ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
You should read the following summary together with the more
detailed information and financial statements and notes thereto and schedules appearing elsewhere in this report. Throughout this
report when we refer to the “Company” “TX Holdings,” “we,” “our” or “us,”
we mean TX Holdings, Inc., a Georgia corporation, and its subsidiaries.
This discussion and analysis of our financial condition and results
of operations is based upon our consolidated financial statements which have been prepared in accordance with GAAP.
The
preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our critical accounting policies and estimates, including those related to revenue recognition and contingencies.
We base our estimates on historical experience, where available, and on various other assumptions we believe to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and
conditions.
Except for historical information, the statements and other information
contained in this Management’s Discussion and Analysis are forward-looking. Our actual results could differ materially from
the results discussed in the forward-looking statements, which include certain risks and uncertainties.
Our independent registered public accounting firm’s report
on the consolidated financial statements included in our Annual Report Form 10-K for the year ended September 30, 2015, contains
an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a
going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or become
our stockholder.
Please refer to and carefully consider the factors described in
Part I, Item 1A - Risk
Factors
of our Form 10-K for the year ended September 30, 2015, and Part II, Item 1A –
Risk Factors in this report.
Overview
We are in the business of supplying, distributing and selling drill
bits, related tools, and other mining supplies, rail and rail material directly and through other suppliers to the United States’
coal mining industry for use in their production and transportation processes. The products are supplied to the Company by various
manufacturers and suppliers.
We purchase mining supplies from several manufacturers and rail
material from several suppliers of such products. Our products are either shipped to our warehouse in Ashland, Kentucky for distribution
to our customers or shipped directly to our customers, including products that we import once they have been received by us at
a port and cleared customs. Our products are transported primarily by ground transportation to our customers. Shipping costs are
born by our customers.
We distribute and sell our products through a Company’ salesman
and two independent sales agents who are compensated on a commissioned basis.
Revenues for the three months ended March 31, 2016 was $564,913
as compared to $951,857 for the same period in 2015, a decrease of approximately 40.7%. Revenue for the six months ended March
31, 2016, was $1,347,178 as compared to $1,592,646 for the same period in 2015, a decrease of approximately 15%.
During the six months ended March 31, 2016, we had a net loss of
$20,472 as compared to net loss of $227,405 for the same period in 2015.
At March 31, 2016, cash and cash equivalents were $1,369 compared
to $61,564 at September 30, 2015.
Net cash used in operating activities was $124,484 during the six
months ended March 31, 2016. Net cash used in operating activities during the same six-month period in 2015 was $214,872.
There was no cash flow from investing activities for the six months
ended March 31, 2016. Cash flow used in investing activities during the six month period ended March 31,2015 was $2,843.
During the six months ended March 31, 2016, net cash provided by
financing activities was $64,289 primarily due to cash advances from our CEO, William Shrewsbury. Cash flow provided by financing
activities for the six months ended March 31, 2015 was $152,349 resulting primarily from the Company’s $171,049 drawdown
from its line of credit.
Mr. William Shrewsbury, the Company’s Chairman and CEO, has
provided financing in the form of demand notes and advances. Effective February 25, 2014, Mr. Shrewsbury agreed to restructure
the principal and interest under such demand notes and certain advances due as of January 31, 2014, and we issued in exchange
a single Consolidated Secured Promissory Note in the principal amount of $2,000,000 (“Consolidated Note”). The principal
and interest thereunder is due ten years from the date of issuance, the principal bears interest at the rate of 5% per annum or
prime rate if higher than 5% per annum, and is subject to certain events of default. Payment of the Consolidated Note is to be
secured or otherwise payable by us out of the death benefit proceeds of key man insurance of $2 million that has been purchased
by us on the life of Mr. Shrewsbury. As of March 31, 2016, Mr. Shrewsbury had also provided non-interest bearing advances to us
of $204,437.
In November, 2012, we obtained a bank line of credit in the amount
of $250,000 which was subsequently increased to $750,000. The line of credit was secured by a lien on our inventory and account
receivable and guaranteed by Mr. Shrewsbury. On December 3, 2015, we entered into a new loan agreement with a bank under which
we obtained a term loan in the amount of $711,376. We utilized proceeds of the new loan to repay our line of credit. The loan
is for a term of five years and matures on December 3, 2020. As of March 31, 2016, the loan balance is $696,938.
