TSS, Inc. - 10-Q quarterly report FY

For the quarterly period ended June 30, 2007

Commission file number: 000-51426

(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 x No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicated by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o Nox

 

As of August 13, 2007, 11,856,545 shares of the registrant's common stock, par value $0.0001 per share, were outstanding.

Consolidated Balance Sheets

 

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Balance Sheets-Continued

Consolidated Statements of Operations

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Operations-Continued

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated Statements of Cash Flow

 

The accompanying notes are an integral part of these consolidated financial statements.

The consolidated financial statements are for the three and six months ended June 30, 2007 and 2006 for Fortress International Group, Inc. (the “Successor Company”, “Fortress” or the “Company”) and are for the period January 1, 2007 to January 19, 2007 (the acquisition date) and the three and six months ended June 30, 2006 for VTC, L.L.C. t/a Total Site Solutions and Vortech, LLC ( collectively the “Predecessor Company” or “TSS/Vortech”).  The Company has included the results of operations for the acquisition of TSS/Vortech from the acquisition date through June 30, 2007 in its financial statements.

Except for the balance sheets of the Company and TSS/Vortech as of December 31, 2006, which are derived from audited financial statements, the accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair statement of such financial position and results of operations have been included. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of results for a full year.

The consolidated financial statements and notes are presented as required by Form 10-Q and do not contain certain information included in the Company’s annual financial statements and notes. These financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto filed with the Securities and Exchange Commission (“SEC”) in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The interim financial statements of TSS/Vortech have also been presented in accordance with the requirements of Form 10-Q. Such information should be read in conjunction with the TSS/Vortech financial statements for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

On January 19, 2007, the Company acquired all of the outstanding membership interests of TSS/Vortech pursuant to the Second Amended and Restated Membership Interest Purchase Agreement dated July 31, 2006, as amended by the Amendment to the Second Amended and Restated Membership Interest Purchase Agreement dated January 16, 2007 (the “Purchase Agreement”). The closing consideration consisted of (i) $11,000,000 in cash, (ii) the assumption of $154,599 of debt of TSS/Vortech, (iii) 2,602,813 shares of Fortress common stock, of which 2,534,988 shares were issued to the selling members and 67,825 shares were issued to Evergreen Capital LLC as partial payment of certain outstanding consulting fees, and (iv) $10,000,000 in two convertible promissory notes of $5,000,000 each, bearing interest at 6%.

All of the shares issued to the selling members (2,534,988 shares) were placed into escrow accounts as follows: 2,461,728 into the General Indemnity escrow to secure the rights of Fortress under the acquisition and 73,260 shares into the Balance Sheet escrow subject to TSS/Vortech delivering $1,000,000 in working capital. These shares will be released subject to certain conditions under the respective agreements. Based on a determination of net working capital at the acquisition date, the Company has recorded a payable for approximately $200,000, included in accounts payable and accrued expenses in the June 30, 2007 consolidated balance sheet, expected to be paid to the sellers as a purchase price adjustment. The share price was based upon the average closing price for twenty days prior to the public announcement of the purchase.

Shareholders owning 756,100 shares of Fortress common stock voted against the acquisition and requested to receive the pro rata share of cash in the Trust Fund. The Company remitted approximately $4,342,000 in exchange for these shares.

Upon consummation of the merger approximately $28.9 million was released from the trust account to be used by the Company.

We paid a premium (i.e., goodwill) over the fair value of the net tangible and preliminarily identified intangible assets acquired for a number of reasons, including the following:

The total purchase price paid, including transaction costs of approximately $1.8 million, has been preliminarily allocated as follows:

The preliminary estimated value and the weighted-average amortization period of each of the components of intangible assets are as follows:

 

Amortization expense totaling $681,183 and $1,210,235 has been included in the accompanying consolidated statement of operations related to the above intangibles, of which $114,075 and $202,673 is included in cost of revenue, for the three and six months ending June 30, 2007, respectively.

The results of operations for TSS/Vortech have been included in the Consolidated Statements of Operations from the acquisition date through June 30, 2007.

This information is not necessarily indicative of the operational results that would have occurred if the acquisition had been consummated on the dates indicated nor is it necessarily indicative of future operating results of the combined enterprise.

On May 7, 2007 the Company purchased all of the assets of Comm Site of South Florida, Inc. for $150,000 paid in cash. In connection with this purchase, $135,000 has been allocated to Goodwill with the balance to other current assets and property and equipment, based on their historic cost which management believes approximates fair value.

The Company held certain investments in a trust account through January 19, 2007 consisting primarily of short term investments. All such investments have been disposed of as of June 30, 2007.

No weighted average common shares or income (loss) per share amounts are shown for the Predecessor since the Predecessor was limited liability company whose capital structure consisted of membership interests. As such, no weighted average number of outstanding shares and earnings per share are presented.

