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 subsidiary.
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 companies for use in their production and transportation processes. We have experienced, and continue to experience,
reduced demand for sales of our mining and rail products due to a continuing decline in U.S. coal production. The demand for,
and production of, coal has been adversely affected by several factors, including increased environmental regulation, declining
coal consumption in the electric power sector, increased competition from natural gas, and the strong dollar. The U.S. Energy
Information Administration has forecast that coal production is expected to decrease by approximately 17% in 2016 and that coal
consumption in the electric power sector, which accounts for more than 90% of total U.S. coal consumption, is forecast to decline
10% in 2016. As a result, several major U.S. coal producers, including certain of our customers, have sought protection under
bankruptcy laws or are engaged in restructuring their businesses and operations resulting in plant closures. Distress in the U.S.
coal mining industry has and will continue to materially affect our business and operations.
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 June 30, 2016 was $381,529
as compared to $636,388 for the same period in 2015, a decrease of approximately 40.0%. Revenue for the nine months ended June
30, 2016, was $1,728,707 as compared to $2,229,033 for the same period in 2015, a decrease of approximately 22.4%.
During the nine months ended June 30, 2016, we had a net loss of
$105,040 as compared to net loss of $310,318 for the same period in 2015.
At June 30, 2016, cash and cash equivalents were $856 compared
to $61,564 at September 30, 2015.
Net cash used in operating activities was $134,948 during the nine
months ended June 30, 2016. Net cash used in operating activities during the same nine-month period in 2015 was $224,478.
There was no cash flow from investing activities for the nine months
ended June 30, 2016. Cash flow used in investing activities during the nine-month period ended June 30, 2015 was $2,843.
During the nine months ended June 30, 2016, net cash provided by
financing activities was $74,240 primarily due to cash advances from our CEO, William Shrewsbury. Cash flow provided by financing
activities for the nine months ended June 30, 2015 was $199,349 primarily from a drawdown of $171,049 under our line of credit,
which line of credit we converted subsequently to a term loan.,
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 June 30, 2016, Mr. Shrewsbury had also provided non-interest bearing advances to us
of $229,437.
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 June 30, 2016, the loan balance is $681,889.
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 June 30, 2016 Compared
to Three Months Ended June 30, 2015
Revenues from Operations
Revenue for the three months
ended June 30, 2016 was $381,529 as compared to $636,388 for the same period in 2015, a decrease of $254,829 or 40.0%. The decrease
in revenue is attributable to overall lower sales demand during the current period, due to declining coal production in the U.S.
as a result of a number of factors, discussed above.
Cost of Goods Sold
During the quarter ended June
30, 2016, our cost of goods sold was $306,289 as compared to cost of goods sold of $503,301 for the quarter ended June 30, 2015,
a decrease of $197,012 or 39.1%. The lower cost of goods sold resulted from lower sales during the current period. As a percentage
of sales, cost of goods sold increased from 79.1% in 2015 to 80.3% during the current period, the 1.2% increase is the direct
result of higher sales of a product mix with relatively higher unit cost during the current quarter.
Gross Profit
Gross profit for the period ended
June 30, 2016 decreased as a percentage of revenue to 19.7% from 20.9% for the same period of the prior year. The decrease in
gross profit resulted from sales of lower gross margin products during the current quarter.
Operating Expenses
Operating
expenses for the three months ended June 30, 2016 were $134,538 as compared to $187,142 for the three months ended June 30, 2015,
a decrease of $52,604 or 28.1%.
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
|
|
|
|
6/30/2016
|
|
|
6/30/2015
|
|
|
$ Change
|
|
|
%Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission Expense
|
|
$
|
21,879
|
|
|
$
|
52,553
|
|
|
$
|
(30,674
|
)
|
|
|
(58.4
|
)
|
Professional fees
|
|
|
5,000
|
|
|
|
14,201
|
|
|
$
|
(9,201
|
)
|
|
|
(64.8
|
)
|
Depreciation expense
|
|
|
2,449
|
|
|
|
4,032
|
|
|
$
|
(1,583
|
)
|
|
|
(39.3
|
)
|
Other operating expense
|
|
|
105,210
|
|
|
|
116,356
|
|
|
$
|
(11,146
|
)
|
|
|
(9.6
|
)
|
Total
|
|
$
|
134,538
|
|
|
$
|
187,142
|
|
|
$
|
(52,604
|
)
|
|
|
(28.1
|
)
|
Commission expense for the three months ended
June 30, 2016 was $21,879 compared to $52,553 for the same period in 2015, a decrease of $30,674 or 58.4%. 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 decreased $9,201or 64.8% during the three months
ended June 30, 2016, as compared to the same period in 2015. The decrease in expense can be attributed to lower legal expenses
of $4,235 and lower advertising expense of $5,000.
