10QSB

U.S. SECURITIES AND EXCHANGE COMMISSIION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)

[X]

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

For the quarterly period ended:

May 31, 2004

[   ]

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from

to

Commission File Number 0-18250

TMS, Inc

(Exact name of small business issuer as specified in its charter)

OKLAHOMA

91-1098155

(State or other jurisdiction of

(IRS Employer Identification No)

incorporation or organization)

206 West Sixth Street

Post Office Box 1358

Stillwater, Oklahoma 74076

(Address of principal executive offices)

(405) 377-0880

(Issuer’s telephone number)

Check whether the issuer (1) 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 [   ]

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

Title of Each Class

Outstanding at June 30, 2004

Common stock, par value $.05 per share

13,112,659

Transitional Small Business Disclosure Format (check one):

Yes [   ]

No [X]

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TMS, Inc.
Condensed Balance Sheets
May 31, 2004 and August 31, 2003
		May 31,
		2004	August 31,
		(unaudited)	2003*
Cash		$ 1,171,344	1,129,470
Trade accounts receivable, net		131,211	387,802
Custom development work in process		156,876	-
Due from related parties		42,323	29,779
Prepaid expenses and other current assets		48,329	33,295
Deferred income taxes		8,210	8,431
	Total current assets	1,558,293	1,588,777
Property and equipment		569,631	2,449,567
Accumulated depreciation and amortization		(465,986)	(1,639,414)
	Net property and equipment	103,645	810,153
Capitalized software development costs, net		473,065	469,319
Other assets		42,180	42,863
Total assets		$ 2,177,183	$ 2,911,112
Current portion of long-term debt		-	31,320
Accounts payable		76,898	109,204
Accrued payroll expenses		136,140	197,423
Deferred revenue		293,742	301,580
	Total current liabilities	506,780	639,527
Long-term debt, net of current installments		-	166,950
Investment in limited liability company		136,313	38,392
Deferred income taxes		8,210	8,431
Total liabilities		651,303	853,300
Common stock		655,633	655,633
Additional paid-in capital		11,348,883	11,348,883
Accumulated deficit		(10,478,636)	(9,946,704)
Total shareholders' equity		1,525,880	2,057,812
Total liabilities and shareholders' equity		$ 2,177,183	2,911,112
*Condensed from audited financial statements.
See accompanying notes to condensed
financial statements.

TMS, Inc.
Condensed Statements of Operations(unaudited)
Three and Nine Months Ended May 31, 2004 and May 31, 2003
		Three Months Ended		Nine Months Ended
		May 31,	May 31,	May 31,	May 31,
		2004	2003	2004	2003
	Licensing and royalties	$      380,138	377,302	1,156,039	1,537,087
	Custom software development	168,106	-	190,688	-
	Customer support and maintenance	168,140	150,659	496,297	445,244
	Other revenue	-	64,750	78,212	65,635
Total revenue		716,384	592,711	1,921,236	2,047,966
	Cost of revenue	167,649	194,925	448,816	459,080
	Selling, general and administrative expense	390,748	439,942	1,249,216	1,419,587
	Research and development expense	106,544	178,667	441,827	466,991
	Loss in limited liability company	(15,296)	(55,873)	(63,699)	(104,530)
Operating income (loss)		36,147	(276,696)	(282,322)	(402,222)
Other (expense) income:
Sale of property		-	-	(260,123)	-
Sale of technology		-	45,296	-	145,256
Other, net		3,994	3,204	11,928	4,608
Income (loss) before income taxes		40,141	(228,196)	(530,517)	(252,358)
Income tax expense		1,415	-	1,415	484,500
Net income (loss)		$       38,726	(228,196)	(531,932)	(736,858)
Basic income (loss) per share		$           0.00	(0.02)	(0.04)	(0.06)
Weighted average common shares		13,112,659	13,112,659	13,112,659	13,112,659
Diluted income (loss) per share		$         (0.00)	$      (0.02)	$          (0.04)	$    (0.06)
Weighted average basic and diluted shares		13,112,659	13,112,659	13,112,659	13,112,659
See accompanying notes to condensed
financial statements.