 

On January 17, 2007, the stockholders of the Company approved the Fortress International Group, Inc. 2006 Omnibus Incentive Compensation Plan (the “Plan”). Under the Plan, the Company reserved 2.1 million shares of the Company’s common stock for issuance to employees and directors through incentive stock options, or non-qualified stock options or through restricted stock units. Pursuant to the Plan, on January 19, 2007 the Company issued of 574,000 shares of restricted stock with grant date value of $5.44 per share in connection with the acquisition of TSS.  The restricted stock units have a vesting period of three years.

On May 1, 2007 the Company issued a total of 86,832 shares of restricted stock with a grant date value of $5.43 per share to the non-employee members of the Board of Directors. These shares were issued as follows:

 

 

Each non-employee director was granted 10,000 shares which vest over a two year period, one third on the grant date, and each one-half of the remaining balance on the first and second anniversaries of the grant date. A total of 50,000 shares were issued to the non-employee directors under this arrangement.

Each of the two new members of the Board of Directors received a one-time grant of $100,000 worth of restricted stock which vests over a three year period, with each one third of the shares vesting on the first, second and third anniversaries of the grant date. A total of 36,832 shares were issued to the two new non-employee directors under this arrangement.

In addition on May 7, 2007 the Company issue 20,000 shares of restricted stock with a grant date value of $5.53 to an employee, these shares have a vesting period of three years.

Prior to the consummation of the acquisition of TSS/Vortech, the Company announced and implemented a common stock repurchase program under which it may purchase up to 3,000,000 shares of common stock, currently the Board of Directors has authorized the repurchase of up to 500,000 shares under this program.  For the three months ended June 30, 2007, the Company paid approximately $688,000 in cash to redeem 133,775 shares of common stock at an average price of $5.14 per share. For the six months ended June 30, 2007 the Company has paid approximately $1,909,000 in cash to redeem 354,775 shares at an average price of $5.38 per share.

On January 19, 2007, the Company announced that it would repurchase shares of those shareholders that voted against the acquisition of TSS and requested that their 756,100 shares be redeemed at the then per share trust value of $5.74 per share (including deferred interest of $0.38 per share). This program was completed in January 2007.

The Company’s effective tax rates are based upon the effective tax to be applicable to the full fiscal year.  Through June 30, 2007, the Company has incurred certain tax losses which may be carried back for federal tax purposes resulting in an income tax recoverable of approximately $840,000.

The Company recorded income tax expense of $182,316 for the three months ended June 30, 2007 due primarily to the establishment of a valuation allowance equal to the balance of the remaining deferred tax assets. The impact of recording this valuation allowance also impacted the income tax benefit recorded of $349,325 in the six months ended June 30, 2007. The June 30, 2007 amount was offset in part by income taxes recoverable as a result of being able to carry carrying back a portion of the net operating loss to prior years. The Company evaluated its remaining deferred tax assets (consisting primarily of net operating loss carryforwards) remaining after carryback and has determined that it is more likely-than-not at this time that these assets will not be realized and has established a full valuation allowance for these amounts.

TSS/Vortech is a limited liability company and incurred no material income taxes prior to the acquisition.

 

 

Management is in the process of evaluating the various tax positions associated with the acquisition of TSS/Vortech and is of the opinion that any deferred tax liabilities that would ultimately result from uncertain tax positions related to these entities would be covered by indemnification provisions provided in the acquisition agreements or would result in an adjustment to goodwill.

Principal payments are due on the above notes as follows:

 

The Company participates in transactions with the following entities affiliated through common ownership and management:

 

 

 

The following table sets forth transactions the Company has entered into with the above related parties for the three and six months ended June 30, 2007 and 2006. It should be noted that Revenue represents amounts earned on contracts with related parties under which we provide services; and Cost of Revenues represents costs incurred in connection with related parties which provide services to us on contracts for our customers. As such a direct relationship to the Revenue and Cost of Revenue information below by company should not be expected.

 

 

The Company reviewed its services by units to determine if any unit of the business is subject to risks and returns that are different than those of other units in the Company.  Based on this review, the Company has determined that all units of the Company are providing comparable services to its clients, and the Company has only one reportable segment.

On January 19, 2007, the Company entered into employment agreements with its Chairman, Chief Executive Officer and President and a consulting agreement (the agreements) with an entity controlled by the Vice-Chairman, each of whom have been serving in that capacity since then. The employment agreements were filed as part of a current report on Form 8-K on January 25, 2007. The agreements specify annual salary, benefits and incentive compensation for the terms of the agreement.  The agreements also provide for twelve months salary if the employee or consultant is terminated other than for cause.

The agreements with the Chief Executive Officer and President also provide a share performance bonus, as described below:

Up to $5.0 million in additional shares of common stock will be issuable if during the period from the closing of the acquisition through July 13, 2008, certain share performance thresholds (alternative and not cumulative) set forth below are satisfied:

 

 

The Company earned approximately 10% and 29% of its revenue for the three and six months ended June 30, 2007, respectively, and approximately 67% of its revenue for both the three and six months ended June 30, 2006 under several contracts with one major customer. Accounts receivable from this customer were $887,633 at June 30, 2007 and $4,807,323 at December 31, 2006.