We were incorporated in the State of Georgia
in 2000.
Recent Acquisitions
On November 21, 2014, and with a view to diversifying our business,
we acquired The Bag Rack, LLC. The acquired company owns all rights to a new product, “The Bag Rack” and was in the
preliminary stages of developing the new product. The Bag Rack is a unique device that enables bags with handles to be stored
in the trunk of a motor vehicle preventing the bags from tipping over and causing spillage. We expect to market and sell the new
product online and through certain national retailers, distributors, and discount stores. The Bag Rack, LLC was acquired from
Mr. Shrewsbury, our CEO and Mr. Rickie Hagan, the founding members of The Bag Rack, LLC, who each owned 50% of the company. In
addition to a purchase price of $500, as consideration for the acquisition, we agreed to pay 20% of the net profits to each founding
member (after royalty payment) of The Bag Rack. The Bag Rack has a provisional patent pending related to the new product and is
obligated to pay a royalty to the original developer of the product equal to 20% of the net profit of each product sold.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2016 Compared
To Three Months Ended March 31, 2015
Revenues from Operations
Revenue for the three months
ended March 31, 2016 was $564,913 as compared to $951,857 for the same period in 2015, a decrease of $386,944 or 40.7%. The decrease
in revenue is attributable to overall lower sales demand during the current period.
Cost of Goods Sold
During the quarter ended March
31, 2016, our cost of goods sold was $394,611 as compared to cost of goods sold of $784,066 for the quarter ended March 31, 2015,
a decrease of $389,455 or 49.7%. The lower cost of goods sold resulted from lower sales demand during the current period. As a
percentage of sales, cost of goods sold decreased from 82.4% in 2015 to 69.9% during the current period, the 12.5% decrease is
the direct result of lower cost purchases from a new supplier, and higher sales of a product mix with relatively higher gross
margins during the current quarter.
Gross Profit
Gross profit for the period ended
March 31, 2016 increased as a percentage of revenue to 30.1% from 17.6% for the same period of the prior year. The increase in
gross profit resulted from lower cost of sales from lower cost purchases and, sales of a product mix with relatively higher gross
margins during the current quarter
Operating Expenses
Operating
expenses for the three months ended March
31, 2016 were $191,662 as compared to $222,111
for the three months ended March
31, 2015, a decrease of $30,449 or 13.7%.
The table below details the components of
operating expense, as well as the dollar and percentage changes for the three-month periods.
|
|
Three Months Ended
|
|
|
|
3/31/2016
|
|
|
3/31/2015
|
|
|
$ Change
|
|
|
%Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission Expense
|
|
$
|
35,541
|
|
|
$
|
65,361
|
|
|
$
|
(29,820
|
)
|
|
|
(45.6
|
)
|
Professional fees
|
|
|
20,075
|
|
|
|
18,034
|
|
|
$
|
2,041
|
|
|
|
11.3
|
|
Depreciation expense
|
|
|
2,449
|
|
|
|
2,390
|
|
|
$
|
59
|
|
|
|
2.5
|
|
Other operating expense
|
|
|
133,597
|
|
|
|
136,326
|
|
|
$
|
(2,729
|
)
|
|
|
(2.0
|
)
|
Total
|
|
$
|
191,662
|
|
|
$
|
222,111
|
|
|
$
|
(30,449
|
)
|
|
|
(13.7
|
)
|
Commission expense for the three months ended
March 31, 2016 was $35,541 compared to $65,361 for the same period in 2015, a decrease of $29,820 or 45.6%. The lower commission
expense is a direct result of lower sales and the introduction of revised lower sales commission rates payable to our sales agent
in 2015.
Professional fees increased $2,041 or 11.3% during the three months
ended March 31, 2016, as compared to the same period in 2015. Higher advertising expense, primarily related to our new Bag Rack
business, accounted for an increase of $5,350 over the prior year. Legal fees in the current period of $12,225, were $3,918 lower
than the same period the prior year.
Depreciation expenses increased $59 or 2.5% during the quarter
ended March 31, 2016, as compared to the same period in 2015.
During the three months ended March 31, 2016, other operating expenses
of $133,597 decreased by $2,729 or 2.0% from $136,326 for the same period in 2015. The lower other operating expenses resulted
primarily from lower travel expenses of $2,971 during the current quarter.
