TSS, Inc. - Quarter Report: 2019 September (Form 10-Q)

 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q  

(Mark One)

 

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

  

For the quarterly period ended September 30, 2019

 

or

 

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

 

Commission file number: 001-33627

 

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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 Round Rock, 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)

 

Securities registered pursuant to Section 12(b) of the Act : None

 

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 every Interactive Data File required to be submitted 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 such files). Yes   ☒   No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☐	Smaller reporting company x
	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 14, 2019              17,559,057

 

 

 

 

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		September 30,				December 31,
		2019				2018
		(unaudited)
Current Assets:
Cash and cash equivalents		$	5,922			$	6,178
Contract and other receivables, net			856				727
Costs and estimated earnings in excess of billings on uncompleted contracts			406				154
Inventories, net			1,185				108
Prepaid expenses and other current assets			156				266
Total current assets			8,525				7,433
Property and equipment, net			515				390
Lease right-of-use asset			1,620				-
Goodwill			780				780
Intangible assets, net			330				398
Other assets			109				109
Total assets		$	11,879			$	9,110
Current Liabilities:
Accounts payable and accrued expenses		$	3,207			$	2,390
Deferred revenues			2,423				2,181
Current portion of lease liabilities			621				-
Total current liabilities			6,251				4,571
Long-term borrowings			1,978				1,838
Non-current portion of lease liabilities			1,125				-
Deferred revenues – non-current portion			117				112
Other liabilities			-				108
Total liabilities			9,471				6,629
Commitments and Contingencies			-				-
Stockholders’ Equity:
Preferred stock, $.0001 par value; 1,000 shares authorized at September 30, 2019 and December 31, 2018; none issued			-				-
Common stock, $.0001 par value; 49,000 shares authorized at September 30, 2019 and December 31, 2018; 18,500 and 17,520 issued; 17,541 and 16,743 outstanding at September 30, 2019 and December 31, 2018, respectively			2				2
Additional paid-in capital			69,544				69,241
Treasury stock 959 and 777 shares at cost at September 30, 2019 and December 31, 2018			(1,698	)			(1,542	)
Accumulated deficit			(65,440	)			(65,220	)
Total stockholders' equity			2,408				2,481
Total liabilities and stockholders’ equity		$	11,879			$	9,110

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		Three Months Ended September 30								Nine Months Ended September 30
		2019				2018				2019				2018
Results of Operations:
Revenue		$	4,176			$	6,371			$	12,375			$	16,587
Cost of revenue			2,679				3,855				7,790				10,140
Gross profit			1,497				2,516				4,585				6,447
Selling, general and administrative expenses			1,425				1,654				4,301				4,747
Depreciation and amortization			84				91				244				297
Total operating costs			1,509				1,745				4,545				5,044
Income (loss) from operations			(12	)			771				40				1,403
Other income (expense):
Interest expense, net			(78	)			(102	)			(238	)			(306	)
Income (loss) from operations before income taxes			(90	)			669				(198	)			1,097
Income tax expense			5				17				22				47
Net income (loss)		$	(95	)		$	652			$	(220	)		$	1,050
Basic income (loss) per common share		$	(0.01	)		$	0.04			$	(0.01	)		$	0.06
Diluted income (loss) per common share		$	(0.01	)		$	0.03			$	(0.01	)		$	0.05

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										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	)
Stock-based compensation			-				-				66				-				-				-				66
Net income			-				-				-				-				-				317				317
Balance at June 30, 2018			16,286			$	2			$	69,001				769			$	(1,536	)		$	(67,259	)		$	208
Stock options exercised			30				-				3				-				-				-				3
Treasury shares repurchased			-				-				-				3				(2	)			-				(2	)
Stock-based Compensation			-				-				62				-				-				-				62
Net income			-				-				-				-				-				652				652
Balance at September 30, 2018			16,316			$	2			$	69,066				772			$	(1,538	)		$	(66,607	)		$	923