Depreciation expense decreased $1,583 or 39.3% during the quarter
ended June 30, 2016, as compared to the same period in 2015.
During the three months ended June 30, 2016, other operating expenses
of $105,210 decreased by $11,146 or 9.6% from $116,356 for the same period in 2015. The lower other operating expenses resulted
primarily from lower travel expenses of $8,802 and lower operating supplies of $4,318 during the current quarter.
Loss from operations
Loss from operations for the
quarter ended June 30, 2016 was $59,298 compared to loss from operations of $54,055 during the same period in 2015. When compared
to the loss for the same period in the prior year, the loss increase in the current period is the direct result of lower sales
partially offset by lower operating expenses.
Other income and (expense)
Other income and expense for the three months ended June 30, 2016,
reflected a net expense of $25,271 as compared to net expense of $28,858 for the quarter ended June 30, 2015, a decrease of $3,587.
Gain from scrap sales during the current quarter account for a profit gain of $6,102 as compared to a gain of $2,952 from scrap
sales during the same period the prior year.
Net loss
For the quarter ended June 30,
2016, we incurred a net loss of $84,569 compared to a net loss of $82,913 for the quarter ended June 30, 2015. Lower product sales
partially offset by lower operating expenses in the current period account for the increase net loss.
Net loss per common share
The net loss $84,569 for the
quarter ended June 30, 2016, as well as the net loss of $82,913 for the quarter ended June 30, 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.
Nine Months Ended June 30, 2016 Compared
to Nine Months Ended June 30, 2015
Revenues from Operations
Revenue
for the nine months ended June 30, 2016 was $1,728,707 as compared to $2,229,033 for the same period in 2015, a decrease of $500,326
or 22.4%. The decrease in revenue is attributable to overall lower sales in the current period due to the declining coal production
in the U.S. as a result of a number of factors, discussed above.
Cost of Goods Sold
During the nine months ended
June 30, 2016, the Company’s cost of goods sold was $1,244,746 as compared to cost of goods sold of $1,810,712 for the nine
months ended June 30, 2015, a decrease of $565,966 or 31.3 %. The lower cost of goods sold resulted from lower sales during the
current period. As a percentage of sales, cost of goods sold decreased from 81.2% in 2015 to72.0% in 2016, the 9.2% 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 nine-month period.
Gross Profit
Gross profit
for the period ended June 30, 2016 increased as a percentage of revenue to 28.0% from 18.8% for the same period the prior year.
The increase in gross profit resulted from lower cost of sales from lower cost purchases, 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 nine-month period ended June 30, 2015.
Operating Expenses
Operating
expenses for the nine months ended June 30, 2016 were $500,453 as compared to $646,503 for the nine months ended June 30, 2015,
a decrease of $146,050 or 22.6%.
The table below details the components of
operating expense, as well as the dollar and percentage changes for the nine-month periods.
|
|
Nine Months Ended
|
|
|
|
6/30/2016
|
|
|
6/30/2015
|
|
|
$ Change
|
|
|
%Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission expense
|
|
$
|
85,251
|
|
|
$
|
158,486
|
|
|
$
|
(73,235
|
)
|
|
|
(46.2
|
)
|
Professional fees
|
|
|
46,421
|
|
|
|
72,511
|
|
|
$
|
(26,090
|
)
|
|
|
(36.0
|
)
|
Bad debt expense
|
|
|
1,926
|
|
|
|
–
|
|
|
|
1,926
|
|
|
|
100.0
|
|
Depreciation expense
|
|
|
7,347
|
|
|
|
9,238
|
|
|
$
|
(1,891
|
)
|
|
|
(20.5
|
)
|
Other operating expense
|
|
|
359,508
|
|
|
|
406,268
|
|
|
$
|
(46,760
|
)
|
|
|
(11.5
|
)
|
Total
|
|
$
|
500,453
|
|
|
$
|
646,503
|
|
|
$
|
(146,050
|
)
|
|
|
(22.6
|
)
|
Commission
expense for the nine months ended June 30, 2016 was $85,251 compared to $158,486 for the same period in 2015, a decrease of $73,235
or 46.2%. The lower commission expense is a direct result of lower sales, the introduction of revised lower sales commission rates
payable to our sales agents in 2015,
and a favorable adjustment to the prior year accrued commission resulting from the
resignation of a sales agent.
