration services, improve our service margins through further pricing and operating efficiency including utilization of our systems integration facility, and increasing our total revenues to a level that will allow us to increase the utilization of our integration and service operations.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses primarily consists of compensation and related expenses, including variable sales compensation, for our executive, administrative and sales and marketing personnel, as well as related travel, selling and marketing expenses, professional fees, facility costs, insurances and other corporate costs. For the three-month period ended September 30, 2017, our selling, general and administrative expenses decreased by $392,000 or 20% compared to the same period of 2016. This decrease was due to lower headcount related costs following the discontinuation of directly providing project management and design services, and due to the closure of our Maryland facility in late 2016. For the nine-month period ended September 30, 2017, our selling, general and administrative expenses decreased by $1,423,000 or 23% compared to the same period of 2016. This decrease was also due to lower headcount and lower professional fees and lower facility costs in 2017.

 

Gain on sale of Business Component

 

In January 2017, we completed the sale of certain identified assets and liabilities connected with a specific customer contract from our project management business for $350,000. The buyer assumed net liabilities of $7,000 resulting in cash proceeds of $343,000. Additionally, we incurred approximately $29,000 in legal, escrow and other costs that would not have been incurred otherwise. As a result, we recorded a net gain of approximately $321,000 from the sale of these assets during the first quarter of 2017.

 

Operating income

 

For the three-month period ended September 30, 2017, we recorded an operating profit of $0.4 million. This was an improvement of $153,000 or 64% from the operating profit of $240,000 that we had in the in the third quarter of 2016. This improvement was driven by improved margins from our more favorable revenue mix and from lower operating expenses following the discontinuation of our design and construction management activities in late 2016. For the nine-month period ended September 30, 2017, our operating profit of $0.8 million was an improvement of $1.7 million or 184% from the $0.9 million operating loss that we had in the comparable period of 2016. This improvement was driven by higher margins, lower operating expenses and the gain realized upon sale of a customer contract during the first quarter of 2017.     

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary sources of liquidity at September 30, 2017 are our cash and cash equivalents on hand, funds available under our receivables factoring agreement and projected cash flows from operating activities.

 

In September 2016, we sold the Maryland-based portion of our facilities maintenance business that was not focused on the modular data center market. During the fourth quarter of 2016, we made the decision to outsource certain services that we had previously provided directly including consulting and design engineering and project management activities. These activities were concentrated on traditional "brick and mortar" type facilities. This decision allows us to continue to provide these services to our customers when required, but at the same time allows us to reduce our fixed staffing and overhead levels. These actions continued the focusing of our activities on the modular data center market. In the first quarter of 2017, we sold another customer contract that was part of our project management business. Collectively these actions generated $1.3 million in cash, resulted in staffing reductions, and allowed us to close our facility in Maryland. Due to these actions, we lowered our level of operating expenses to improve our efforts at achieving ongoing profitability.

 

If we continue to meet the cash flow projections in our current business plan, we expect that we will have adequate capital resources necessary to continue operating our business for at least the next twelve months. Our business plan and our assumptions around the adequacy of our liquidity are based on estimates regarding expected revenues and future costs. However, there are potential risks, including that our revenues may not meet our projections, our costs may exceed our estimates, or our working capital needs may be greater than anticipated. Further, our estimates may change, and future events or developments may also affect our estimates. Any of these factors may change our expectation of cash usage in the remainder of 2017 and beyond or significantly affect our level of liquidity, which may require us to seek additional financing or take other measures to reduce our operating costs in order to continue operating.

 

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In July 2017, we extended the term of our 2015 promissory note to July 19, 2022. In conjunction with this modification we amended the exercise price of the warrant granted with that original note, and modified the interest payments so that ½ of the interest is now paid "in kind". We also entered into a new $650,000 promissory note on this date with the same lender on substantially the same terms and conditions as the original loan, to provide additional working capital for the Company. In October 2017, we entered into a new $400,000 promissory note with new lenders on substantially the same terms and conditions as the preceding notes.

 

In May 2016, we entered into a full-recourse, receivables factoring agreement with RTS Financial Service (RTS) whereby RTS may purchase eligible accounts receivable from us. RTS will advance 80% of the face value of our receivables and the balance (less fees) is paid to us after our customer remits funds to RTS. Advances are subject to a financing cost of prime plus 7% per annum. Advances under this agreement are at the discretion of RTS and there is no maximum or committed facility amount such as existed under our bank-based revolving credit facility. Upon entering this facility with RTS we repaid all outstanding amounts due under our revolving credit facility with our former bank.