										Additional																Total
		Common Stock								Paid-in				Treasury Stock								Accumulated				Stockholders'
		Shares				Amount				Capital				Shares				Amount				Deficit				Equity
Balance January 1, 2019			17,520			$	2			$	69,241				777			$	(1,542	)		$	(65,220	)		$	2,481
Restricted stock vested			390				-				-				-				-				-				-
Treasury shares repurchased			-				-				-				159				(137	)			-				(137	)
Stock options exercised			310				-				31				-				-				-				31
Stock-based compensation			-				-				72				-				-				-				72
Net income (loss)			-				-				-				-				-				(31	)			(31	)
Balance at March 31, 2019			18,220			$	2			$	69,344				936			$	(1,679	)		$	(65,251	)		$	2,416
Treasury shares repurchased			-				-				-				20				(16	)			-				(16	)
Stock options exercised			230				-				23				-				-				-				23
Stock-based compensation			-				-				87				-				-				-				87
Net income (loss)			-				-				-				-				-				(94	)			(94	)
Balance at June 30, 2019			18,450			$	2			$	69,454				956			$	(1,695	)		$	(65,345	)		$	2,416
Treasury shares repurchased			-				-				-				3				(3	)			-				(3	)
Stock options exercised			50				-				5				-				-				-				5
Stock-based compensation			-				-				85				-				-				-				85
Net income (loss)			-				-				-				-				-				(95	)			(95	)
Balance at September 30, 2019			18,500			$	2			$	69,544				959			$	(1,698	)		$	(65,440	)		$	2,408

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		Nine Months Ended September 30,
		2019				2018
Cash Flows from Operating Activities:
Net income (loss)		$	(220	)		$	1,050
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			244				297
Non-cash interest			80				75
Amortization of debt discount			60				64
Stock-based compensation			244				177
Changes in operating assets and liabilities:
Contract and other receivables			(129	)			(1,630	)
Costs and estimated earnings in excess of billings on uncompleted contracts			(252	)			(88	)
Inventories, net			(1,077	)			51
Prepaid expenses and other assets			110				(100	)
Right-of-use assets			391				-
Accounts payable and accrued expenses			817				247
Deferred revenues			247				962
Operating lease liabilities			(373	)			-
Other liabilities			-				8
Net cash provided by operating activities			142				1,113
Cash Flows from Investing Activities:
Capital expenditures			(301	)			(196	)
Net cash used in investing activities			(301	)			(196	)
Cash Flows from Financing Activities:
Proceeds from issuance of equity			59				3
Repurchase of stock			(156	)			(2	)
Net cash provided by (used in) financing activities			(97	)			1
Net increase (decrease) in cash and cash equivalents			(256	)			918
Cash and cash equivalents at beginning of period			6,178				2,268
Cash and cash equivalents at end of period		$	5,922			$	3,186
Supplemental disclosure of cash flow information:
Cash paid for interest		$	182			$	173
Cash paid for taxes		$	63			$	49

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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, facilities management and IT reseller services. Our corporate offices and our integration facility are located in Round Rock, Texas.

 

The accompanying consolidated balance sheet as of December 31, 2018, 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 (“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, 2018.

 

Accounting Changes

 

Except for the changes discussed below, we have consistently applied the accounting policies to all periods presented in these unaudited consolidated financial statements.

 

On January 1, 2019, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification, or ASC, Topic 842, Leases (“ASC 842”), which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASC 842 is intended to represent an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. We adopted ASC 842 using a modified retrospective approach for all leases existing at January 1, 2019. The adoption of ASC 842 had a substantial impact on our balance sheet. The most significant impact was the recognition of the operating lease right-of-use assets and the liability for operating leases. Accordingly, upon adoption, leases that were classified as operating leases under previous GAAP were classified as operating leases under ASC 842, and we recorded an adjustment of $1.96 million to operating lease right-of-use assets and the related lease liability. The lease liability is based on the present value of the remaining lease payments, determined under prior GAAP, discounted using our secured incremental borrowing rate at the effective date of January 1, 2019. As permitted under ASC 842, we elected several practical expedients that permit us not to reassess (1) whether a contract is or contains a lease, (2) the classification of existing leases, and (3) whether previously capitalized costs continue to qualify as initial indirect costs. The application of the practical expedients did not have a significant impact on the measurement of the right-of-use assets or operating lease liabilities.

 

See Note 5 for further information on leases.

 

Revenue Recognition

 

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

 

Maintenance services

 

We generate maintenance services revenues from fees that provide our customers with as-needed maintenance and repair services on modular data centers during the contract term. Our contract terms 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 recognize revenue from these services on a ratable basis over the contract term. We can mitigate our exposure to credit losses by discontinuing services in the event of non-payment, however our history of non-payments and bad debt 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 September 30, 2019 and December 31, 2018, 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.

 

Reseller services

 

We generate revenues from fees we charge our customers to procure third-party hardware, software and professional services on their behalf that are then used in our integration services as we integrate these components to deliver a completed system to our customer. We recognize our reseller services revenue upon completion of the procurement activity. In some cases, we arrange for the purchase of third-party hardware, software or professional services that are resold directly to the original equipment manufacturer (OEM) and other customers, and in these instances, we act as an agent in the transaction and recognize revenue as the amount of any fee or commissions that we expect to be entitled to. Accounts receivable from our reseller activities are typically due within 30-60 days of invoicing.