TMS, Inc.
Condensed Statements of Cash Flows (unaudited)
Nine Months Ended May 31, 2004 and May 31, 2003
		May 31,	May 31,
		2004	2003
Net cash flows provided by
	operating activities	$      24,463	482,338
Cash flows from investing activities:
	Purchases of property and equipment	(31,509)	(35,233)
	Capitalized software development costs	(222,363)	(181,670)
	Proceeds from sale of technology	-	250,000
	Proceeds from sale of property	431,226	-
	Investment in limited liability company	(120,702)	(183,244)
	Distribution from limited liability company	154,922	200,000
	Other, net	4,107	1,541
	Net cash provided by investing activities	215,681	51,394
Cash flows from financing activities:
	Repayments of long-term debt	(198,270)	(21,655)
	Net cash used in financing activities	(198,270)	(21,655)
Net increase in cash		41,874	512,077
Cash at beginning of period		1,129,470	783,550
Cash at end of period		$ 1,171,344	1,295,627
Non-cash investing and financing activities:
Investment in limited liability company     through contribution of technology		$                -	94,939
See accompanying notes to condensed
	financial statements.

TMS, Inc.

Notes to Condensed Financial Statements (unaudited)

Unaudited Interim Condensed Financial Statements

The unaudited interim condensed financial statements and related notes were prepared by TMS, Inc.  Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to rules and regulations established by the Securities and Exchange Commission.  The accompanying unaudited interim condensed financial statements should be read in conjunction with the audited financial statements and related notes included in our Form 10-KSB Annual Report for the fiscal year ended August 31, 2003.

The unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods presented. All adjustments are normal and recurring, except for the impairment write-down discussed in “Sale of Property” footnote below.    

Interim results are subject to year-end adjustments and audit by independent auditors.  The financial data for the interim periods may not necessarily be indicative of the results expected for the year.

Sale of Property

On December 31, 2003 the Company sold its corporate headquarters’ building located in Stillwater, Oklahoma.  The new owner of the building is an individual, Jevon Nasalroad, who purchased the property for investment purposes. The Company is now a tenant in the building and has leased approximately 5,500 square feet of space for a minimum of two years at an annual cost of approximately $56,000. The contracted purchase price of the building was $460,000.  The net proceeds from the sale, after closing costs, were $431,226 and were used to pay off a $191,800 mortgage.  

During the first quarter ended November 30, 2003, the Company’s net loss included a $266,537 write-down to reflect an impairment of the value of the property sold.  The amount of the impairment was based on the amount that the net book value of the property exceeded the contracted purchase price plus estimated costs incurred for the final sale. During the second quarter ended February 29, 2004, the Company adjusted the impairment cost from $266,537 to $260,123 to reflect the actual final loss on the building sale.    

Net Income (Loss) Per Share

Options to purchase 413,974 and 538,974 shares of common stock at prices ranging from $.125 to $.40 per share were outstanding at May 31, 2004 and May 31, 2003, respectively, but were not included in the computation of diluted net income (loss) per share because the options’ exercise prices were greater than the average market price of common shares. The Company had total options outstanding to purchase 413,974 and 538,974 shares of common stock at May 31, 2004 and May 31, 2003, respectively. All options expire during periods through the year 2008.

Related Party Transactions

Revenue for the nine month period ended May 31, 2004 included approximately $123,000 for the sale of an image scanner and software to Measurement Incorporated, the Company’s partner in VSC Technologies, LLC. Revenue for the three and nine month periods ended May 31, 2003 included approximately $67,000 and $113,000 for the sale of image scanners and software to Measurement Incorporated.  

The Company currently has an agreement with the LLC whereby its employees provide software development services at a fixed rate per hour.  For the three and nine month periods ended May 31, 2004 the Company billed the LLC approximately $72,000 and $215,000, respectively, for software development services, and for the three and nine month periods ended May 31, 2003 the Company billed the LLC approximately $91,000 and $292,000, respectively, for software development services. Fifty percent of such services related to Measurement Incorporated’s obligation to fund LLC software development and the remaining 50% increased the Company’s investment in the LLC.  At May 31, 2004 “Due from related parties” included approximately $36,000 from the LLC for software development services and approximately $7,000 for other general and administrative costs.  