Income (loss) from operations
Loss from operations for the
quarter ended March
31, 2016 was $21,360 compared to loss from operations of $54,320
during the same period in 2015. When compared to the loss for the same period in the prior year, the lower loss in the current
period is the direct result of lower product cost, sales of a product mix with relatively higher gross margins and lower operating
expenses in the current period.
Other income and (expense)
Other income and expense for the three months ended March 31, 2016,
reflected a net expense of $29,744 as compared to net expense of $27,802 for the quarter ended March 31, 2015, an increase of
$1,942. Gain from scrap sales during the quarter ended March 31, 2015, account for a profit gain of $840.
Net Income or Loss
For the quarter ended March 31,
2016, we incurred a net loss of $51,104 compared to a net loss of $82,122 for the quarter ended March 31. 2015. Lower product
cost, sales of a product mix with relatively higher gross margin, and lower operating expenses in the current period account for
the lower net loss.
Net earnings (loss) per common share
The net loss $51,104 for the
quarter ended March
31, 2016, as well as the net loss of $82,122 for the quarter ended
March
31, 2015, when divided by the number of common shares outstanding of 48,053,084
basic shares in both years resulted in a net loss per share, respectively, of less than $0.01 in both periods.
Six Months Ended March 31, 2016 Compared
to Six Months Ended March 31, 2015
Revenues from Operations
Revenue
for the six months ended March 31, 2016 was $1,347,178 as compared to $1,592,646 for the same period in 2015, a decrease of $245,468
or 15.4%. The decrease in revenue is attributable to overall lower sales demand in the current period.
Cost of Goods Sold
During the six months ended March
31, 2016, the Company’s cost of goods sold was $938,457 as compared to cost of goods sold of $1,307,412 for the six months
ended March 31, 2015, a decrease of $368,955 or 28.2 %. The lower cost of goods sold resulted from lower sales demand during the
current period. As a percentage of sales, cost of goods decreased from 82.1% in 2015 to 69.6% in 2016, the 12.5% decrease is the
direct result of lower cost purchases from a new supplier, and higher sales of a product mix with relatively higher gross margins
during the current six-month period.
Gross Profit
Gross profit
for the period ended March 31, 2016 increased as a percentage of revenue to 30.3% from 17.9% for the same period the prior year.
The increase in gross profit resulted from lower cost of sales from lower cost purchase, sales of product mix with relatively
higher gross margins during the current period, and a $55,000 loss from the sale of obsolete inventory sold as scrap during the
prior six-month period ended March 31, 2015.
Operating Expenses
Operating
expenses for the six months ended March
31, 2016 were $365,915 as compared to $459,361
for the six months ended March
31, 2015, a decrease of $93,446 or 20.3%.
The table below details the components of
operating expense, as well as the dollar and percentage changes for the six-month periods.
|
|
Six Months Ended
|
|
|
|
3/31/2016
|
|
|
3/31/2015
|
|
|
$ Change
|
|
|
%Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission Expense
|
|
$
|
63,373
|
|
|
$
|
105,934
|
|
|
$
|
(42,561
|
)
|
|
|
(40.2
|
)
|
Professional fees
|
|
|
41,421
|
|
|
|
58,310
|
|
|
$
|
(16,889
|
)
|
|
|
(29.0
|
)
|
Bad Debt Expense
|
|
|
1,926
|
|
|
|
|
_
|
|
$
|
1,926
|
|
|
|
100.0
|
|
Depreciation expense
|
|
|
4,898
|
|
|
|
5,206
|
|
|
$
|
(308
|
)
|
|
|
(5.9
|
)
|
Other operating expense
|
|
|
254,297
|
|
|
|
289,911
|
|
|
$
|
(35,614
|
)
|
|
|
(12.3
|
)
|
Total
|
|
$
|
365,915
|
|
|
$
|
459,361
|
|
|
$
|
(93,446
|
)
|
|
|
(20.3
|
)
|
Commission
expense for the six months ended March 31, 2016 was $63,373 compared to $105,934 for the same period in 2015, a decrease of $42,561
or 40.2%. The lower commission expense is a direct result of lower sales, the introduction of revised lower sales commission rates
payable to our sales agents,
and a favorable adjustment to the prior year accrued commission resulting from the resignation
of a sales agent.
Professional
fees decreased $16,889 or 29.0% during the six months ended March 31, 2016, as compared to the same period in 2015. The lower
professional fees resulted from lower legal fees of $18,393 and investor relations expense of $9,150, partially offset by higher
advertising expense of $10,654.