The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report.

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” “intend,” “project,” “goal,” “potential,” “target,” and similar terms or the negative of such terms. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in “Risk Factors,” as well as by future decisions by us.

 

 

We were formed in Delaware on December 20, 2004 as a special purpose acquisition company formed under the name “Fortress America Acquisition Corporation” for the purpose of acquiring, through a merger, capital stock exchange, asset acquisition or other business combination, operating businesses in the homeland security industry.

On January 19, 2007, we acquired all of the outstanding membership interests of each of VTC, L.L.C., doing business as Total Site Solutions (“TSS”), and Vortech, L.L.C. (“Vortech” and, together with TSS, “TSS/Vortech”) and simultaneously changed our name to Fortress International Group, Inc. (the “Company”). The closing consideration consisted of (i) $11,000,000 in cash, (ii) the assumption of $154,599 of debt of TSS/Vortech, (iii) 3,176,813 shares of our stock, of which 2,534,988 shares were issued to the selling members, 67,825 shares were issued to Evergreen Capital LLC as partial payment of certain outstanding consulting fees and (iii) $10,000,000 in two convertible, interest-bearing promissory notes of $5,000,000 each.

We provide comprehensive services for the planning, design, and development of mission critical facilities and information infrastructure. We also provide a single source solution for highly technical mission-critical facilities such as data centers, operation centers, network facilities, server rooms, security operations centers, communications facilities and the infrastructure systems that are critical to their function. Our services include technology consulting, engineering and design management, construction management, system installations, operations management, and facilities management and maintenance.

During the past three years, our revenue growth has been driven mainly by government spending on homeland security initiatives spurred by the events of September 11, 2001. These events have also affected businesses, which are increasing spending on data security and privacy. These homeland security initiatives include projects that require the hardening, relocation, renovation and upgrade of mission-critical facilities to protect critical government information networks and data processing centers against attacks. In addition to these factors there are other drivers that cause our market to remain robust. Legislation such as Sarbanes Oxley compliance for publicly traded companies, HIPPA laws regarding protection and availability of data for healthcare organizations and the government’s critical infrastructure protection program for industries that are vital to our economy have resulted in such companies having the need to invest to protect their networks, the reliability of those networks, and maintain their ability to perform transactions that are financial or informational in nature. With respect to these critical infrastructure systems, the companies focus on physical security, network security, redundancies for uninterruptible power supply systems, electrical switch gear, stand-by power generators, heat rejection and cooling systems, fire protection systems, monitoring and control systems, and security systems, as well as the physical environment that houses critical operations. We help our customers plan for, prevent or mitigate against the consequences of attacks, power outages and natural disasters. We provide our services, directly and indirectly, to both government customers and private sector customers.

 

TSS has obtained a facility clearance from the United States Department of Defense. This clearance enables the companies to access and service restricted government projects. In addition to the facility clearance, TSS has successfully cleared over one-third of its employees, allowing them individual access to restricted projects and facilities. Several additional employees are currently in the process for clearance.

 

 

In the future, we expect to use enhanced resources to expand geographically through internal growth initiatives, as well as through potential acquisitions of specialized mission critical engineering or IT services firms (primarily in the United States).

 

Our customers include United States government and homeland defense agencies and private sector businesses that in some cases are the end user of the facility or in other cases, such as our major real estate investment trust, or REIT, customer, Corporate Office Properties Trust, are providing a facility to a government end user. We categorize contracts where a government agency is the ultimate end user of the facility as government-related contracts.

 

Our revenues are derived from fees for our professional services as well as revenues earned under construction management contracts and facility management contracts with varying terms.

 

We believe there are high barriers to entry in our sector for new competitors due to our specialized technology service offerings we deliver for our customers, our top secret clearances, and our turnkey suite of deliverables offered. We compete for business based upon our reputation, past experience, and our technical engineering knowledge of mission critical facilities and their infrastructure. We are developing and creating long term relationships with our customers because of our excellent reputation in the industry and will continue to create facility management relationships with our customers that we expect will provide us with steadier revenue streams to improve the value of our business.

 

We believe a strong indicator of our future performance is our backlog of uncompleted projects in process or recently awarded. Our backlog represents contracts that have been awarded that we believe will result in revenue in the future. We have broken our backlog into the following three categories: (i) technology consulting, which represents the value of future revenue under existing contacts for professional services related to consulting and/or engineering design contracts; (ii) construction management, which represents the value of future revenues for construction projects; and (iii) facility management, which represents the value of future revenues for providing recurring maintenance services on our customers’ mission critical facilities, networks and communication systems.

At June 30, 2007, our backlog was approximately $55.4 million, compared to approximately $20.6 million at December 31, 2006. We believe that most of the backlog at June 30, 2007 will be recognized during the remainder of 2007. The following table reflects the value of our backlog in the above three categories as of June 30, 2007 and as of December 31, 2006, respectively.

 

The tables below include pro-forma information to assist in the analysis of the results of operations: