TSS, Inc. - Quarter Report: 2018 March (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 March 31, 2018

 

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 May 15, 2018              15,557,130

---

 

TSS, INC.

 

QUARTERLY REPORT ON FORM 10Q

 

For the Quarterly Period Ended March 31, 2018

 

“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	18
Item 4.	Controls and Procedures	19
PART II–OTHER INFORMATION		19
Item 1.	Legal Proceedings	19
Item 6.	Exhibits	20

 

---

 

---

 

		March 31,				December 31,
		2018				2017
		(unaudited)
Current Assets:
Cash and cash equivalents		$	1,837			$	2,268
Contract and other receivables, net			1,975				990
Costs and estimated earnings in excess of billings on uncompleted contracts			193				223
Inventories, net			94				134
Prepaid expenses and other current assets			115				114
Total current assets			4,214				3,729
Property and equipment, net			385				418
Goodwill			1,907				1,907
Intangible assets, net			525				561
Other assets			112				112
Total assets		$	7,143			$	6,727
Current Liabilities:
Accounts payable and accrued expenses		$	2,647			$	2,841
Deferred revenues			2,801				2,494
Total current liabilities			5,448				5,335
Long-term borrowings			1,702				1,656
Deferred revenue - noncurrent portion			122				-
Other liabilities			46				41
Total liabilities			7,318				7,032
Commitments and Contingencies			-				-
Stockholders’ Equity (Deficit):
Preferred stock, $.0001 par value; 1,000 shares authorized at March 31, 2018 and December 31, 2017; none issued			-				-
Common stock, $.0001 par value; 49,000 shares authorized at March 31, 2018 and December 31, 2017; 16,286 and 16,316 issued; 15,517 and 15,547 outstanding at March 31, 2018 and December 31, 2017, respectively			2				2
Additional paid-in capital			68,935				68,886
Treasury stock 769 shares at cost at March 31, 2018 and December 31, 2017			(1,536	)			(1,536	)
Accumulated deficit			(67,576	)			(67,657	)
Total stockholders' equity (deficit)			(175	)			(305	)
Total liabilities and stockholders’ equity (deficit)		$	7,143			$	6,727

---

 

		Three Months Ended March 31
		2018				2017
Results of Operations:
Revenue		$	4,849			$	4,389
Cost of revenue			2,983				2,530
Gross profit			1,866				1,859
Selling, general and administrative expenses			1,575				1,741
Depreciation and amortization			106				139
Gain on sale of business component			-				(321	)
Total operating costs			1,681				1,559
Income from operations			185				300
Other income (expense):
Interest expense, net			(93	)			(77	)
Income from operations before income taxes			92				223
Income tax expense (benefit)			11				(31	)
Net income		$	81			$	254
Basic income per common share:		$	0.01			$	0.02
Diluted Income per common share		$	0.00			$	0.02

---

 

										Additional																Total
		Common Stock								Paid-in				Treasury Stock								Accumulated				Stockholders'
		Shares				Amount				Capital				Shares				Amount				Deficit				Equity (Deficit)
Balance January 1, 2018			16,316			$	2			$	68,886				769			$	(1,536	)		$	(67,657	)		$	(305	)
Restricted stock cancelled			(30	)			-				-				-				-				-				-
Stock-based compensation			-				-				49				-				-				-				49
Net income			-				-				-				-				-				81				81
Balance at March 31, 2018			16,286			$	2			$	68,935				769			$	(1,536	)		$	(67,576	)		$	(175	)

---

 

		Three Months Ended March 31,
		2018				2017
Cash Flows from Operating Activities:
Net income		$	81			$	254
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			106				139
Non-cash interest			24				-
Amortization of debt discount			22				10
Stock-based compensation			49				10
Gain on sale of business component			-				(321	)
Changes in operating assets and liabilities:
Contract and other receivables			(985	)			912
Costs and estimated earnings in excess of billings on uncompleted contracts			30				249
Inventories, net			40				(7	)
Prepaid expenses and other assets			(1	)			(18	)
Accounts payable and accrued expenses			(194	)			(1,619	)
Deferred revenues			429				(247	)
Other liabilities			5				(46	)
Net cash used in operating activities			(394	)			(684	)
Cash Flows from Investing Activities:
Capital expenditures			(37	)			(33	)
Proceeds from sale of business component			-				314
Net cash provided by (used in) investing activities			(37	)			281
Cash Flows from Financing Activities:
Payment on long-term borrowings			-				(150	)
(Repayment) borrowings under receivables factoring agreement			-				(303	)
Repurchase of treasury stock			-				(1	)
Net cash used in financing activities			-				(454	)
Net decrease in cash and cash equivalents			(431	)			(857	)
Cash and cash equivalents at beginning of period			2,268				2,152
Cash and cash equivalents at end of period		$	1,837			$	1,295
Supplemental disclosure of cash flow information:
Cash paid for interest		$	48			$	68
Cash paid for taxes		$	4			$	8

---

 

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 an office in Dulles, Virginia.