Professional
fees decreased $26,090 or 36.0% during the nine months ended June 30, 2016, as compared to the same period in 2015. The lower
professional fees resulted from lower legal fees of $22,584 and investor relations expense of $9,150, partially offset by higher
advertising expense of $5,644.
Depreciation
expense decreased $1,891 or 20.5% during the nine months ended June 30, 2016, as compared to the same period in 2015. A fully
depreciated delivery truck during the current period accounted for the decrease.
During the
nine months ended June 30, 2016, other operating expenses of $359,508 decreased by $46,760 or 11.5% from the $406,268 for the
same period in 2015. The lower other operating expenses resulted from lower travel expense of $45,222. The lower travel expense
is associated with the prior year overseas travel by an officer and agent to meet with suppliers.
Loss from operations
Loss from
operations for the nine months ended June 30, 2016 was $16,492 compared to loss from operations of $228,182 during the same period
in 2015. The loss decrease is the result of current period lower cost of sales from lower cost purchases, sales of a product mix
with relatively higher gross margins and, lower operating expenses. The loss decrease 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 nine months ended June 30, 2016, reflected a net expense of $88,548 as compared to a net expense
of $82,136 for the nine months ended June 30, 3015, an increase of $6,412. The other expense increase result from miscellaneous
income from the sale of scrap of $15,505 recorded in the nine-month period ended June 30, 2015.
Net Loss
For the
nine months ended June 30, 2016, the Company had a net loss of $105,040 compared to a net loss of $310,318 for the nine months
ended June 30, 2015. The reduced loss is the result of a decrease in loss from operations in the current period of $211,690 due
to lower cost of sales from lower cost purchase, sales of a product mix with relatively higher gross margins and lower operating
expenses.
Net loss per common share
The net
loss of $105,040 for the nine months ended June 30, 2016, as well as the net loss of $310,308 for the nine months ended June 30,
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 nine-month period and a negligible loss per share of $0.01 for the nine
months ended June 30, 2015.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents a summary of our net cash provided
(used) by operating, investing and financing activities:
|
|
Nine Months Ended
|
|
Liquidity and capital resources
|
|
6/30/2016
|
|
|
6/30/2015
|
|
Net cash used in operating activities
|
|
$
|
(134,948
|
)
|
|
$
|
(224,478
|
)
|
Net cash used in investing activities
|
|
|
–
|
|
|
|
(2,843
|
)
|
Net cash provided by financing activities
|
|
|
74,240
|
|
|
|
199,349
|
|
Net decrease in cash equivalents
|
|
$
|
(60,708
|
)
|
|
$
|
(27,972
|
)
|
At June 30, 2016, we had cash and cash equivalents
of $856 as compared to $61,564 at September 30, 2015, a decrease of $60,708 or 98.6%. The decrease in cash is the direct result
of the net cash used for operating activities of $134,948. The decrease in cash was partially offset by stockholder/officer net
advances of $104,800 during the nine months ended June 30, 2016.
Cash Flows Used in Operating Activities
Net cash used in operating activities
for the nine months ended June 30, 2016, was $134,948 compared to cash used in operations of $224,478 in 2015, a decrease of $89,530
or 39.9%.
During the nine months ended June 30, 2016, we
had a net loss of $105,040 as compared to a net loss of $310,318 for the same period during the prior year.
In the current nine-month period the company
had non-cash expenses for depreciation of $7,347 and bad debt expense of $1,926.
A decrease in accounts receivable
of $170,834, other current assets of $1,538 and, an increase in accrued liabilities of $61,399, and of stockholder/officers advances
for operations of $18,000, were more than offset by an increase in inventory of $15,432, an increase in commission advances of
$516, and a decrease in accounts payable of $275,004.
