AMCON Distributing Company - 10-Q quarterly report FY2014 Q2

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2014

OR

For the transition period from                to                

Commission File Number 1-15589

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (402) 331-3727

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes o  No x

The Registrant had 611,432 shares of its $.01 par value common stock outstanding as of April 14, 2014.

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PART I — FINANCIAL INFORMATION

Item 1.                       Financial Statements

AMCON Distributing Company and Subsidiaries

Condensed Consolidated Balance Sheets

March 31, 2014 and September 30, 2013

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

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AMCON Distributing Company and Subsidiaries

Condensed Consolidated Unaudited Statements of Operations

for the three and six months ended March 31, 2014 and 2013

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

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AMCON Distributing Company and Subsidiaries

Notes to Condensed Consolidated Unaudited Financial Statements

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

AMCON Distributing Company and Subsidiaries (“AMCON” or the “Company”) operate two business segments:

·              Our wholesale distribution segment (“Wholesale Segment”) distributes consumer products in the Central, Rocky Mountain, and Southern regions of the United States. Additionally, our Wholesale Segment provides a full range of programs and services to assist our customers in managing their business and profitability.

·              Our retail health food segment (“Retail Segment”) operates sixteen health food retail stores located throughout the Midwest and Florida.

WHOLESALE SEGMENT

Our Wholesale Segment is one of the largest wholesale distributors in the United States serving approximately 4,500 retail outlets including convenience stores, grocery stores, liquor stores, drug stores, and tobacco shops. We currently distribute over 16,000 different consumer products, including cigarettes and tobacco products, candy and other confectionery, beverages, groceries, paper products, health and beauty care products, frozen and chilled products and institutional foodservice products. We also provide a full range of consultative services to our customers in the areas of marketing, merchandising, inventory optimization, and information systems that allow our customers to compete and maximize their profitability. Convenience stores represent our largest customer category.  In October 2013, Convenience Store News ranked us as the seventh (7th) largest convenience store distributor in the United States based on annual sales.

Our Wholesale Segment operates six distribution centers located in Illinois, Missouri, Nebraska, North Dakota, South Dakota, and Tennessee. These distribution centers, combined with cross dock facilities, include approximately 602,000 square feet of permanent floor space. Our principal suppliers include Altria, RJ Reynolds, Commonwealth Brands, Lorillard, Hershey, Kellogg’s, Kraft, and Mars. We also market private label lines of water, candy products, batteries, film, and other products. The Company does not maintain long term purchase contracts with its suppliers.

RETAIL SEGMENT

Our Retail Segment is a specialty retailer of natural/organic groceries and dietary supplements which focuses on providing high quality products at affordable prices, with an exceptional level of customer service and nutritional consultation. All of the products carried in our stores must meet strict quality and ingredient guidelines, and include offerings such as gluten-free and antibiotic-free groceries and meat products, as well as products containing no artificial colors, flavors, preservatives, or partially hydrogenated oils. We design our retail sites in an efficient and flexible small-store format, which emphasizes a high energy and shopper-friendly environment.

We operate within the natural products retail industry, which is a subset of the large and stable U.S. grocery industry. This industry includes conventional, natural, gourmet and specialty food markets, mass and discount retailers, warehouse clubs, health food stores, dietary supplement retailers, drug stores, farmers markets, mail order and online retailers, and multi-level marketers. According to The Natural Foods Merchandiser, a leading industry trade publication, retail sales in the natural foods industry exceeded $80 billion during the 2012 calendar year.

Our Retail Segment operates sixteen retail health food stores as Chamberlin’s Market & Café and Akin’s Natural Foods Market. These stores carry over 32,000 different national and regionally branded and private label products including high-quality natural, organic, and specialty foods consisting of produce, baked goods, frozen foods, nutritional supplements, personal care items, and general merchandise. Chamberlin’s, which was established in 1935, operates six stores in and around Orlando, Florida. Akin’s, which was also established in 1935, has a total of ten locations in Arkansas, Kansas, Missouri, Nebraska, and Oklahoma.