 

The accompanying consolidated balance sheet as of December 31, 2017, 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, 2017.

 

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 operating losses, negative working capital, and our stockholders’ deficiency 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 while we believe that we have adequate plans to address these issues, there is still substantial doubt about our ability continue as a going concern. Our operating results have improved since 2016 and we achieved operating and net income in 2017. During 2016 and 2017 we sold certain parts of our business and discontinued several other services. These actions, along with cost reductions made at that time, 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. We also obtained additional debt financing during 2017 and restructured our existing 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 2018 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.

 

Revenue Recognition

 

On January 1, 2018, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers (ASU 2014-09), using the modified retrospective method. Adoption of ASU 2014-09 did not have a material impact on our consolidated financial position or results of operations.

 

We recognize revenues when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

 

 

Maintenance services

 

We generate maintenance services revenues from fees that provide our customers with as-needed maintenance and repair services on modular data centers during the contract term. We recognize revenue from these services on a ratable basis over the contract term. Our contracts are typically one year in duration, are billed annually in advance, and are non-cancellable. As a result, we record deferred revenue (a contract liability) and accounts receivable for any amounts for which we have a right to invoice but for which services have not been provided. We can mitigate our exposure to credit losses by discontinuing services in the event of non-payment, however our history of non-payments and bad debt expense has been insignificant.

 

Integration services

 

We generate integration services revenues from fees that provide our customers with customized system and rack-level integration services. We recognize revenue upon shipment to the customer of the completed systems as this is when we have completed our services and when the customer obtains control of the promised goods. We typically extend credit terms to our integration customers based on their credit worthiness and generally do not receive advance payments. As such, we record accounts receivable at the time of shipment, when our right to the consideration becomes unconditional. Accounts receivable from our integration customers are typically due within 30-60 days of invoicing. An allowance for doubtful accounts is provided based on a periodic analysis of individual account balances, including an evaluation of days outstanding, payment history, recent payment trends, and our assessment of our customers’ credit worthiness. As of March 31, 2018 and December 31, 2017, our allowance for doubtful accounts was less than $8,000.

 

Equipment sales

 

We generate revenues under fixed price contracts from the sale of data center and related ancillary equipment to customers in the United States. We recognize revenue when the product is shipped to the customer as that is when the customer obtains control of the promised goods. Typically, we do not receive advance payments for equipment sales, however if we do, we record the advance payment as deferred revenue. Normally we record accounts receivable at the time of shipment, when our right to the consideration has become unconditional. Accounts receivable from our equipment sales are typically due within 30-45 days of invoicing.

 

Deployment and Other services

 

We generate revenues from fees we charge our customers for other services, including repairs or other services not covered under maintenance contracts, installation and servicing of equipment including modular data centers that we sold, and other fixed-price services including repair, design and project management services. In some cases, we arrange for a third party to perform warranty and servicing of equipment, and in these instances, we recognize revenue as the amount of any fees or commissions that we expect to be entitled to. Other services are typically invoiced upon completion of services or completion of milestones. We record accounts receivable at the time of completion when our right to consideration becomes unconditional.

 

Some of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations based on relative standalone selling prices.

 

Judgments

 

We consider several factors in determining that control transfers to the customer upon shipment of equipment or upon completion of our services. These factors include that legal title transfers to the customer, we have a present right to payment, and the customer has assumed the risks and rewards of ownership at the time of shipment or completion of the services.

 

Sales taxes

 

Sales (and similar) taxes that are imposed on our sales and collected from customers are excluded from revenues.

 

 

Shipping and handling costs

 

Costs for shipping and handling activities, including those activities that occur subsequent to transfer of control to the customer, are recorded as cost of sales and are expensed as incurred. We accrue costs for shipping and handling activities that occur after control of the promised good or service has transferred to the customer.