The Company’s agreement with the LLC includes a provision that allows the Company to receive cash distributions at the end of each calendar year for five years beginning December 31, 2002.  Eligibility for such distributions, which are subject to certain maximum amounts that graduate downward over the five-year period, are based on whether the Company’s financial return from the LLC is at least equal to the amount of software development cost that the Company has invested in the LLC.  When and if the LLC becomes profitable, the Company would be required to pay back such distributions by foregoing a portion of future cash profits from the LLC.  During the quarter ended February 29, 2004, the Company received a $150,000 cash distribution from the LLC which decreased the Company’s investment in the LLC.  

Legal Proceedings

We are a party to a lawsuit involving the Virtual Scoring Center technology we transferred to VSC Technologies, LLC.  On October 23, 2002, we, along with VSC Technologies, LLC and Measurement Incorporated, filed an action in the United States District Court for the Eastern District of North Carolina against NCS Pearson, Inc.  In the complaint, we and the other plaintiffs seek a declaratory judgment that the Virtual Scoring Center technology owned by VSC Technologies, LLC and marketed by Measurement Incorporated and us does not infringe twenty patents belonging to NCS Pearson.  On June 3, 2003, NCS filed their answer to our complaint, along with a set of counterclaims that assert infringement of thirteen of their patents.  

We believe that the Virtual Scoring Center technology does not infringe the NCS Pearson patents and we designed that technology to carefully avoid infringement, but we cannot assure you that we will be successful in our claims or our defense against NCS Pearson’s counterclaims.

If the court rules that the Virtual Scoring Center infringes the NCS Pearson patents and NCS Pearson prevails in their counterclaims, this could result in a monetary judgment against us. Because this action is at an early stage, we cannot estimate the extent of any potential damages if there is a judgment against us.

An injunction against us and VSC Technologies, LLC would be severely damaging to our business growth opportunities and our plans to exploit the Virtual Scoring Center technology.   Measurement Incorporated has agreed to indemnify us against our costs and any liability arising in connection with the action against NCS Pearson. But that indemnification responsibility has certain dollar limitations and other conditions. Consequently, we may have financial exposure if we do not prevail in this action and the conditions for indemnification are not met or our costs and liability exceed the indemnification coverage.

Item 2.  Management’s Discussion and Analysis or Plan of Operation

This Quarterly Report on Form 10-QSB contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Our actual results could differ materially from those set forth in the forward-looking statements because of certain risks and uncertainties, such as those inherent generally in the computer software industry and the impact of competition, pricing and changing market conditions. As a result, you should not rely on these forward-looking statements.

CRITICAL ACCOUNTING ESTIMATES

Our discussion and analysis of financial condition and operations are based on our financial statements, prepared in accordance with accounting principles generally accepted in the United States of America and included in this report on  Form 10-QSB.  Certain amounts included in or affecting our financial statements and related disclosure must be estimated, requiring us to make certain assumptions with respect to values or conditions which cannot be known with certainty at the time the financial statements are prepared.  Therefore, the reported amounts of our assets and liabilities, revenues and expenses and associated disclosures with respect to contingent assets and obligations are necessarily affected by these estimates.  We evaluate these estimates on an ongoing basis, utilizing historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances.  Nevertheless, actual results may differ significantly from our estimates.  We believe that certain accounting policies are of more significance in our financial statement preparation process than others, as discussed below.

Computer Software Costs

We capitalize our software development product costs after we have established technological feasibility and prior to the release of our products for sale.  Such costs are primarily based on the salaries of our employees and contractors that contribute to the development of our products, including a factor for related overhead.  Once a product is released for sale, we begin amortizing the capitalized costs on a straight-line basis over the product’s estimated economic life.  On a periodic basis, we compare the unamortized costs of our products to their estimated net realizable values.  If our estimates of net realizable value fall below the unamortized product costs, the excess is charged directly to operations to reflect impairment.  For the nine month periods ended May 31, 2004 and May 31, 2003, we incurred approximately $4,000 and $26,000 respectively, of charges for impairment of capitalized software development.

Revenue

Our revenue is primarily derived from the license of software toolkits and applications, royalties from customers based on those licenses, and fees for technical support and product maintenance.  We recognize license and royalty revenue only after we have delivered the software, fulfilled all of our significant obligations, and resolved any significant uncertainties regarding customer acceptance. Technical support and product maintenance fees are deferred and recognized as revenue on a straight-line basis over the applicable contract period.  Occasionally, technical support and product maintenance is bundled with a software license fee.  In such cases, we estimate the fair value of our technical support and product maintenance obligations using the established fees that we charge to other customers. Such revenue is deferred as a separate element of the contract and recognized ratably over the applicable contract period.  Any remaining rev enue is then recorded as the software license fee.  

