ITEM
2
.
MANAGEMENT’S DISCUSSION AND ANALYSIS O
F FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
You should read the following summary together with th
e more detailed information
and
consolidated
financial statements and notes thereto and schedules appearing elsewhere in this report.
W
hen we refer to the
“Company
” “
TX Holdings
,” “we,” “our” or “us,” we mean
TX Holdings
, In
c
.,
and its subsidiary
.
The discussion and analysis contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) 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 MD&A 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, 2017, contained an explanatory paragraph in which 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 the Risk Factors section in our Form 10-K for the year ended September 30, 2017, and in this report.
Business and Operational 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 United States’ coal mining companies for use in their production and transportation processes. Our coal mining customers are primarily located in Ohio, Pennsylvania, Kentucky and West Virginia. Our principal executive offices and warehousing facility is located in Ashland, Kentucky.
Recent
Developments in
U.S.
Coal Industry
Due to declining U.S. coal production and bankruptcies and restructurings among certain U.S. coal companies, we experienced a reduction in demand for our mining and rail products during fiscal 2015 and 2016 and the first quarter of fiscal 2017. The demand for, and production of, coal has been adversely affected by several factors, including increased environmental regulation in the U.S., declining coal consumption in the electric power sector, increased competition from natural gas, and a strong U.S. dollar. Commencing in the second fiscal quarter of 2017, demand for our products increased due to U.S. coal production, as discussed below, following a period of production decline.
The U.S. Energy Information Administration (EIA) has reported in its
Short-Term Energy Outlook
(STEO) released March 2018 estimates U.S. coal production was 772 million short tons (MMst) in 2017, 44 MMst (6%) higher than in 2016
The EIA
Short-Term Energy Outlook
(STEO) released April 2018 states that the EIA expects the share of U.S. total utility-scale electricity generation from natural gas fired power plants to rise from 32% in 2017 to 34% in both 2018 and 2019. The forecast generation share from coal in both 2018 and 2019 averages 29%, down from 30% in 2017. The nuclear share of generation was 20% in 2017 and is forecast to average 20% in 2018 and 19% in 2019. Non-hydropower renewables provided slightly less than 10% of electricity generation in 2017 and are expected to provide 10% in 2018 and nearly 11% in 2019. The generation share of hydropower was over 7% in 2017 and is forecast to fall below 7% in both 2018 and 2019.
The EIA forecasts coal production to decline by almost 5% to 736 million short tons (MMst) in 2018 and then increase by 1% to 745 MMst in 2019. Lower expected global demand for U.S. coal exports (down 17% in 2018 and another 5% in 2019) and lower forecasts of coal use in the electric power sector (down 5% in 2018) contribute to the forecast of lower coal production.
U.S. coal exports were 97 MMst in 2017, a 61% increase from the previous year, but they are expected to decrease in both 2018 and 2019. Exports of metallurgical coal, which are used in the steelmaking process, remain at 55 MMst in 2018 and decline to 54 MMst in 2019. Steam coal exports, which were an estimated 42 MMst in 2017, are expected to decline to 26 MMst and 23 MMst in 2018 and 2019, respectively.
Low natural gas prices, warmer-than-normal temperatures during the 2015-16 winter that reduced electricity demand, the retirements of some coal-fired generators, and lower international coal demand had contributed to declining U.S. coal production. As a result, several major U.S. coal producers sought protection under bankruptcy laws or engaged in restructurings of their businesses and operations, and certain plants closed or were or are being sold or operations curtailed.
Continued or renewed distress in the U.S. coal mining industry will materially affect the demand for our products.
The EIA estimates the delivered coal price averaged $2.10 per million British thermal units (MMBtu) in 2017, which was 1 cent/MMBtu lower than the 2016 price. Coal prices are forecast to increase to $2.21/MMBtu in 2018 and to remain at that level in 2019.
Our Business
We purchase mining supplies such as drill bits, augurs and related products from domestic as well as overseas manufacturers and rail material such as tee rail, switches, ties and other rail products from several suppliers of such products and distribute and sell such products to U.S. coal mining companies and other suppliers. Our products are either shipped to our warehouse in Ashland, Kentucky, for distribution to our customers or shipped directly to our customers, including products 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 an independent sales agent who is compensated on a commission basis.
We were incorporated in the State of Georgia in 2000.
Results of Operations
Revenues for the second fiscal quarter of 2018 were $1,098,590 as compared to $923,403 for the same period in 2017, an increase of approximately 19.0%.