Cash Flows Used in Investing Activities
There was no cash flow from investing activities
for the period ended June 30, 2016. During the comparable nine- 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 nine months ended June 30, 2016, cash provided by financing
activities was $74,240 compared to cash provided by financing activities of $199,349 during the same period in 2015. During the
current nine-month period, the Company made payment on its term loan of $29,487, on its line of credit of $1,073 and received
stockholder net advances of $104,800. For the nine months ended June 30, 2015, the Company received stockholder net advances of
$28,300 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 nine-months period ended June 30, 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 June 30, 2016, the loan balance is $681,889. 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. The Consolidated Note 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 nine months ended June 30, 2016, we received $104,800
cash advance from Mr. Shrewsbury, bringing the total outstanding advance balance to $229,437. 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 month-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 June 30, 2016, we had cash and cash equivalents of $856 as
compared to $61,564 as of September 30, 2015. The decrease in cash as of June 30, 2016, resulted from a $275,000 decrease in accounts
payable as several invoices became due during the current period. The decrease in payable was partially offset by a decrease in
receivables and an increase in accrued liabilities. During the current nine-month period, we had a net increase in advances from
Mr. Shrewsbury of $104,800.
Our accounts receivable was $412,283 as of June 30, 2016, as compared
to $585,043 as of September 30, 2015, a decrease of $172,760 or 29.5%. The lower June 30, 2016 receivable balance is the direct
result of lower sales due to lower sales demand.
Inventory was $2,238,469 as of June 30, 2016 as compared to $2,223,037
as of September 30, 2015, an increase of $15,432 or 0.7%. Due to lower sales demand, we are maintaining inventory at September
30, 2015 levels.
During the nine months ended June 30, 2016, our accumulated deficit
increased from $14,752,711 to $14,857,751, an increase of $105,040 or 0.7% due to the reported net loss during the nine months
ended June 30, 2016.
During the nine months ended June 30, 2016, the Company’s
net loss was $105,040 compared to a net loss of $310,318 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, lower operating expenses, and a $55,000 loss
from the sale of obsolete inventory sold as scrap during the nine-month period ended June 30, 2015.
Currently, 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 June 30, 2016, the
loan balance was $681.889.
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 obligations under the note or related documents;
|
|
·
|
a
warranty, representation or statement made to the bank under the loan documents 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;
|
|
·
|
a
material adverse change in our financial condition, or the bank believes the prospect
of payment or performance of the loan is impaired or
|
|
·
|
the
bank in good faith believes itself insecure.
|
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:
|
·
|
incur
any indebtedness other than to the bank or for trade debt incurred in the ordinary course;
|
|
·
|
sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber
any of its assets, except for permitted liens;
|
|
·
|
sell
our accounts receivable, except to the bank;
|
|
·
|
engage
in business activities substantially different from our current activities;
|
|
·
|
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;
|
|
·
|
pay
any dividend other than in stock;
|
|
·
|
lend
money, invest or advance money or assets to another person or entity;
|
|
·
|
purchase,
create or acquire an interest in any other entity;
|
|
·
|
incur
any obligation as a surety or guarantor other than in the ordinary course; or
|
|
·
|
enter
into any agreement containing any provision which would be violated or breached by the
performance of our obligations under the loan agreements.
|
Interest under the loan is variable and is based
upon the Wall Street Journal Prime rate, currently 3.50% 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:
|
·
|
we fail to pay
when due any principal or interest under the Consolidated Note;
|
|
·
|
we violate any
covenant or agreement contained in the Consolidated Note, the Exchange Agreement or related
transaction documents;
|
|
·
|
an assignment
for the benefit of creditors by us;
|
|
·
|
the application
for the appointment of a receiver or liquidator for us or our property;
|
|
·
|
the filing of
a petition in bankruptcy by or against us;
|
|
·
|
the issuance
of an attachment or the entry of a judgment against us in excess of $250,000;
|
|
·
|
a default by
us with respect to any other indebtedness or with respect to any installment debt whether
or not owing to Mr. Shrewsbury;
|
|
·
|
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;
|
|
·
|
our termination
of existence or dissolution;
|
|
·
|
the death of
Mr. Shrewsbury; or
|
|
·
|
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.
|
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 June 30, 2016, Mr. Shrewsbury had advanced
an aggregate of $229,437 to the Company. The advances do not bear interest and are repayable upon demand. As of June 30, 2016,
the Company also has a payable of $30,000 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 June 30, 2016 and September 30, 2015.