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In the event of a liquidation of the Company, the holders of the Preferred Stock would be entitled to receive the liquidation preference plus any accrued and unpaid dividends prior to the distribution of any amount to the holders of the Common Stock. The shares of Preferred Stock are optionally redeemable by the Company beginning on various dates, as listed in the above table, at redemption prices equal to 112% of the liquidation preference. The redemption prices decrease 1% annually thereafter until the redemption price equals the liquidation preference, after which date it remains the liquidation preference. The Preferred Stock is redeemable at the liquidation value and at the option of the holder.  The Series A Preferred Stock and 8,000 shares of the Series B Preferred Stock are owned by Mr. Christopher Atayan, AMCON’s Chief Executive Officer and Chairman of the Board.  The Series B Preferred Stockholders have the right to elect one member of our Board of Directors, pursuant to the voting rights in the Certificate of Designation creating the Series B.  Mr. Atayan was first nominated and elected to this seat in 2004.

4. INVENTORIES

At March 2014, inventories consisted of finished goods and are stated at the lower of cost determined on a First-in, First-out (“FIFO”) basis, or market. The wholesale distribution and retail health food segment inventories consist of finished products purchased in bulk quantities to be redistributed to the Company’s customers or sold at retail. Finished goods included total reserves of approximately $0.8 million at both March 2014 and September 2013. These reserves include the Company’s obsolescence allowance, which reflects estimated unsalable or non-refundable inventory based upon an evaluation of slow moving and discontinued products.

5. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill by reporting segment of the Company consisted of the following:

Other intangible assets of the Company consisted of the following:

Goodwill, trademarks and tradenames are considered to have indefinite useful lives and therefore no amortization has been taken on these assets. At March 2014, identifiable intangible assets considered to have finite lives were represented by customer relationships and the value of a non-competition agreement acquired as part of acquisitions. The customer relationships are being amortized over eight years and the value of the non-competition agreement is being amortized over five years. These intangible assets are evaluated for accelerated attrition or amortization adjustments if warranted.  Amortization expense related to these assets was $0.1 million and $0.2 million for the three and six month periods ended March 2014, respectively, and $0.1 million and $0.2 million for the three and six month periods ended March 2013, respectively.

Estimated future amortization expense related to identifiable intangible assets with finite lives is as follows at March 2014:

(1) Represents amortization for the remaining six months of Fiscal 2014.

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6. DIVIDENDS

The Company paid cash dividends on its common stock and convertible preferred stock totaling $0.2 million and $0.3 million for the three and six month periods ended March 2014, respectively, and $0.2 million and $0.3 million for the three and six month periods ended March 2013, respectively.

7. EARNINGS PER SHARE

Basic earnings per share available to common shareholders is calculated by dividing net income less preferred stock dividend requirements by the weighted average common shares outstanding for each period. Diluted earnings per share available to common shareholders is calculated by dividing net income less preferred stock dividend requirements (when anti-dilutive) by the sum of the weighted average common shares outstanding and the weighted average dilutive options, using the treasury stock method.

(1)              Diluted earnings per share calculation includes all stock options, convertible preferred stock, and restricted stock deemed to be dilutive.

(2)              Diluted earnings per share calculation excludes dividends for convertible preferred stock deemed to be dilutive, as those amounts are assumed to have been converted to common stock of the Company.

(1)              Diluted earnings per share calculation includes all stock options, convertible preferred stock, and restricted stock units deemed to be dilutive.

(2)              Diluted earnings per share calculation excludes dividends for convertible preferred stock deemed to be dilutive, as those amounts are assumed to have been converted to common stock of the Company.

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8. DEBT

The Company primarily finances its operations through a credit facility provided under an agreement with Bank of America (the “Facility”).  The Facility included the following significant terms at March 2014:

·                  A July 2018 maturity date without a penalty for prepayment.

·                  $70.0 million revolving credit limit.

·                  Loan accordion allowing the Company to increase the size of the credit facility agreement by $25.0 million.

·                  A provision providing an additional $10.0 million of credit advances for certain inventory purchases.

·                  Evergreen renewal clause automatically renewing the agreement for one year unless either the borrower or lender provides written notice terminating the agreement at least 90 days prior to the end of any original or renewal term of the agreement.

·                  The Facility bears interest at either the bank’s prime rate, or at LIBOR plus 125 - 175 basis points depending on certain credit facility utilization measures, at the election of the Company.