Gross profit during the second fiscal quarter of 2018 was $212,046 compared to $118,439 during the same period in 2017. Gross profit in the current quarter increased by 79.0% when compared to the same period in fiscal 2017.
As a percentage of revenue, gross profit increased to 19.3% during the second quarter of fiscal 2018 from 12.8% during the second quarter of fiscal 2017.
During the second fiscal quarter of 2018, we had net income of $47,543 as compared to a net loss of $54,059 for the same period in fiscal 2017.
Liquidity and Capital Resources
At March 31, 2018, cash and cash equivalents were $5,406 compared to $40,345 at September 30, 2017.
Net cash used in operating activities was $15,801 during the six months ended March 31, 2018. Net cash provided by operating activities during the same six-month period in 2017 was $36,366.
There was no cash flow from investing activities for either of the six-month period ended March 31, 2018, or 2017.
During the six months ended March 31, 2018, net cash used in financing activities was $19,138 due to a repayment of $29,638 on our bank term loan and net advances from our CEO, William Shrewsbury in the amount of $10,500.
Mr. William Shrewsbury, our Chairman and CEO, is providing financing to us in the form of a Consolidated Secured Promissory Note of $2,000,000 (“Consolidated Note”) and periodic advances. The principal and interest under the Consolidated Note is due February 24, 2024.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. 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, 2018, Mr. Shrewsbury had also provided non-interest-bearing advances to us of $44,487.
In November 2012, we obtained a bank line of credit of $250,000 which was subsequently increased to $750,000. 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. The loan is secured by a lien on our inventory and accounts receivable and guaranteed by Mr. Shrewsbury. 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, 2018, the loan balance was $576,367.
RESULTS OF OPERATIONS
Results of Operations – For the three months ended
March 31,
2018
, versus the three months ended
March
31
, 201
7
Revenues from Operations
Revenues for the second quarter of fiscal 2018 were $1,098,590 as compared to $923,403 for the same period in fiscal 2017, an increase of $175,187 or 19.0%. The increase in revenues is attributable to higher sales of our rail products
during the current period due to increased or renewed operations at previously downsized or shut-down coal mines as the coal industry experiences increased demand, a more favorable regulatory environment, and due to relatively higher natural gas prices.
Cost of Goods Sold
During the quarter ended March 31, 2018, our cost of goods sold was $886,544 as compared to cost of goods sold of $804,964 for the quarter ended March 31, 2017, an increase of $81,580 or 10.1% due to an increase in sales during the current period. As a percentage of sales, cost of goods sold decreased from 87.2% in 2017 to 80.7% during the current period due to higher sales of a product mix with relatively lower unit cost during the current quarter.
Gross Profit
Gross profit for the period ended March 31, 2018, increased as a percentage of revenue to 19.3% from 12.8% for the same period of the prior fiscal year. The increase in gross profit resulted from a favorable mix of lower cost rail related products with higher margins sold during the current quarter.
Operating Expenses
Operating expenses for the three months ended March 31, 2018 were $132,495 as compared to $142,734 for the three months ended March 31, 2017, a decrease of $10,239 or 7.2%. As a percentage of revenues, operating expenses decreased from 15.5% in 2017 to 12.1% in 2018. The decrease is attributable to the impact of certain operating expenses remaining fixed and also our higher revenue during the second fiscal quarter of 2018.
The table below details the components of operating expenses, as well as the dollar and percentage changes for the comparative three-month periods.
|
|
Three Months Ended
|
|
|
|
3
/31/201
8
|
|
|
3
/31/201
7
|
|
|
$ Change
|
|
|
% Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission expense
|
|
$
|
44,577
|
|
|
$
|
32,839
|
|
|
$
|
11,738
|
|
|
|
35.7
|
|
Professional fees
|
|
|
5,400
|
|
|
|
3,554
|
|
|
$
|
1,846
|
|
|
|
51.9
|
|
Bad debt expense
|
|
|
20
|
|
|
|
–
|
|
|
|
20
|
|
|
|
100.0
|
|
Depreciation expense
|
|
|
1,792
|
|
|
|
2,449
|
|
|
$
|
(657
|
)
|
|
|
(26.8
|
)
|
Other operating expense
|
|
|
80,706
|
|
|
|
103,892
|
|
|
$
|
(23,186
|
)
|
|
|
(22.3
|
)
|
Total
|
|
$
|
132,495
|
|
|
$
|
142,734
|
|
|
$
|
(10,239
|
)
|
|
|
(7.2
|
)
|
Commission expense for the three months ended March 31, 2018, was $44,577 compared to $32,839 for the same period in 2017, an increase of $11,738 or 35.7%. The higher commission expense is a direct result of the 19.0% increase in sales and higher sales margins during the current period.