Depreciation
expenses increased $308 or 5.9% during the six months ended March 31, 2016, as compared to the same period in 2015. Depreciation
on a new refurbished delivery truck put into operation the second quarter of 2015 account for the increase.
During the
six months ended March 31, 2016, other operating expenses of $254,297 decreased by $35,614 or 12.3% from the $289,911 for the
same period in 2015. The lower other operating expenses resulted from lower travel expense of $35,674. The lower travel expense
is associated with the prior year overseas travel by an officer and agent to meet with suppliers.
Income (loss) from operations
Income from
operations for the six months ended March 31, 2016 was $42,806 compared to loss from operations of $174,127 during the same period
in 2015. The favorable income from operations is the result of current period lower cost of sales from lower cost purchase, sales
of a product mix with relatively higher gross margins and, lower operating expenses. The favorable increase also results from
a $55,000 loss incurred in the prior period from the sale of obsolete inventory sold as scrap.
Other income and (expense)
The other
income and expense category for the six months ended March 31, 2016, reflected a net expense of $63,278 as compared to a net expense
of $53,278 for the six months ended March 31, 2015, an increase of $10,000. The other expense increase result from miscellaneous
income of $12,553 recorded in the six- month period ended March 31, 2015.
Net Income or Loss
For the
six months ended March 31, 2016, the Company had a net loss of $20,472 compared to a net loss of $227,405 for the six months ended
March 31, 2015. The loss reduction is the result of an increase in the current period income from operation of $216,933 due to
lower cost of sales from lower cost purchase, sales of product mix with relatively higher gross margins and lower operating expenses.
Net earnings per common share
The net
loss of $20,472 for the six months ended March 31, 2016, as well as the net loss of $227,405 for the six months ended March 31,
2015, when divided by the number of common shares outstanding of 48,053,084 basic and diluted shares in both years resulted in
a net loss per share of less than $0.01 in the current six month period and a negligible earnings per share of less than $0.01
for the six months ended March 31, 2015.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents a summary of our net cash provided
(used) by operating, investing and financing activities:
|
|
Six Months Ended
|
|
Liquidity and capital resources
|
|
3/31/2016
|
|
|
3/31/2015
|
|
Net cash used in operating activities
|
|
$
|
(124,484
|
)
|
|
$
|
(214,872
|
)
|
Net cash used in investing activities
|
|
|
|
_
|
|
|
(2,843
|
)
|
Net cash provided by financing activities
|
|
|
64,289
|
|
|
|
152,349
|
|
Net decrease in cash equivalents
|
|
$
|
(60,195
|
)
|
|
$
|
(65,366
|
)
|
At March 31, 2016, we had cash and cash equivalents
of $1,369 as compared to $61,564 at September 30, 2015, a decrease of $60,195 or 97.8%. The decrease in cash is the direct result
of the net cash used for operating activities of $124,484. The decrease in cash was partially offset by stockholder/officer net
advances of $79,800 during the six months ended March 31, 2016.
Cash Flows Used in Operating Activities
Net cash used in operating
activities for the six months ended March 31, 2016, was $124,484 compared to cash used in operations of $214,872 in 2015, a decrease
of $90,388 or 42.1%.
During the six months ended March 31, 2016, we
had a net loss of $20,472 as compared to a net loss of $227,405 for the same period during the prior year.
In the current six-month period the company has
non-cash expenses for depreciation of $4,898 and bad debt expense of $1,926.
A decrease in accounts receivable
of $63,173, other current assets of $1,538 and, an increase in accrued liabilities of $29,305, and of stockholder/officers advances
for operations of $12,000, were more than offset by an increase in inventory of $165,635, an increase in commission advances of
$7,173, and a decrease in accounts payable of $44,044.
Cash Flows Used in Investing Activities
There was no cash flow from investing activities
for the period ended March 31, 2016. During the comparable six- month period in the prior year, we capitalized $4,149 incurred
in refurbishing a new truck used for product delivery and, a $1,306 payment was received as a partial payment on the note receivable
held by us arising from the sale of a previously owned oil lease.