 

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 revenues 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’s):

 

 

Remaining Performance Obligations

 

Remaining performance obligations include deferred revenue and amounts we expect to receive for goods and services that have not yet been delivered or provided under existing, non-cancellable contracts. For contracts that have an original duration of one year or less, we have elected the practical expedient applicable to such contracts and we do not disclose the transaction price for remaining performance obligations at the end of each reporting period and when we expect to recognize this revenue. As of September 30, 2019, deferred revenue of $2,423,000 represents our remaining performance obligations for our maintenance contracts, all of which are expected to be recognized within one year. The remaining $117,000 of deferred revenue is our remaining performance obligations for other services, all of which is expected to be recognized between one and two years.

 

Concentration of Credit Risk

 

We are currently economically dependent upon our relationship with a large US-based IT OEM. If this relationship is unsuccessful or discontinues, our business and revenue will 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.

 

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 69% and 75% of our accounts receivable at September 30, 2019 and December 31, 2018, respectively. A US-based electrical equipment supplier represented 12% of our accounts receivable at September 30, 2019. No other customer represented more than 10% of our accounts receivable at September 30, 2019 or at December 31, 2018.

 

 

 

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, net

 

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

 

 

We recognized amortization expense related to intangibles of approximately $22,000 and $24,000 for the three-month periods ended September 30, 2019 and 2018, respectively. We recognized amortization expense related to intangibles of approximately $68,000 and $91,000 for the nine-month periods ended September 30, 2019 and 2018, 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 its indefinite lived intangible assets for impairment. We performed a quantitative analysis of our goodwill and intangibles at December 31, 2018 as part of our annual testing for impairment and concluded that there was no impairment. There were no identified triggering events or circumstances that occurred during the three and nine-months period ended September 30, 2019 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’s):

  

 

Depreciation of property and equipment and amortization of leasehold improvements and software totaled $62,000 and $65,000 for the three-month periods ended September 30, 2019 and 2018, respectively. Depreciation of property and equipment and amortization of leasehold improvements and software totaled $176,000 and $206,000 for the nine-month periods ended September 30, 2019 and 2018, respectively.

 

 

Accounts Payable and Accrued Expenses

 

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

 

 

Note 3 – Long term borrowings

   

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

 

 

 

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 1% if the prepayment is made between July 20, 2019 and July 19, 2020.

 

 

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. Approximately $5,000 was amortized during each of the three-month periods ended September 30, 2019 and 2018, respectively, for this warrant. Approximately $14,000 was amortized during each of the nine-month periods ended September 30, 2019 and 2018, respectively.

 

On July 19, 2017, we 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 1% if the prepayment is made between July 20, 2019 and July 19, 2020.

 

The obligations under the loan to MHW and MHW Partners are secured by substantially all of the Company’s assets pursuant to the terms of a security agreement. At the time we entered into the revolving line of credit described below, MHW and MHW Partners executed a subordination agreement to evidence their agreement that their security interest is subordinated to the security interest of Texas Capital Bank, N.A.

 

In conjunction with entering into the loan with MHW Partners, 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 each of the three-month periods ended September 30, 2019 and 2018, respectively. Approximately $15,000 was amortized during each of the nine-month periods ended September 30, 2019 and 2018, 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 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. Mr. Ikeda exercised the warrant in December 2018.

 

 

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. Mr. Berg exercised the warrant in December 2018.

 

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 each of the three-month periods ended September 30, 2019 and 2018, respectively, and approximately $30,000 was amortized during each of the nine-month periods ended September 30, 2019 and 2018, respectively. 

 

Note 4 – Revolving Line of Credit

 

In December 2018, we entered into a revolving line of credit (the “credit facility”) with Texas Capital Bank, National Association (“Lender”) pursuant to a Business Loan Agreement (Asset Based) (the “Loan Agreement”). The obligations under the credit facility are secured by substantially all of our assets. Our wholly-owed subsidiaries, Vortech LLC, VTC, LLC, Total Site Solutions Arizona, LLC and Alletag Builders, Inc. jointly and severally guaranteed our obligations under the credit facility.