Professional fees increased $1,846 or 51.9% during the three months ended March 31, 2018 as compared to the same period in 2017. The increase can be attributed to higher legal expenses related to SEC compliance and other compliance related matters.
Bad debt expense of $20 was written-off during the current three-month period. There was no bad debt expense incurred in the same period the prior year.
Depreciation expense as of March 31, 2018, was $1,792, $657 lower than the same period the prior year. The lower depreciation is the result of shipping related equipment becoming fully depreciated.
During the three months ended March 31, 2018, other operating expenses of $80,706 decreased by $23,186 or 22.3% from $103,892 for the same period in 2017. The lower other operating expenses resulted primarily from lower travel related expenses of $6,604, lower truck maintenance expense of $2,824 and lower audit related expense of $3,880.
Income/(l
oss
)
from operations
Income from operations for the quarter ended March 31, 2018 was $79,551 compared to loss from operations of $24,295 during the same period in 2017.When compared to the loss for the same period in the prior year, the loss reduction in the current period is the direct result of increased sales of rail products with a relatively higher sales margins.
Other income and (expense)
Other income and expense for the three months ended March 31, 2018, reflected a net expense of $32,008 as compared to net expense of $29,764 for the quarter ended March 31, 2017. Higher interest expense on our term loan in the current period accounts for the increase in expense.
Net income (loss)
For the quarter ended March 31, 2018, we had net income of $47,543 compared to a net loss of $54,059 for the quarter ended March 31, 2017due to higher sales of rail products, sales of products with higher sales margins, and lower operating expenses.
Net
income (
loss
)
per common share
The net income of $47,543 for the quarter ended March 31, 2018, as well as the net loss of $54,059 for the quarter ended March 31, 2018, when divided by the number of common shares outstanding of 48,053,084 basic shares in both years resulted in a net income and loss per share of less than $0.01 in both periods.
Results of operations – For the six months ended March 31, 201
8
versus the six months ended March 31, 201
7
Revenues from Operations
Revenue for the six months ended March 31, 2018 was $2,098,066 as compared to $1,420,320 for the same period in 2017, an increase of $677,746 or 47.73%. The increase in revenues is attributable to higher sales of our rail related products during the current period due to increased or renewed operations at previously downsized or shut-down coal mines as the coal industry experiences increased demand, a more favorable regulatory environment, and due to relatively higher natural gas prices.
Cost of Goods Sold
During the six months ended March 31, 2018, our cost of goods sold was $1,745,998 as compared to cost of goods sold of $1,201,777 for the six months ended March 31, 2017, an increase of $544,231 or 45.3%due to higher sales during the current period. As a percentage of sales, cost of goods sold decreased from 84.6%% in 2017 to 83.2% during the current period, a decrease of approximately 1.4% as a result of sales of our products with lower cost due to purchases of certain products at lower cost from a new supplier and higher sales of a product mix with relatively lower unit cost during the current period.
Gross Profit
Gross profit for the period ended March 31, 2018, increased as a percentage of revenue to 16.8% from 15.4% for the same period of the prior year, or approximately 1.4%. The increase in gross profit resulted from sales of certain products with a lower cost from a new supplier during the current period.
Operating Expenses
Operating expenses for the six months ended March 31, 2018 were $278,606 as compared to $271,615 for the six months ended March 31, 2017, an increase of $6,991 or 2.6%.
The following table details the components of operating expenses as well as the dollar and percentage changes for the comparative three-month periods.
|
|
Six Months Ended
|
|
|
|
3/31/2018
|
|
|
3/31/2017
|
|
|
$ Change
|
|
|
% Change
|
|
Operating Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commission expense
|
|
$
|
86,179
|
|
|
$
|
56,356
|
|
|
$
|
29,823
|
|
|
|
52.9
|
|
Professional fees
|
|
|
16,900
|
|
|
|
7,620
|
|
|
$
|
9,280
|
|
|
|
121.8
|
|
Bad debt expense
|
|
|
20
|
|
|
|
905
|
|
|
|
(885
|
)
|
|
|
(97.8
|
)
|
Depreciation expense
|
|
|
3,584
|
|
|
|
4,898
|
|
|
$
|
(1,314
|
)
|
|
|
(26.8
|
)
|
Other operating expense
|
|
|
171,923
|
|
|
|
201,836
|
|
|
$
|
(29,913
|
)
|
|
|
(14.8
|
)
|
Total
|
|
$
|
278,606
|
|
|
$
|
271,615
|
|
|
$
|
6,991
|
|
|
|
2.6
|
|
Commission expense for the six months ended March 31, 2018, was $86,179 compared to $56,356 for the same period in 20176, an increase of $29,823 or 52.9%. The higher commission expense is a direct result of higher sales and gross margins in the current period.