Our revenue also includes amounts related to the performance of custom software development services.  Such revenue is recognized as the services are performed using the percentage-of-completion method and is deferred to the extent that customer billings or payments exceed the percentage complete.  Provisions for losses, if any, are recorded at the time such losses are known.

Income Taxes

We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized at the enacted tax rates for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Following is a summary of the significant items that comprise our estimated deferred tax assets and liabilities:

		May 31, 2004	August 31, 2003
Deferred tax assets:
Tax operating loss carryforwards	$	1,124,880	911,691
Other		37,056	34,731
Total gross deferred tax assets		1,161,936	946,422
Less valuation allowance		904,496	716,668
Net deferred tax assets		257,440	229,754
Deferred tax liabilities:
Property and equipment		(14,226)	(15,628)
Loss in limited liability company		(63,639)	(35,973)
Capitalized software costs		(179,575)	(178,153)
Net deferred tax	$	-	-

Deferred tax assets are recognized when it is more likely than not that those benefits from deferred tax assets will be realized.  The ultimate realization of deferred tax assets is dependent upon our ability to generate future taxable income during the periods in which the temporary differences that create deferred tax assets become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, past earnings history, sales backlog and tax operating loss carryforward expiration dates when determining the amount of deferred tax assets to recognize.

During the nine month period ended May 31, 2004, the Company increased its valuation allowance for deferred tax assets and increased the deferred tax asset, net of valuation allowance, from $229,754 at August 31, 2003 to $257,440 at May 31, 2004.  In order to fully realize the net deferred tax assets prior to the expiration of tax operating loss carryforwards, the Company will have to generate approximately $682,000 in taxable income through increased income from operations, the reversal of deferred tax liabilities, or both. At May 31, 2004, the Company had approximately $3.0 million of tax operating loss carryforwards, of which approximately 79% do not begin to expire until our fiscal year 2019.

RESULTS OF OPERATIONS

Following is selected financial information for each of our reportable segments for the three and nine month periods ended May 31, 2004 and May 31, 2003.  

Component Product Technologies Segment

	Three Months Ended					Nine Months Ended
	May 31,    2004	May 31, 2003	Dollar Increase	Percent Increase	May 31,    2004		May 31,  2003	Dollar (Decrease)	Percent (Decrease)
Revenue	$  706,759	524,711	182,048	35%	$1,789,234		1,931,527	(142,293)	(7.4%)
Operating  income (loss)	$ 201,196	(63,979)	265,175	414%	$  205,697		344,978	(139,281)	(40.4%)
Operating income  (loss) as % of revenue	28.5%	(12.2%)			11.5%		17.9%

Revenue from the component product technologies segment is primarily derived from licensing, royalties, custom development and customer support and maintenance of our Prizm® web-based Viewer, ScanFix®, Prizm® Image Processing, Prizm® Gray, ViewDirector™ and FormFix® products.  All revenue is derived from external sources.

For the three and nine month periods ended May 31, 2004, revenue from custom software development services accounted for approximately $168,000, or 24%, and $191,000, or 11%, of the total revenue for the segment, respectively.  No custom software development was included in revenue for the comparable three and nine month periods last year and was the primary reason for the overall increase in revenue for the current year third quarter. Increased revenue from custom software development services was offset by lower licensing and royalty revenue for both the three and nine month periods ended May 31, 2004.

We believe that the lack of widespread adoption of color and gray image processing technologies in the document management marketplace has impacted our ability to not only improve revenue for this segment, but also replace licensing and royalty revenue from our more mature viewing and black and white image processing products.   Additionally, we believe that licensing and royalty revenue from our viewing technology may continue to be impacted by increased competition from low or no cost web-based viewing technologies and the expected increase in demand for document images to be created or converted to Adobe’s PDF file format. The document management marketplace is also expected to continue to migrate to more specialized technology solutions applicable to niche markets or industries.  Our products have typically been applicable across many types of document imaging technology solutions, and although we have development plans that include c ertain specialized applications, which may continue to include more custom software development, there can be no assurance that we will be successful in penetrating our targeted niche markets.  