·                  Lending limits subject to accounts receivable and inventory limitations.

·                 An unused commitment fee equal to one-quarter of one percent (1/4%) per annum on the difference between the maximum loan limit and average monthly borrowings.

·                  Secured by collateral including all of the Company’s equipment, intangibles, inventories, and accounts receivable.

·                  A financial covenant requiring a fixed charge coverage ratio of at least 1.0 as measured by the previous twelve month period then ended only if excess availability falls below 10% of the maximum loan limit as defined in the credit agreement.

·                  Provides that the Company may not pay dividends on its common stock in excess of $1.00 per share on an annual basis.  There is, however, no limit on common stock dividends if certain excess availability measurements have been maintained for the thirty day period immediately prior to the payment of any such dividends or distributions and if immediately after giving effect to any such dividend or distribution payments the Company has a Fixed Charge Coverage Ratio of at least 1.10 to 1.0 as defined in the credit facility agreement.

Cross Default and Co-Terminus Provisions

The Company’s owned real estate in Bismarck, ND, Quincy, IL, and Rapid City, SD, is financed through a term loan with BMO Harris, NA (“BMO”) which is also a participant lender on the Company’s revolving line of credit. The BMO loan contains cross default provisions which cause the loan with BMO to be considered in default if the loans where BMO is the lender, including the revolving credit facility, is in default. There were no such cross defaults at March 2014. In addition, the BMO loan contains co-terminus provisions which require all loans with BMO to be paid in full if any of the loans are paid in full prior to the end of their specified terms.

Other

AMCON has issued a letter of credit in the amount of approximately $0.4 million to its workers’ compensation insurance carrier as part of its self-insured loss control program.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements.

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9. EQUITY-BASED INCENTIVE AWARDS

Omnibus Plan

The Company has an Omnibus Incentive Plan (“the Omnibus Plan”) which provides for equity incentives to employees. The Omnibus Plan was designed with the intent of encouraging employees to acquire a vested interest in the growth and performance of the Company. The Omnibus Plan permits the issuance of up to 150,000 shares of the Company’s common stock in the form of stock options, restricted stock awards, restricted stock units, performance share awards as well as awards such as stock appreciation rights, performance units, performance shares, bonus shares, and dividend share awards payable in the form of common stock or cash. The number of shares issuable under the Omnibus Plan is subject to customary adjustments in the event of stock splits, stock dividends, and certain other distributions on the Company’s common stock.  At March 2014, awards with respect to a total of 147,700 shares, net of forfeitures, had been awarded pursuant to the Omnibus Plan and awards with respect to another 2,300 shares may be awarded under the plan.

Stock Options

The stock options issued by the Company expire ten years from the grant date and include graded vesting schedules ranging between three and five years. Stock options issued and outstanding at March 2014 are summarized as follows:

Restricted Stock Units

At March 2014, nonvested restricted stock units awarded pursuant to the Company’s Omnibus Plan were as follows:

(1)                                 10,600 of the restricted stock units were vested as of March 2014. The remaining 5,300 restricted stock units will vest on October 25, 2014.

(2)                                 5,000 of the restricted stock units were vested as of March 2014.  The remaining 10,000 restricted stock units will vest in equal amounts on October 23, 2014 and October 23, 2015.

(3)                                 14,000 restricted stock units will vest in equal amounts on October 22, 2014, October 22, 2015, and October 22, 2016.  The remaining 3,900 restricted stock units will vest in equal amounts on October 22, 2014, October 22, 2015, October 22, 2016, October 22, 2017, and October 22, 2018.

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10. BUSINESS SEGMENTS

AMCON has two reportable business segments: the wholesale distribution of consumer products and the retail sale of health and natural food products. The retail health food stores’ operations are aggregated to comprise the Retail Segment because such operations have similar economic characteristics, as well as similar characteristics with respect to the nature of products sold, the type and class of customers for the health food products and the methods used to sell the products. Included in the “Other” column are intercompany eliminations, and assets held and charges incurred by our holding company. The segments are evaluated on revenues, gross margins, operating income (loss), and income before taxes.