Professional fees increased $9,280 or 121.8% during the six months ended March 31, 2018, as compared to the same period in 2017. The increase in expense can be attributed to higher legal expenses of $9,280 related to SEC compliance and other compliance related matters.
Bad debt expense for the six- month period ended March 31, 2018 was $20 as compared to $905 for the same period in 2017, a decrease of $885 or 97.8%.
Depreciation expense of $3,584 for the six months ended March 31, 2018, was lower by $1,314 than for the same six-month period the prior year. The lower depreciation is the result of shipping related equipment becoming fully depreciated.
During the six months ended March 31, 2018, other operating expenses of $171,923 decreased by $29,913 or 14.82% from $201,836 for the same period in 2017. The lower other operating expenses resulted primarily from lower payroll and payroll taxes of $30,934 during the current six-month period.
Income/(l
oss
)
from operations
Income from operations for the six months ended March 31, 2018 was $73,462 compared to loss from operations of $53,072 during the same period in 2017. When compared to the loss for the same period in the prior year, the income in the current period is the direct result of higher sales, higher sales margins and, lower operating expenses.
Other
income and
(
expense
)
Other income for the current six-month period increased by $6,476 due to scrap sales sold. Interest expense for the six months ended March 31, 2018, reflected a $63,916 expense as compared to $61,644 expense for the six months ended March 31, 2017, an increase of $2,272 due to higher interest expense under our bank term loan resulting from an increase in the rate of interest under such loan.
Net income/
(
loss)
For the six months ended March 31, 2018, we had net income of $16,022 compared to a net loss of $114,716 for the six months ended March 31, 2017, a difference of $130,738. The net income (as opposed to a net loss in the prior period) was a result of higher sales, sales of products with higher sales margins and lower operating expenses.
Net
earnings/
(
loss
)
per common share
The net income of $16,022 for the six months ended March 31, 2018, as well as the net loss of $114,716 for the six months ended March 31, 2017, when divided by the number of common shares outstanding of 48,053,084 basic shares in both periods resulted in a net income and loss per share of less than $0.01 in both periods.
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
|
|
|
|
3/31/2018
|
|
|
3/31/2017
|
|
Liquidity and capital resources
|
|
|
|
|
|
|
|
|
Net cash provided /(used) in operating activities
|
|
$
|
(15,801
|
)
|
|
$
|
36,366
|
|
Net cash provide/(used) in investing activities
|
|
|
–
|
|
|
|
–
|
|
Net cash provided/(used) in financing activities
|
|
|
(19,138
|
)
|
|
|
(17,227
|
)
|
Increase/(decrease) in cash equivalents
|
|
$
|
(34,939
|
)
|
|
$
|
19,139
|
|
At March 31, 2018, we had cash and cash equivalents of $5,406 as compared to $40,345 at September 30, 2017, a decrease of $34,939 or 86.6%.
Cash
Flows
Provided/
(
Used
)
in
Operating Activities
Net cash used in operating activities for the six-months ended March 31, 2018, was $15,801 compared to cash provided of $36,366 in 2017, a decrease of $52,167.
During the six months ended March 31, 2018, we had a net income of $16,022 as compared to a net loss of $114,716 for the same period in the prior year.
In the current six-month period, the Company had non-cash expenses for depreciation of $3,584 and $20 bad debt expense.
An increase in accounts receivable of $162,620 was partially offset by an increase in accounts payable of $87,771, a decrease in inventory of $4,441 and a decrease in commission advance of $18,680. Other current assets decreased by $836 due to a decrease in employee’s advances.
Cash
Flows
P
rovided/
(U
s
ed
)
in
Investing Activities
There was no cash flow used in investing activities for the period ended March 31, 2018 or 2017.
Cash Flows P
rovided/
(U
s
ed)
in
Financing Activities
During the six months ended March 31, 2018, cash used in financing activities was $19,138 compared to cash used by financing activities of $17,227 during the same period in 2017. During the current six-month period, the Company made payment on its term loan of $29,638 and received net advances from our CEO of $10,500.
On December 3, 2015, we entered into a new fixed term loan agreement with a bank of $711,376 the proceeds of which were used to repay our previous line of credit. The loan is for a term of five years and matures on December 3, 2020. As of March 31, 2018, the loan balance was $576,367. The current rate of interest under the loan is 4.50% per annum. Principal, interest and collection costs under the loan are guaranteed by Mr. Shrewsbury.