The profitability of this segment has historically depended on our ability to secure significant sales of multiple licenses and/or royalties to individual customers. For the third quarter ended May 31, 2004 and 2003 one customer accounted for 23% and 14% of the total revenue for the segment, respectively.  For the nine month period ended May 31, 2003 one customer accounted for 13% of the total segment revenue.  No one customer accounted for greater than 10% of total segment revenue for the nine month period ended May 31, 2004. The lack of significant multiple license and/or royalty sales to individual customers contributed to the decline in revenue and operating results during the current nine month period compared to the same period last year.

Because of the specific factors described above, our ability to predict the timing and extent of revenue for this segment is difficult.  Our inability to secure additional significant revenue transactions with individual customers and/or increase the volume through the release of new or enhanced products that meet current market needs could have a material adverse affect on our business, operating results and financial position.

Assessment Scoring Technologies Segment

	Three Months Ended		Nine Months Ended
	May 31, 2004	May 31,         2003		May 31,     2004	May 31, 2003
Revenue	$      9,625	68,000		132,002	116,439
Operating loss	$   (75,915)	(147,002)		(161,759)	(504,013)

The financial results for this segment reflect operating activities associated with the license and support of our Digital Mark Recognition™ (“DMR®”) software product and our 50% equity interest in VSC Technologies, LLC, an entity that we formed with Measurement Incorporated in October 2002.  Revenue for the three and nine month period ended May 31, 2004 was primarily derived from the license of DMR and the resale of scanner equipment to Measurement Incorporated.  Revenue for the comparable prior periods was also primarily derived from the license of DMR and resale of scanner equipment to Measurement Incorporated.        

We have an agreement with the LLC whereby we provide software development services, at a fixed rate per hour.  The segment’s operating expenses were reduced by approximately $72,000 and $91,000, for the three month periods ended May 31, 2004 and 2003, respectively, and $215,000 and $292,000 for the nine month periods ended May 31, 2004 and 2003, respectively, for such software development services. Fifty percent of the software development services were billed to the LLC and 50% were recorded as an increase to our investment in the LLC. Additionally, during the prior year first quarter and prior to the formation of the LLC we received approximately $23,000 from Measurement Incorporated for partial funding of the Virtual Scoring Center software product.   Of that amount, $21,000 was recorded as reduction to capitalized software development costs and the remaining $2,000 reduced our research and development expense.

The decrease in operating loss for the three and nine months ended May 31, 2004 compared to the same periods last year primarily resulted from a reduction in sales and marketing activities, lower DMR development costs, and lower professional fees that were applicable in the prior period for closing the LLC transaction.  The operating loss for the current and prior third quarter included approximately $15,000 and $56,000, respectively, for our 50% share of the LLC net loss. For the current and prior nine month periods, our 50% share of the LLC net loss approximated $64,000 and $104,000, respectively.       

Measurement Incorporated is currently using the Virtual Scoring Center software product on a limited basis for its own scoring operation. Based on their use of the software, we believe that additional investment in the design and development of the product will be required to make it more viable for both Measurement Incorporated’s and other general commercial use. Accordingly, we are not yet actively marketing the product for license to third parties.  

Our agreement with the LLC includes a provision that allows us to receive cash distributions at the end of each calendar year for five years beginning December 31, 2002. Eligibility for such distributions, which are subject to certain maximum amounts that graduate downward over the five-year period, are based on whether our financial return from the LLC is at least equal to the amount of software development cost that we have invested in the LLC. When and if the LLC becomes profitable, we would be required to pay back such distributions by foregoing a portion of future cash profits from the LLC.  The funds received from the LLC pursuant to this cash distribution arrangement and our software development services to the LLC, described above, help mitigate the financial risk associated with the additional development and delay in marketing the Virtual Scoring Center product to third parties.  However, given the increased unpredictability of financial results from our Component Product Technology business segment, we can provide no assurance that it will be feasible for us to continue to participate in the LLC at our current investment level.  Accordingly, we may be required to pursue other alternatives related to our investment, including selling all or a portion of our ownership interest.   

Total Company Operating Results

Following is a report of total company revenue and a reconciliation of reportable segments’ operating income (loss) to our total net income (loss) for the three and nine month periods ending May 31, 2004 and 2003.