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Item 2.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the Management’s Discussion and Analysis and other sections, contains forward-looking statements that are subject to risks and uncertainties and which reflect management’s current beliefs and estimates of future economic circumstances, industry conditions, company performance and financial results. Forward-looking statements include information concerning the possible or assumed future results of operations of the Company and those statements preceded by, followed by or that include the words “future,” “position,” “anticipate(s),” “expect,” “believe(s),” “see,” “plan,” “further improve,” “outlook,” “should” or similar expressions. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions.

You should understand that the following important factors, in addition to those discussed elsewhere in this document, could affect the future results of the Company and could cause those results to differ materially from those expressed in our forward-looking statements:

·                  increases in state and federal excise taxes on cigarette and tobacco products,

·                  the increasing demand and sales of electronic cigarettes over the internet,

·                  increasing health care costs and the potential impact on discretionary consumer spending,

·                  changes in laws and regulations and ongoing compliance with the Patient Protection and Affordable Care Act,

·                  increasing competition in our retail health food segment,

·                  the expansion of large and well capitalized national and regional health food retail store chains,

·                  integration risk related to acquisitions or other efforts to expand,

·                  higher commodity prices which could impact food ingredient costs for many of the products we sell,

·                  regulation of cigarette and tobacco products by the FDA, in addition to existing state and federal regulations by other agencies,

·                  potential bans or restrictions imposed by the FDA on the manufacture, distribution, and sale of certain cigarette and tobacco products,

·                  increases in manufacturer prices,

·                  increases in inventory carrying costs and customer credit risk,

·                  changes in promotional and incentive programs offered by manufacturers,

·                  decreased availability of capital resources,

·                  demand for the Company’s products, particularly cigarette and tobacco products,

·                  new business ventures or acquisitions,

·                  the opening of new health food retail stores,

·                  domestic regulatory and legislative risks,

·                  increasing competition in our wholesale segment,

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·                  poor weather conditions,

·                  increases in fuel prices,

·                  consolidation trends within the retail health food, convenience store, and wholesale distribution industries,

·                  natural disasters and domestic unrest,

·                  other risks over which the Company has little or no control, and any other factors not identified herein.

Changes in these factors could result in significantly different results. Consequently, future results may differ from management’s expectations. Moreover, past financial performance should not be considered a reliable indicator of future performance. Any forward-looking statement contained herein is made as of the date of this document. Except as required by law, the Company undertakes no obligation to publicly update or correct any of these forward-looking statements in the future to reflect changed assumptions, the occurrence of material events or changes in future operating results, financial conditions or business over time.

CRITICAL ACCOUNTING ESTIMATES

Certain accounting estimates used in the preparation of the Company’s financial statements require us to make judgments and estimates and the financial results we report may vary depending on how we make these judgments and estimates. Our critical accounting estimates are set forth in our annual report on Form 10-K for the fiscal year ended September 30, 2013, as filed with the Securities and Exchange Commission. There have been no significant changes with respect to these policies during our fiscal quarter ended March 2014.

SECOND FISCAL QUARTER 2014 (Q2 2014)

The following discussion and analysis includes the Company’s results of operations for the three and six months ended March 2014 and March 2013.

Wholesale Segment

Our Wholesale Segment is one of the largest wholesale distributors in the United States serving approximately 4,500 retail outlets including convenience stores, grocery stores, liquor stores, drug stores, and tobacco shops. We currently distribute over 16,000 different consumer products, including cigarettes and tobacco products, candy and other confectionery, beverages, groceries, paper products, health and beauty care products, frozen and chilled products and institutional foodservice products. We also provide a full range of consultative services to our customers in the areas of marketing, merchandising, inventory optimization, and information systems that allow our customers to compete and maximize their profitability. Convenience stores represent our largest customer category. In October 2013, Convenience Store News ranked us as the seventh (7th) largest convenience store distributor in the United States based on annual sales.

Our Wholesale Segment operates six distribution centers located in Illinois, Missouri, Nebraska, North Dakota, South Dakota, and Tennessee. These distribution centers, combined with cross-dock facilities, include approximately 602,000 square feet of permanent floor space. Our principal suppliers include Altria, RJ Reynolds, Commonwealth Brands, Lorillard, Hershey, Kellogg’s, Kraft, and Mars. We also market private label lines of water, candy products, batteries, film, and other products.  The Company does not maintain long term purchase contracts with its suppliers.