Cash Flows Provided by Financing Activities
During the six months ended March 31, 2016, cash provided by financing
activities was $64,289 compared to cash provided by financing activities of $152,349 during the same period in 2015. During the
current six-month period, the Company made payment on its term loan of $14,438, line of credit of $1,073 and received stockholder
advances of $79,800. For the six months ended March 31, 2015, the Company repaid net advances of $18,700 and as a result of cash
flows shortfalls, we had increased reliance on advances from Mr. Shrewsbury to fund operations. Also, we financed our operation
during the six-months period ended March 31, 2015, by drawing-down $171,049 under our bank credit line.
In November 2012, we obtained a $250,000 line of credit from a
bank. On August 26, 2014, the bank increased our existing bank line of credit from $250,000 to $750,000 and extended the term
of the line of credit. The line of credit was secured by a priority security interest in our inventory and accounts receivable
and matured on November 7, 2015. Interest on the line of credit was payable monthly and was calculated on the basis of a variable
index. On December 3, 2015, we entered into a new loan agreement with the bank under which we obtained a term loan in the amount
of $711,376. We utilized proceeds of the new loan to repay our line of credit. The loan is for a term of five years and matures
on December 3, 2020. As of March 31, 2016, the loan balance is $696,938. The current rate of interest under the loan is 3.50%
per annum. Principal, interest and collection costs under the loan are guaranteed by Mr. Shrewsbury.
On February 25, 2014, we and Mr. Shrewsbury entered into an agreement
to consolidate an aggregate of $2,000,000 of amounts due to Mr. Shrewsbury, including $1.062 million due under a Revolving Promissory
Demand Note issued to Mr. Shrewsbury on or about April 30, 2012, $289,997 due under a 10% Promissory Note issued to Mr. Shrewsbury
on or about February 27, 2009, accrued but unpaid interest of $262,157 as of January 31, 2014, under such notes and advances by
Mr. Shrewsbury in the amount of $385,846 as of January 31, 2014, and issued in replacement a Secured Consolidated Note (“Consolidated
Note”) for such amount. The Consolidated Note bears interest at 5% per annum or prime rate if higher than 5% per annum,
principal and interest are repayable ten years from February 25, 2014, and it is subject to customary events of default. Payment
of the Consolidated Note is to be secured or otherwise payable by us out of the death benefit proceeds of key man insurance of
$2 million that has been purchased by us on the life of Mr. Shrewsbury.
During the six months ended March 31, 2016, we received $79,800
cash advance from Mr. Shrewsbury, bringing the total outstanding advance balance to $204,437. Cash advances from Mr. Shrewsbury
are repayable upon demand and do not bear interest.
Financial Condition and Going Concern Uncertainties
Except for each of the six consecutive quarters ended June 30,
2014 and the first three months period of the current year, since inception, the Company has not generated sufficient cash to
fund its operations and has incurred operating losses. Currently, the Company relies substantially upon financing provided by
Mr. Shrewsbury, the Company’s Chief Executive Officer, and a secured bank loan in connection with the financing of its business
operations. In view of these matters, realization of certain assets in the accompanying balance sheet is dependent upon continued
operations, which, in turn, is dependent upon our ability to meet our financial requirements, upon the continued provision of
financing from Mr. Shrewsbury and under the Company’s bank loan, and the success of our future operations.
Our independent registered public accounting firm’s report
on the consolidated financial statements included in our Annual Report on Form 10-K for the year ended September 30, 2015, contained
an explanatory paragraph wherein they expressed an opinion that there is a substantial doubt about our ability to continue as
a going concern. Accordingly, careful consideration of such opinion should be given in determining whether to continue or to become
our stockholder.
As of March 31, 2016, we had cash and cash equivalents of $1,369
as compared to $61,564 as of September 30, 2015. The decrease in cash as of March 31, 2016, resulted from an increase in working
capital arising from management’s decision to increase inventory levels in anticipation of higher sales demand. The higher
inventory was partially offset by a decrease in receivables. During the current six-month period, we had also a net increase in
advances from Mr. Shrewsbury of $79,800.
Our accounts receivable was $519,944 as of March 31, 2016, as compared
to $585,043 as of September 30, 2015, a decrease of $65,099 or 11.1%. The lower March 31, 2016 receivable balance is the direct
result of lower sales due to lower sales demand.
Inventory was $2,388,672 as of March 31, 2016 as compared to $2,223,037
as of September 30, 2015, an increase of $165,635 or 7.5%. The higher inventory is attributable to an anticipated increase in
sales demand.