 

Our quarterly operating results have shown mixed but improving results over the past twelve months with large quarterly fluctuations in revenue and operating results. Our quarterly revenues have fluctuated between $4.2 million to $7.3 million. Our gross profit margin has ranged from 33% to 42%, and our operating results have varied from an operating loss of $0.1 million to an operating profit of $0.4 million in the third quarter of 2017. We continue to operate the business with a net working capital deficit and with a stockholders' equity deficiency. Due to these fluctuations and our liquidity position, we continue to look at alternative sources of funding to strengthen our balance sheet. Our recent debt financings have helped us manage our liquidity and provided funding for our business.. There can be no guarantee that will not require additional funding, and that such financing will be available to us when we require it or that we will complete any such financing.

 

As of September 30, 2017 and December 31, 2016, we had cash and cash equivalents of $1 million and $2.2 million, respectively.

 

Significant uses of cash

 

Operating activities:

 

Cash used in operating activities for the nine-month period ended September 30, 2017 was $1.0 million compared to cash provided from operating activities of $1.3 million for the nine-month period ended September 30, 2016. This decrease was primarily driven by a shrinkage in our balance sheet as we discontinued our project management activities. This required us to pay off $2.6 million in our accounts payable and accrued expenses as we decreased and completed a number of large project management contracts. This was offset by lower receivables and higher net income of approximately $1.7 million compared to the same period of 2016.

 

Historically our project management activities required large amounts of working capital as we managed projects with large values, exceeding $10 million in some cases. The timing of equipment purchases and delivery of products and services could result in material quarterly fluctuations in our level of receivables, payables and deferred cost and revenue balances. As we have been winding down our remaining project management contracts, we have seen large decreases in our accounts receivable and accounts payable balances as we exit these services and settle our remaining trade obligations under these contracts. We anticipate that our level of trade receivables and payables will be smaller in the future due to the absence of these large project management contracts, and that fluctuations in our working capital will be smaller in magnitude than historical fluctuations.

 

Investing activities:

 

Cash provided by investing activities was $0.2 million during the nine-month period ended September 30, 2017 compared to cash provided by investing activities of $0.3 million in 2016. In 2017, we received cash proceeds of approximately $0.3 million from the sale of a specific customer contract in our first quarter, offset by purchases of property and equipment. Our capital expenditures were approximately $140,000 and $240,000 in 2017 and 2016, respectively. In 2016 we generated $0.5 million in proceeds from the sale of a portion of our facilities maintenance business that was based in Maryland.

 

Financing activities:

 

Cash used in financing activities was $338,000 for the nine-month period ended September 30, 2017 compared to cash used in financing activities of $1,770,000 for the period ended September 30, 2016. In 2017 we repaid $737,000 against our accounts receivables factoring facility as our level of eligible receivables has changed due to our evolving revenue mix. We also repaid the final $250,000 against our convertible note payable to Mr. Gallagher. We offset these payments with $650,000 in proceeds from the issuance of new debt. In 2016 we repaid $225,000 against our convertible note payable to Mr. Gallagher and repaid $2.15 million against our revolving bank facility upon its expiration in 2016. This was offset by funds received of $605,000 from our accounts receivables factoring facility.

 

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Future uses of cash

 

Our history of annual operating losses, declining current ratio, and our stockholders' deficit may, in themselves, cause uncertainty about our ability to continue to operate our business as a going concern. During 2016, we sold off a portion of our facilities maintenance operation and in the first quarter of 2017, we sold a customer contract from our project management operations. Combined, these actions provided $1.3 million in liquidity to the business. During the fourth quarter of 2016, we also made the decision to outsource certain service offerings which further allowed us to reduce our headcount and our level of overhead expenses, and we closed our office facility in Maryland. In July 2017, we borrowed an additional $650,000 of long-term debt and extended the repayment term of our existing long-term debt by a further two years. In October 2017, we borrowed an additional $400,000 in long-term debt under our multiple advance term-loan facility. We believe that there are further adjustments to reduce costs and improve profitability that could be made to our business if we were required to do so. We have had operating profits for the last five quarters and believe that by focusing our business on facilities maintenance and systems integration activities, we have a higher probability of sustaining profitability and improving our overall liquidity position.