Retail Segment

Our Retail Segment is a specialty retailer of natural/organic groceries and dietary supplements which focuses on providing high quality products at affordable prices, with an exceptional level of customer service and nutritional consultation. All of the products carried in our stores must meet strict quality and ingredient guidelines, and include offerings such as gluten-free and antibiotic-free groceries and meat products, as well as products containing no artificial colors, flavors, preservatives, or partially hydrogenated oils. We design our retail sites in an efficient and flexible small-store format, which emphasizes a high energy and shopper-friendly environment.

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Our management team is focused on a number of initiatives in our retail segment. These efforts include a number of merchandising and marketing strategies designed to promote customer retention and attract a new generation of younger customers who are increasingly embracing natural products, as well as reconfiguring certain aspects of our procurement processes.

For over seventy-five years, our health food stores have succeeded with a simple value proposition; helping our customers maintain good health. While consumer tastes and product offerings will evolve and change over time, we believe our customer focused philosophy will remain attractive.

RESULTS OF OPERATIONS — THREE MONTHS ENDED MARCH 2014

(1)              Sales are reported net of costs associated with incentives provided to retailers. These incentives totaled $4.8 million in Q2 2014 and $4.6 million in Q2 2013.

SALES

Changes in sales are driven by two primary components:

(i)         changes to selling prices, which are largely controlled by our product suppliers, and excise taxes imposed on cigarettes and tobacco products by various states; and

(ii)      changes in the volume of products sold to our customers, either due to a change in purchasing patterns resulting from   consumer preferences or the fluctuation in the comparable number of business days in our reporting period.

SALES — Q2 2014 vs. Q2 2013

Sales in our Wholesale Segment decreased $1.5 million during Q2 2014 as compared to Q2 2013. Significant items impacting sales during Q2 2014 included a $8.3 million decrease in sales primarily related to the volume and mix of cigarette cartons sold.  This decrease was partially offset by a $5.4 million increase in sales related to price increases implemented by cigarette manufacturers, and a $1.4 million increase in sales related to higher sales in our tobacco, beverage, snacks, candy, grocery, health & beauty products, automotive, food service, and store supplies categories (“Other Products”).

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Q2 2014 sales in our Retail Segment decreased $0.7 million as compared to Q2 2013.  During Q2 2014, sales at our existing retail locations decreased $1.6 million, primarily related to lower sales volumes resulting from competitive conditions in the markets we operate.  This decrease was partially offset by a $0.9 million increase in sales from new store openings.

GROSS PROFIT — Q2 2014 vs. Q2 2013

Our gross profit does not include fulfillment costs and costs related to the distribution network which are included in selling, general and administrative costs, and may not be comparable to those of other entities. Some entities may classify such costs as a component of cost of sales. Cost of sales, a component used in determining gross profit, for the wholesale and retail segments includes the cost of products purchased from manufacturers, less incentives we receive which are netted against such costs.  Gross profit in our Wholesale Segment decreased $0.3 million in Q2 2014 as compared to Q2 2013. This decrease in gross profit was primarily related to the volume and mix of cigarette cartons sold.

Q2 2014 gross profit in our Retail Segment decreased $0.4 million as compared to Q2 2013.  This change was primarily related to lower sales volume in our existing stores, partially offset by gross profit generated by the new health food stores added between the comparative periods.

OPERATING EXPENSE — Q2 2014 vs. Q2 2013

Operating expense includes selling, general and administrative expenses and depreciation and amortization. Selling, general, and administrative expenses include costs related to our sales, warehouse, delivery and administrative departments for all segments. Specifically, purchasing and receiving costs, warehousing costs and costs of picking and loading customer orders are all classified as selling, general and administrative expenses. Our most significant expenses relate to employee costs, facility and equipment leases, transportation costs, fuel costs, insurance, and professional fees.  Q2 2014 operating expenses increased $0.4 million as compared to Q2 2013. Of this increase, approximately $0.4 million related to operating costs associated with new health food store openings and $0.2 million related to higher health insurance costs.  These increases were partially offset by a $0.2 million decrease in other operating expenses.