During the six months ended March 31, 2016, our accumulated deficit
increased from $14,752,711 to $14,773,183, an increase of $20,472 or 0.1% due to the reported net loss during the six months ended
March 31, 2016.
During the six months ended March 31, 2016, the Company’s
net loss was $20,472 compared to a net loss of $227,405 for the comparable period in 2015. The decrease in net loss can be directly
attributed to higher sales of a product mix with relatively higher gross margins and lower operating expenses and a $55,000 loss
from the sale of obsolete inventory sold as scrap during the six month period ended March 31, 2015.
Currently, in addition to funds utilized to purchase
inventory, we are spending approximately $60,000 per month on operations. Management believes that the Company’s available
cash, cash flows from operations, the loans and advances provided by Mr. Shrewsbury and the loan provided by the bank to be sufficient
to fund the Company operations during the next 12 months.
We continue to rely substantially upon financings
provided by Mr. Shrewsbury and a bank loan to fund our operations. The terms of such financings are discussed below.
BANK LOAN
Under the terms of a business loan agreement, originally entered
on November 7, 2012, and as amended through August 26, 2014, we obtained a secured revolving line of credit in the amount of $750,000
from Town Square Bank. Interest on the loan was payable monthly in arrears. Interest under the loan was variable and was based
upon Wall Street Journal Prime Rate.
On December 3, 2015, we entered into a new loan agreement with
Town Square Bank pursuant to which we obtained a term loan in the amount of $711,376. We utilized proceeds of the new loan to
repay our former line of credit. The loan is for a term of five years and matures on December 3, 2020. As of March 31, 2016, the
loan balance was $696,938.
During the term of the loan, we agreed to make
equal monthly repayments of principal and interest of $6,967 commencing January 3, 2016, and to make a final payment on December
3, 2020, of the outstanding balance of the interest and principal then due, estimated to be approximately $391,896. Early repayment
of amounts due under the loan will not affect the monthly repayment amount, unless otherwise agreed to by the bank.
An event of default under
the loan will occur upon the occurrence of any of the following events:
|
·
|
we
fail to make any payment when due under the note;
|
|
·
|
we
fail to comply with any term, obligation, covenant or condition in the loan documents
or any other agreement with the bank;
|
|
·
|
we
default under any loan, extension of credit, security agreement, purchase or sales agreement
or other agreement with any creditor that materially affects our property or our ability
to repay the note or perform our obligation under the note or related documents;
|
|
·
|
a
warranty, representation or statement made to the bank under the loan document is or
becomes materially false or misleading;
|
|
·
|
the
dissolution or termination of our existence, our insolvency, the appointment of a receiver
for any part of our property, any assignment for the benefit of creditors, any type of
creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency
laws by or against us;
|
|
·
|
the
commencement of foreclosure or forfeiture proceedings by any creditor or any governmental
agency against any collateral securing the loan;
|
|
·
|
any
of the preceding events occurs with respect to any loan guarantor;
|
|
·
|
a
25% or more change in the ownership of our common stock;
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a
material adverse change in our financial condition, or the bank believes the prospect
of payment or performance of the loan is impaired or
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the
bank in good faith believes itself insecure.
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The loan agreements contain certain affirmative
covenants, including an obligation to: notify the bank of a material adverse change in our financial condition and of any threatened
litigation or claim or other proceeding which could materially affect our financial condition; maintain certain liability insurance
in amounts acceptable to the bank; maintain qualified executive and management personnel; comply with applicable environmental
laws and perform environmental studies required by the bank; and certify annually to the bank compliance with the representations
and warranties in the bank loan documents. The loan agreements contain certain other customary covenants, terms and conditions.
In addition, the loan agreements contain certain
negative covenants, including that we will not, without the bank’s consent:
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incur
any indebtedness other than to the bank or for trade debt incurred in the ordinary course;
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sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber
any of its assets, except for permitted liens;
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sell
our accounts receivable, except to the bank;
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engage
in business activities substantially different from our current activities;
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cease
operations, liquidate, merge, transfer, acquire or consolidate with another entity, change
our name, dissolve, or sell the inventory or accounts receivable secured under the loan;
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pay
any dividend other than in stock;
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lend
money, invest or advance money or assets to another person or entity;
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purchase,
create or acquire an interest in any other entity;
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incur
any obligation as a surety or guarantor other than in the ordinary course; or
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enter
into any agreement containing any provision which would be violated or breached by the
performance of our obligations under the loan agreements.