		Three Months Ended		Nine Months Ended
		May 31, 2004	May 31, 2003		May 31, 2004	May 31, 2003
Total company revenue		$  716,384	592,711		1,921,236	2,047,966
Operating income (loss) for
	reportable segments	125,281	(210,981)		43,938	(159,035)
Unallocated corporate expenses		(89,134)	(65,715)		(326,260)	(243,187)
Interest income		3,994	5,715		12,835	16,171
Interest expense		-	(3,970)		(4,811)	(12,184)
Sale of property		-	-		(260,123)	-
Sale of technology		-	45,296		-	145,256
Other, net		-	1,459		3,904	621
Income tax expense		1,415	-		1,415	484,500
	Net income (loss)	$    38,726	(228,196)		(531,932)	(736,858)
Income (loss) per share:
	Basic	$        0.00	(0.02)		(0.04)	(0.06)
	Diluted	0.00	(0.02)		(0.04)	(0.06)

Lower costs from our Assessment Scoring Technologies segment was the primary factor that contributed to the improvement in total segment operating results for the current nine month period ended May 31, 2004 as compared to the same period last year. Increased revenue from custom software development projects along with lower costs in the Assessment Scoring Technology segment were the primary factors that contributed to the improved total segment operating results for the current three month period ended May 31, 2004. Unallocated corporate expenses increased for both the three and nine month periods ended May 31, 2004 compared to the same periods last year because of director’s and officer’s insurance, board of directors’ fees and professional fees associated with strategic planning activities.  

The net loss for the nine month period ended May 31, 2004 was also impacted by a loss on the sale of our Company’s headquarters building (see “Sale of Property” in the Notes to the Condensed Financial Statements for further information).   

Net loss for the three and nine month periods ended May 31, 2003, included recognition of a portion of the $155,000 gain realized upon our transfer of the Virtual Scoring Center technology to the LLC. The unrecognized portion of the gain was deferred and recognized in income during the prior year as we continued to fulfill our ongoing commitment to fund our 50% share software development costs.  

The income tax provision for the nine months ended May 31, 2003, included a deferred tax benefit of $94,656 and an increase in the valuation allowance for deferred tax assets of $579,156. During the second quarter of the prior fiscal year we made the decision to increase our valuation allowance and reduce the carrying amount of our net deferred tax assets because of our history of pre-tax losses and because our ability to time the closing of significant revenue opportunities became more difficult.  

During the nine month period ended May 31, 2004, the Company increased its valuation allowance for deferred tax assets and increased the deferred tax asset, net of valuation allowance, from $229,754 at August 31, 2003 to $257,440 at May 31, 2004.  In order to fully realize the net deferred tax assets prior to the expiration of tax operating loss carryforwards, the Company will have to generate approximately $682,000 in taxable income through increased income from operations, the reversal of deferred tax liabilities, or both. At May 31, 2004, we had approximately $3.0 million of tax operating loss carryforwards, of which approximately 79% do not begin to expire until our fiscal year 2019. Income tax expense of $1,415 for the three and nine month period was paid to the state of North Carolina. We registered our business in North Carolina in the prior year because of our activities with the LLC.  

FINANCIAL CONDITION

Working capital at May 31, 2004 was $1,051,513 with a current ratio of 3.1:1, compared to $949,250 with a current ratio of 2.5:1 at August 31, 2003.  

Net cash provided by operations for the nine months ended May 31, 2004 was approximately $24,000 despite our net loss of approximately $532,000 for the same period. Our net loss for the current nine months included approximately $518,000 in noncash items related to the sale of the building and recurring depreciation and amortization expense.  

Net cash provided by investing activities for the nine months ended May 31, 2004 approximated $216,000 which included approximately $431,000 in net proceeds from the sale of our headquarters building and an approximate $155,000 distribution from VSC Technologies LLC.  Pursuant to our agreement with the LLC, for the first five years of LLC operations we are eligible to receive cash distributions at the end of each calendar year beginning on December 31, 2002.  We are eligible for such distributions, subject to certain maximum amounts which graduate downward over the five year period, if our financial return from the LLC is not at least equal to the amount of software development cost that we have invested in the LLC. When and if the LLC becomes profitable, we will be required to pay back such distributions by foregoing a portion of future cash profits from the LLC.  The $586,000 collectively received from the building sale and the LLC cash dist ribution was offset by approximately $222,000 in software development costs for investment in new and enhanced software products and the approximate $121,000 cash investment for our share of LLC software development and other operating costs.  