RESULTS OF OPERATIONS — SIX MONTHS ENDED MARCH 2014:

(1)                       Sales are reported net of costs associated with incentives provided to retailers. These incentives totaled $9.7 million for the six month ended March 2014 and $9.2 million for the six months ended March 2013.

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SALES — Six months Ended March 2014

Sales in our Wholesale Segment increased $2.1 million for the six months ended March 2014 as compared to the same prior year period.  Significant items impacting sales for the six months ended March 2014 included a $11.2 million increase in sales related to price increases implemented by cigarette manufacturers and a $5.6 million increase in sales related to higher sales in our tobacco, beverage, snacks, candy, grocery, health & beauty products, automotive, food service, and store supplies categories (“Other Products”).  These increases were partially offset by a $14.7 million decrease in sales related to the volume and mix of cigarette cartons sold.

Sales in our Retail Segment for the six months ended March 2014 decreased $0.9 million as compared to the same prior year period. For the six month period ended March 2014, sales at our existing retail locations decreased $2.4 million, primarily related to lower sales volumes resulting from competitive conditions in the markets we operate. This decrease was partially offset by a $1.5 million increase in sales from new store openings.

GROSS PROFIT — Six months Ended March 2014

Our gross profit does not include fulfillment costs and costs related to the distribution network which are included in selling, general and administrative costs, and may not be comparable to those of other entities. Some entities may classify such costs as a component of cost of sales. Cost of sales, a component used in determining gross profit, for the wholesale and retail segments includes the cost of products purchased from manufacturers, less incentives we receive which are netted against such costs.

Gross profit in our Wholesale Segment increased $0.1 million for the six month period ended March 2014 as compared to the same prior year period. This change was primarily related to a $0.4 million increase in our Other Product category gross profit, partially offset by a $0.3 million decrease in gross profit related to the volume and mix of cigarette cartons sold.

Gross profit in our Retail Segment increased $0.4 million for the six month period ended March 2014 as compared to the same prior year period.  This change was primarily related to lower sales volume in our existing stores, partially offset by gross profit generated by the new health food stores added between the comparative periods.

OPERATING EXPENSE — Six months Ended March 2014

Operating expense includes selling, general and administrative expenses and depreciation and amortization. Selling, general, and administrative expenses include costs related to our sales, warehouse, delivery and administrative departments for all segments. Specifically, purchasing and receiving costs, warehousing costs and costs of picking and loading customer orders are all classified as selling, general and administrative expenses. Our most significant expenses relate to employee costs, facility and equipment leases, transportation costs, fuel costs, insurance, and professional fees. Operating expenses increased $1.1 million during the six months ended March 2014 as compared to the same prior year period.  Of this increase, approximately $0.7 million related to operating costs associated with new health food store openings and $0.8 million related to higher health insurance costs.  These increases were partially offset by a $0.4 million decrease in other operating expenses.

LIQUIDITY AND CAPITAL RESOURCES

Overview

·                  General. The Company requires cash to pay operating expenses, purchase inventory, and make capital investments.  In general, the Company finances its cash flow requirements with cash generated from operating activities and credit facility borrowings.

·                  Operating Activities. The Company generated cash of approximately $0.1 million from operating activities during the six months ended March 2014. Significant uses of cash during the period included an increase in inventory and reductions in accounts payable, accrued expenses and wages, and income tax payable. These uses of cash were offset by net earnings during the period and a reduction in accounts receivable.

Our variability in cash flows from operating activities is dependent on the timing of inventory purchases and seasonal fluctuations.  For example, periodically we have inventory “buy-in” opportunities which offer more favorable pricing terms. As a result, we may have to hold inventory for a period longer than the payment terms. This generates a cash outflow from operating activities which we expect to reverse in later periods. Additionally, during the warm weather months, which is our peak time of operations, we generally carry higher amounts of inventory to ensure high fill rates and customer satisfaction.

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·                  Investing Activities. The Company used approximately $1.8 million of cash during the six month period ended March 2014.  Of this amount, approximately $1.3 million related to capital expenditures for property and equipment and $0.5 million related to the acquisition discussed in Note 2.