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Interest under the loan is variable and is based
upon the Wall Street Journal Prime rate, currently 3.25% per annum. In the event of a default, interest under the loan may be
increased by 2%. The loan is secured by a priority security interest in the Company’s inventory and accounts receivable
and has been guaranteed by our CEO.
ADVANCES AND LOANS FROM MR. SHREWSBURY
In connection with the expansion of our business, Mr. Shrewsbury,
the Company’s Chairman and CEO, provided financing to us in the form of demand notes and advances. On February 25, 2014,
we entered into a Note Exchange Agreement (“Exchange Agreement”) with Mr. Shrewsbury pursuant to which certain outstanding
indebtedness due to Mr. Shrewsbury was consolidated and restructured. Under the terms of the agreement, we and Mr. Shrewsbury
consolidated the following indebtedness: the principal due under the Revolving Promissory Demand Note issued to Mr. Shrewsbury
on April 30, 2012 (“Revolving Note”), in the amount of $1,062,000 and accrued but unpaid interest due thereunder as
of January 31, 2014, in the amount of $168,905; the principal due under the 10% Promissory Note issued to Mr. Shrewsbury effective
February 27, 2009 (the “10% Note”), in the amount of $289,997 and accrued but unpaid interest due thereunder as of
January 31, 2014, in the amount of $93,252; and $385,846 of the non-interest bearing advances previously made by Mr. Shrewsbury
and outstanding as of January 31, 2014. We issued in exchange and in replacement for such indebtedness a Consolidated Secured
Promissory Note (the “Consolidated Note) in the principal amount of $2,000,000. Upon issuance of the Consolidated Note,
the Revolving Note and 10%
Note were cancelled. Mr. Shrewsbury agreed to waive any prior defaults
under the terms of such cancelled notes and to release the Company from any claims related thereto.
The principal and interest under the Consolidated Note is due and
payable ten years from the date of issuance and is to be secured by the proceeds of key man insurance purchased by us on the life
of Mr. Shrewsbury. The Consolidated Note bears interest at the rate of 5% per annum except that, if the prime rate reported by
the Wall Street Journal (“WSJ Prime Rate”) exceeds 5%, then the Consolidated Note will bear interest at the WSJ Prime
Rate.
An event of default will occur under the Consolidated Note upon:
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we fail to pay
when due any principal or interest under the Consolidated Note;
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we violate any
covenant or agreement contained in the Consolidated Note, the Exchange Agreement or related
transaction documents;
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an assignment
for the benefit of creditors by us;
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the application
for the appointment of a receiver or liquidator for us or our property;
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the filing of
a petition in bankruptcy by or against us;
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the issuance
of an attachment or the entry of a judgment against us in excess of $250,000;
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a default by
us with respect to any other indebtedness or with respect to any installment debt whether
or not owing to Mr. Shrewsbury;
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the
sale
of all or substantially all of our assets or a transfer of more than 51% of our equity
interests to a person not currently a holder of our equity interests;
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our termination
of existence or dissolution;
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the death of
Mr. Shrewsbury; or
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the failure to
pay when due any premium under the key man policy required to be purchased on the life
of Mr. Shrewsbury under the Exchange Agreement.
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In addition, in consideration of Mr. Shrewsbury agreeing to consolidate
and restructure the indebtedness, the Company granted to Mr. Shrewsbury options to purchase an aggregate of 500,000 shares of
our common stock pursuant to the terms of a Non-Qualified Stock Option Agreement, issued February 25, 2014. The options are exercisable
commencing April 1, 2014, and for a period of three years thereafter. The options are exercisable at a price of $0.0924 per share
subject to certain anti-dilution adjustments in the event of stock dividends, subdivisions, capital reorganizations, a consolidation
or merger, or sale of all or substantially all of our assets.
As of March 31, 2016, Mr. Shrewsbury had advanced
an aggregate of $204,437 to the Company. The advances do not bear interest and are repayable upon demand. As of March 31, 2016,
the Company also has a payable of $24,000 to Mr. Shrewsbury for warehouse storage rental.
The Consolidated Note and advances are subordinate
to the Company’s bank indebtedness.
Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet arrangements, transactions,
obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect
upon our financial condition, or results of operations as of March 31, 2016 and September 30, 2015.