 

Our business plans and our assumptions around the adequacy of our liquidity are based on estimates regarding estimated revenues and future costs and our ability to secure sources of funding if needed. However, our revenue 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 expectation of our cash usage during 2017 and beyond and significantly affect our level of liquidity, which may require us to seek additional financing or take other measures to reduce our operating costs in order to continue operating. Any action to reduce operating costs may negatively affect our range of services that we offer or our ability to deliver such services, which could materially impact our financial results.. The consolidated financial statements included in this filing do not include any adjustments that might result from the Company not being able to continue as a going concern.

 

If we raise additional funds through the issuance of debt or equity securities, the ownership of our existing stockholders may be significantly diluted. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. We do not know whether we will be able to secure additional funding, or funding on terms acceptable to us, to continue our operations as planned. If financing is not available, we may be required to reduce, delay or eliminate certain business activities or to sell all or parts of our operations.

 

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 including the funds from our customer financing programs, and borrowings under our accounts receivable factoring 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 or the sale of part or all of our operations. However, the timing and effect of these steps may not completely alleviate a material effect on liquidity.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2017 and December 31, 2016, we had no off balance sheet arrangements.

 

Critical Accounting Policies and Pronouncements

 

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, 2016. See also Item 1. Financial Statements Note 1 - Significant Accounting Policies regarding Recent Accounting Pronouncements.

  

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 September 30, 2017. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of September 30, 2017, the Company's disclosure controls and procedures were effective such that information relating to the Company (including its combined subsidiaries) required to be disclosed in the Company's SEC reports (1) is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (2) is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding financial disclosures.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in the Company's internal control over financial reporting for the three months ended September 30, 2017 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.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Currently, 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.

 

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Item 6. Exhibits. 

 

4.1

First Amendment among TSS, Inc., Innovative Power Systems, Inc., VTC, L.L.C., Vortech, L.L.C., Total Site Solutions Arizona, LLC, Alletag Builders, Inc., MHW Partners, LP, MHW SPV II, LLC, Andrew Berg and Glen Ikeda dated October 6, 2017 (previously filed with the Commission as Exhibit 99.1 to the Company's Current Report on Form 8-K filed on October 13, 2017, and incorporated herein by reference).

   

4.2

Promissory Note made by TSS, Inc. Innovative Power Systems, Inc., VTC, L.L.C., Vortech, L.L.C., Total Site Solutions Arizona, LLC, and Alletag Builders, Inc. payable to the order of Glen Ikeda, dated October 6, 2017 (previously filed with the Commission as Exhibit 99.2 to the Company's Current Report on Form 8-K filed on October 13, 2017, and incorporated herein by reference).

   

4.3

Promissory Note, made by TSS, Inc. Innovative Power Systems, Inc., VTC, L.L.C., Vortech, L.L.C., Total Site Solutions Arizona, LLC, and Alletag Builders, Inc. payable to the order of Andrew Berg, dated October 10, 2017 (previously filed with the Commission as Exhibit 99.3 to the Company's Current Report on Form 8-K filed on October 13, 2017, and incorporated herein by reference).

   

4.4

Warrant between TSS, Inc. and Glen Ikeda, dated October 6, 2017 (previously filed with the Commission as Exhibit 99.5 to the Company's Current Report on Form 8-K filed on October 13, 2017, and incorporated herein by reference.

   

4.5

Warrant between TSS, Inc. and Andrew Berg, dated October 10, 2017 (previously filed with the Commission as Exhibit 99.5 to the Company's Current Report on Form 8-K filed on October 13, 2017, and incorporated herein by reference).

   

31.1*

Certification of TSS, Inc. Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

31.2*

Certification of TSS, Inc. Interim Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

32.1**

Certification of TSS, Inc. Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

32.2**

Certification of TSS, Inc. Interim Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 


 

101.INS *

XBRL Instance Document

101.SCH *

XBRL Taxonomy Extension Schema

101.CAL *

XBRL Taxonomy Extension Calculation Linkbase

101.DEF *

XBRL Taxonomy Extension Definition Linkbase

101.LAB *

XBRL Taxonomy Extension Label Linkbase

101.PRE*

XBRL Taxonomy Extension Presentation Linkbase

 

   

*

Filed herewith.

 

**

Furnished herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

TSS, INC.

 

 

 

Date: November 14, 2017

By:

/s/ Anthony Angelini

 

 

Anthony Angelini

 

 

President and Chief Executive Officer

 

 

(Principal Executive Officer)

 

 

By:

/s/ John K. Penver

   

John K. Penver

   

Chief Financial Officer

   

(Principal Financial Officer)

 

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