·                  Financing Activities. The Company generated cash of $1.9 million from financing activities during the six month period ended March 2014.  Of this amount, approximately $4.9 million related to net borrowings on the Company’s credit facility.  These borrowings were offset by $0.6 million in long-term debt repayments, $1.9 million related to the repurchase of shares of the Company’s common stock and Series B Convertible Preferred Stock, $0.4 million related to dividends on the Company’s common and preferred stock, and $0.1 million related to equity-based awards.

·                  Cash on Hand/Working Capital.  At March 2014, the Company had cash on hand of $0.4 million and working capital (current assets less current liabilities) of $58.6 million. This compares to cash on hand of $0.3 million and working capital of $53.4 million at September 2013.

Credit Agreement

The Company primarily finances its operations through a credit agreement (the “Facility”) with Bank of America. The Facility included the following significant terms at March 2014:

·                  A July 2018 maturity date without a penalty for prepayment.

·                  $70.0 million revolving credit limit.

·                  Loan accordion allowing the Company to increase the size of the credit facility agreement by $25.0 million.

·                  A provision providing an additional $10.0 million of credit advances for certain inventory purchases.

·                  Evergreen renewal clause automatically renewing the agreement for one year unless either the borrower or lender provides written notice terminating the agreement at least 90 days prior to the end of any original or renewal term of the agreement.

·                  The Facility bears interest at either the bank’s prime rate, or at LIBOR plus 125 - 175 basis points depending on certain credit facility utilization measures, at the election of the Company.

·                  Lending limits subject to accounts receivable and inventory limitations.

·                  An unused commitment fee equal to one-quarter of one percent (1/4%) per annum on the difference between the maximum loan limit and average monthly borrowings.

·                  Secured by collateral including all of the Company’s equipment, intangibles, inventories, and accounts receivable.

·                  A financial covenant requiring a fixed charge coverage ratio of at least 1.0 as measured by the previous twelve month period then ended only if excess availability falls below 10% of the maximum loan limit as defined in the credit agreement.

·                  Provides that the Company may not pay dividends on its common stock in excess of $1.00 per share on an annual basis. There is, however, no limit on common stock dividends if certain excess availability measurements have been maintained for the thirty day period immediately prior to the payment of any such dividends or distributions and if immediately after giving effect to any such dividend or distribution payments the Company has a Fixed Charge Coverage Ratio of at least 1.10 to 1.0 as defined in the credit facility agreement.

The amount available for use on the Facility at any given time is subject to a number of factors including eligible accounts receivable and inventory balances that fluctuate day-to-day. Based on our collateral and loan limits as defined in the Facility agreement, the credit limit of the Facility at March 2014 was $61.6 million, of which $19.8 million was outstanding, leaving $41.8 million available.

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Item 3.                            Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4.                            Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in company reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in company reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

As required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act, an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2014 was made under the supervision and with the participation of our senior management, including our principal executive officer and principal financial officer. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures will prevent all errors and fraud. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect the fact that there are resource constraints, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management’s override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control that occurred during the fiscal quarter ended March 31, 2014, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1.                            Legal Proceedings

None.

Item 1A.                   Risk Factors

There have been no material changes to the Company’s risk factors as previously disclosed in Item 1A “Risk Factors” of the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2013.

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Table of Contents

Item 2.                            Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable

Item 3.                            Defaults Upon Senior Securities

Not Applicable

Item 4.                            Mine Safety Disclosures

Not applicable.

Item 5.                            Other Information

Not applicable.

Item 6.                            Exhibits

(a) Exhibits

31.1                   Certification by Christopher H. Atayan, Chief Executive Officer and Chairman, furnished pursuant to section 302 of the Sarbanes-Oxley Act

31.2                   Certification by Andrew C. Plummer, Vice President, Chief Financial Officer, and Principal Financial Officer furnished pursuant to section 302 of the Sarbanes-Oxley Act

32.1                   Certification by Christopher H. Atayan, Chief Executive Officer and Chairman, furnished pursuant to section 906 of the Sarbanes-Oxley Act

32.2                   Certification by Andrew C. Plummer, Vice President, Chief Financial Officer, and Principal Financial Officer furnished pursuant to section 906 of the Sarbanes-Oxley Act

101                      Interactive Data File (filed herewithin electronically)

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