On February 25, 2014, we issued to Mr. Shrewsbury a Consolidated Secured Promissory Note (“Consolidated Note”) to consolidate an aggregate of $2,000,000 in outstanding debt and unpaid interest due to Mr. Shrewsbury. The Consolidated Note bears interest at 5% per annum or prime rate if higher than 5% per annum and 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 six months ended March 31, 2018, we received advances of $186,000 from Mr. Shrewsbury and repaid $175,500 in cash advances to Mr. Shrewsbury, bringing the total outstanding advance balance to $44,487. Cash advances from Mr. Shrewsbury are repayable upon demand and do not bear interest.
As of March 31, 2018, the Company had an accrued liability in the amount of $396,179 due to Jose Fuentes, CFO, for past services.
Financial Condition and Going Concern Uncertainties
Since inception, the Company, with a few exceptions including during the three and six months ended March 31, 2018, has not generated sufficient cash to fund its operations and has incurred operating losses and as of March 31, 2018, the Company’s accumulated deficit was $15,539,914. Currently, in addition to funds from operations, the Company relies substantially upon financing provided by Mr. Shrewsbury, the Company’s Chief Executive Officer, and a secured bank loan that is guaranteed by Mr. Shrewsbury to finance its business operations. In view of these matters, realization of certain assets in the accompanying balance sheet is dependent upon continued operations which are 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 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, 2017, contained an explanatory paragraph in which our auditors 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, 2018, we had cash and cash equivalents of $5,406 as compared to $40,345 as of September 30, 2017.
Our accounts receivable was $620,843 as of March 31, 2018, as compared to $458,203 as of September 30, 2017, an increase of $162,640 or 35.55%. The higher March 31, 2018 receivable balance is the direct result of a 47.7% increase in the current period sales as compared to 2017.
Inventory was $1,685,909 as of March 31, 2018, as compared to $1,690,350 as of September 30, 2017, a decrease of $4,441 or 0.2%. The inventory decrease can be directly attributed to an increase in sales demand for rail related products during the current fiscal period.
Accounts payable for the six months ended March 31, 2018, were $742,544 as compared to $654,773 as of September 30, 2017, an increase of $87,771 or 13.4%. The increase in accounts payable is due to increased inventory purchases in response to higher sales demand.
During the six months ended March 31, 2018, our accumulated deficit decreased from $15,555,936 to $15,539,914, an increase of $16,022 due to the reported net income during the six months ended March 31, 2018.
During the six months ended March 31, 2018, the Company’s net income was $16,022 compared to a net loss of $114,716 for the comparable period in 2017. The net income is due to increased sales of our rail and mining related products, including products with higher sales margins, partially offset by marginally higher operating expenses of $6,991.
Currently, in addition to product purchases for resale, we are spending approximately $50,000 per month on operations. Management believes that the Company’s available cash, cash flows from operations, loans and advances provided by Mr. Shrewsbury, and the loan provided by the bank to be sufficient to fund the Company’s 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
On December 3, 2015, we obtained a term loan from Town Square Bank of $711,376. We used 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, 2018, the loan balance was $576,367.
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, estimated to be approximately $391,896. Early repayment of 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;
|
|
●
|
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.
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The loan agreements contain 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 other customary covenants, terms and conditions.
In addition, the loan agreements contain 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 our 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 4.50% 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
Since 2006, Mr. Shrewsbury, our Chairman and CEO, has provided financing to us in the form of demand notes and advances.
Mr. Shrewsbury, our Chairman and CEO, has 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 under which an aggregate of $2,000,000 of our indebtedness (including amounts of accrued interest) to Mr. Shrewsbury was consolidated and restructured and we issued in exchange for the indebtedness a Consolidated Secured Promissory Note (the “Consolidated Note) in the principal amount of $2,000,000.
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 life 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. As of March 31, 2018, accrued interest on the note was $409,589.
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;
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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.
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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 were exercisable commencing April 1, 2014, and for a period of three years thereafter. The options were exercisable at a price of $0.0924 per share subject to 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. The options expired on March 31, 2017.
As of March 31, 2018, Mr. Shrewsbury had advanced an aggregate of $44,487 to the Company. The advances do not bear interest and are repayable upon demand. As of March 31, 2018, the Company also has a payable of $72,000 to Mr. Shrewsbury for warehouse storage rental.
The Consolidated Note and advances are subordinate to the Company’s bank indebtedness.
O
ff-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, 2018 and September 30, 2017.