 

The maximum amount of the credit facility is $1,500,000. The credit facility is subject to a borrowing base of 80% of eligible accounts receivables, subject to customary exclusions and limitations. Borrowings under the credit facility will bear interest at LIBOR plus 3% (effective rate of 5.04% at September 30, 2019). Certain accounts receivables subject to a vendor payment program with a customer are excluded from the definition of eligible accounts receivables under the credit facility. In addition to interest payable on the principal amount of indebtedness outstanding from time to time under the credit facility, we will pay a 0.25% unused credit facility fee, payable quarterly in arrears. The credit facility matures on December 31, 2020.

 

The credit facility requires that we maintain a minimum liquidity of $500,000 at all times excluding availability under the loan. It also requires us to comply with certain financial covenants including a maximum Total Leverage Ratio of 3.00, a minimum Total Interest Coverage Ratio of 2.50 and a minimum Total Fixed Charge Coverage Ratio of 1.25. The credit facility also limits the amount of new indebtedness to $250,000 per fiscal year without Lender’s prior written approval.

 

The Loan Agreement and ancillary documents include customary affirmative covenants for secured transactions of this type, including maintaining adequate books and records, periodic financial reporting, compliance with laws, maintenance of insurance, maintenance of assets, timely payment of taxes, and notices of adverse events. The Loan Agreement and ancillary documents include customary negative covenants, including incurrence of other indebtedness, mergers, consolidations and transfers of assets and liens on assets of the company. The Loan Agreement and ancillary documents also include customary events of default, including payment defaults, failure to perform or observe terms, covenants or agreements included in the Loan Agreement and ancillary documents, insolvency and bankruptcy defaults, judgment defaults, material adverse chance defaults, and change of ownership defaults.

 

There were no amounts outstanding under this credit facility at September 30, 2019. We were in compliance with all financial covenants at September 30, 2019 except for the minimum interest coverage ratio and the bank has waived this requirement for the third quarter of 2019. We anticipate being in compliance with all covenants in the fourth quarter of 2019. The maximum amount we were eligible to borrow at September 30, 2019 was approximately $137,000.

 

Note 5 - Leasing Arrangements

 

We have operating leases for our office and integration facilities as well as for certain equipment and vehicles. Our leases have remaining lease terms of 1 to 3 years. As of September 30, 2019, we have not entered into any lease arrangement classified as a finance lease.

 

We determine if an arrangement is a lease at inception. Operating leases are included in lease right-of-use assets, current lease liabilities and lease liabilities, non-current, on our consolidated balance sheet. We have elected an accounting policy to not recognize short-term leases (one year or less) on the balance sheet. We also elected the package of practical expedients which applies to leases that commenced before the adoption date. By electing the package of practical expedients, we did not need to reassess whether any existing contracts are or contain leases, the lease classification for any existing leases and initial direct costs for any existing leases.

 

 

Right-of-use assets and operating lease liabilities are recognized based on the present value of future minimum lease payments over the lease term at commencement date. When the implicit rate of the lease is not provided or cannot be determined, we use our incremental borrowing rate based on the information available at the commencement date to determine the present value of future payments. Lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise those options. Lease expense for minimum lease payments is recognized on a straight- line basis over the lease term. Components of lease expense and other information is as follows:

 

 

 

Future minimum lease payments under non-cancellable leases as of September 30, 2019 were as follows (in ’000’s):

 

 

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

 

 

 

 

For the three-month period ended September 30, 2019 potentially dilutive shares of 3,251,000 were excluded from the calculation of dilutive shares because their effect would have been anti-dilutive.  

 

For the nine-month period ended September 30, 2019 potentially dilutive shares of 3,325,000 were excluded from the calculation of dilutive shares because their effect would have been anti-dilutive.

 

Note 7 – Related Party Transactions

 

 

We have $945,000 principal outstanding at September 30, 2019 in promissory notes payable to MHW, net of remaining discount of $51,000. Per the terms of the notes, we paid interest of approximately $ 32,000 and $30,000 during the three-month periods ended September 30, 2019 and 2018, respectively, and we paid interest of $95,000 and $89,000 during the nine-month periods ended September 30, 2019 and 2018, respectively. We have $650,000 principal outstanding at September 30, 2019 in promissory notes payable to MHW Partners, net of remaining discount of $54,000. Per the terms of the notes, we paid interest of $22,000 and $21,000 during the three-month periods ended September 30, 2019 and 2018, respectively, and we paid interest of $65,000 and $61,000 during the nine-month periods ended September 30, 2019 and 2018, 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 tied to appreciation in the valuation of the common stock in excess of the applicable strike price under the warrant issued to MHW.

 

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 June 30, 2019 and 2018 and other segment-related information is as follows (in ’000’s):

 

 

 

 

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.

 

 

 

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