 

The following table shows our revenues disaggregated by reportable segment and by product or service type (in $’000):

 

 

Remaining Performance Obligations

 

As part of our adoption of ASU 2014-09, we have elected to use a practical expedient to exclude disclosure of transaction prices allocated to remaining performance obligations, and when we expect to recognize such revenue, for all periods prior to the date of initial application of the standard.

 

As of March 31, 2018, Deferred Revenue of $2,444,000 represents our remaining performance obligations for our maintenance contracts, all of which are expected to be recognized within one year. The remaining $479,000 of Deferred Revenue is our remaining performance obligations for other services, all of which is expected to be recognized between one and three years.

 

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 may suffer. The loss of or a significant reduction in orders from this customer or the failure to provide adequate products or services to it could significantly reduce our revenue.

 

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

 

 

No other customers represented more than 10% of our revenues for any periods presented. Our US-based IT OEM customer represented 66% and 26% of our accounts receivable at March 31, 2018 and December 31, 2017, respectively. A US-based electronic equipment manufacturer represented 22% of our accounts receivable at December 31, 2017. A US-based technology consulting company represented 23% of our accounts receivable at December 31, 2017. No other customer represented more than 10% of our accounts receivable at March 31, 2018 or at December 31, 2017.

 

 

Recently Issued Accounting Pronouncements

 

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. Adoption of this new guidance did not have a material impact on our consolidated financial statements.

 

Note 2 – Supplemental Balance Sheet Information

 

Receivables

 

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

 

 

Inventories

 

We state inventories at the lower of cost or net realizable value, using the first-in-first-out-method (in ‘000’s) as follows:

 

 

Goodwill and Intangible Assets

 

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

 

 

 

We recognized amortization expense related to intangibles of approximately $36,000 for each if the three-month periods ended March 31, 2018 and 2017, 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, we will evaluate our indefinite lived intangible assets for impairment. We performed a quantitative analysis of our goodwill and intangibles at December 31, 2017 as part of our annual testing for impairment and concluded that there was no impairment. Although there were events and circumstances in existence at December 31, 2017 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, 2017 for our goodwill and other long-lived intangible assets. There were no identified triggering events or circumstances that occurred during the three -month period ended March 31, 2018 that would have required an interim impairment analysis of our goodwill and other long-lived intangible assets.

 

Property and Equipment

 

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

  

 

Depreciation of property and equipment and amortization of leasehold improvements and software totaled $70,000 and $125,000 the three-month periods ended March 31, 2018 and 2017.

 

 

Accounts Payable and Accrued Expenses

 

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

 

 

 

Note 3 – Long term borrowings

   

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

 

 

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.

 

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 its agreement that its 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 March 31, 2018 and 2017, 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 note held by MHW and is subject to the same loan agreement. Similar to the note 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 March 31, 2018.

 

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.

 

 

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 exercisable 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.

 

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 exercisable 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 the 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 a 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 straight-line method (which approximates the effective interest rate method). Approximately $10,000 was amortized during the three-month period ended March 31, 2018. 

 

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:

 

 

 

Note 6 - Net Income Per-Share

 

Basic and diluted income 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 per share computations for income from continuing operations. In the table below, income represents the numerator and shares represents the denominator (in thousands except per share amounts).  

 

 

 

For the three-month periods ended March 31, 2018 and 2017 potentially dilutive shares of 400,000 and 3,282,000, respectively, were excluded from the calculation of dilutive shares because their effect would have been anti-dilutive in those periods.  

 

Note 7 – Related Party Transactions

 

We have $945,000 principal outstanding at March 31, 2018 in promissory notes payable to MHW, net of remaining discount of $91,000. Per the terms of the notes, we paid interest of approximately $ 29,000 and $28,000 during the three-month periods ended March 31, 2018 and 2017, respectively. We have $650,000 principal outstanding at March 31, 2018 in promissory notes payable to MHW Partners, net of remaining discount of $94,000. Per the terms of the notes, we paid interest of $20,000 during the three-month period ended March 31, 2018. 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.

 

We have $300,000 in principal outstanding at March 31, 2018 in promissory notes payable to M. Glen Ikeda, a shareholder in the Company. The loan matures July 19, 2022 and bears no interest. We are permitted to make optional payments at any time without penalty. We issued Mr. Ikeda a warrant to purchase up to 954,231 shares of our common stock in connection with entering into the promissory note.

 

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 for the three -month periods ended March 31, 2018 and 2017 and other segment-related information is as follows (in thousands):

 

 

 

 

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

---

 

---

---

---

---

---

---