Net cash flows used in financing activities during the nine month period ended May 31, 2004 approximated $198,000 and primarily represented the pay off of our building mortgage upon final sale of the headquarters building.  

In January 2004 we renewed our line of credit with a bank that provides for borrowing based on a percentage of certain eligible trade accounts receivable.  The maximum borrowing under the line of credit is $500,000. The maximum borrowing amount was reduced to $500,000 from the $1,000,000 provided in the prior year based on our history of eligible accounts receivable.  At May 31, 2004, approximately $188,000 was available for borrowing under the line of credit.  There was no balance outstanding against our line of credit at May 31, 2004.

We anticipate that our existing working capital, which includes the $239,426 we received upon final sale and mortgage pay off on the headquarters building and the annual cash distribution that we received pursuant to our agreement with the LLC, and our line of credit will be adequate to meet our current obligations and current operating and capital requirements.  

The funding of long-term needs (including funding for increased product development and expanded marketing and promotion of our products) is dependent upon increased revenue and profitability and may require obtaining funds through outside sources. Although our management is currently exploring various options for improving the overall financial position of the Company, we can give no assurance that we will be successful in such endeavors or that we will be able to become profitable and thus maintain the necessary level of working capital to adequately fund the continued development and promotion of our products. Continued losses or lack of revenue growth may require that we consider strategic alternatives in order to maximize value to our shareholders. Options available to us could be a "going private" transaction, sale of the Company and other possibilities. We have made no plans at this time to make any proposals to our shareholde rs to address this situation, but we may find it necessary in the future to do so.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2003, the Financial Accounting Standards Board (“FASB”) issued a revised version of FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51”.  FIN 46 sets forth guidance to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  

We have a 50% equity interest in VSC Technologies, LLC.  The LLC qualifies as a variable interest entity.   An equity investor is required to consolidate a variable interest entity if it is deemed the “primary beneficiary”. The primary beneficiary is defined as the investor that is expected to either absorb the majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both.  We are in the process of evaluating whether we qualify as the primary beneficiary of the LLC. If we are required to consolidate the LLC in accordance with this Interpretation, the financial effects will be implemented in our second quarter of fiscal 2005.   We have also evaluated our exposure to economic loss as a result of our involvement with the LLC, and estimate that from the inception of the LLC in October 2002 through December 31, 2005, that our maximum exposure to economic loss appro ximates $250,000.

Item 3.  Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14 under the Securities Exchange Act of 1934). Based upon that evaluation, the President and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II - Other Information

Item 6.  Exhibits and Reports on Form 8-K

(a) Exhibits

31

Certification of Principal Executive and Financial Officer Pursuant to SEC Rule 13a-14

32

Certification of Principal Executive and Financial Officers Pursuant to 18 U.S.C. Section 1350

(b) Reports on Form 8-K

None.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  

Registrant:  TMS, Inc

Date:

June 30, 2004

/s/ Deborah D. Mosier

Deborah D. Mosier, President and Chief Financial Officer

Principal Executive and Financial Officer

EX-31

EXHIBIT 31

CERTIFICATION PURSUANT TO
SEC RULE 13a-14

I, Deborah D. Mosier, certify that:

1. I have reviewed this report on Form 10-QSB of TMS, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;  

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;

4. The small business issuer’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))for the small business issuer and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and

5. The small business issuer’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer’s auditors and the audit committee of small business issuer’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer’s internal control over financial reporting.

Date: June 30, 2004

/s/ Deborah D. Mosier

Deborah D. Mosier

President and Chief Financial Officer,

Principal Executive and Financial Officer

EX-32

EXHIBIT 32

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350

The undersigned hereby certifies that to her knowledge the quarterly report of TMS, Inc. (the “Company”) filed with the Securities and Exchange Commission on the date hereof fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in such report fairly represents, in all material respects, the financial condition and results of operations of the Company.

A signed original of this written statement required by Section 906 of The Sarbanes-Oxley Act of 2002 has been provided to TMS, Inc. and will be retained by TMS, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

Date: June 30, 2004

/s/Deborah D. Mosier

Deborah D. Mosier

President and Chief Financial Officer,

Principal Executive and Financial Officer