SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________________
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2003
--------------
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to _________
Commission file number 000-31148
-----------------------------------------------
PENNEXX FOODS, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-3008972
----------------------------------------- --------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5501 Tabor Avenue, Philadelphia, PA 19120
--------------------------------------------------------------------------------
(Address of principal executive offices)
215-743-4331
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
--------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
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
----- ------
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes No X
----- ------
APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Indicate by check mark whether the registrant filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes No
----- ------
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 31,724,822
----------------------
2
INDEX
Page
PART I -- FINANCIAL INFORMATION...........................................4
Item 1. Financial Statements......................................4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................10
Item 3. Quantitative and Qualitative Disclosures
About Market Risk .......................................19
Item 4. Controls and Procedures..................................19
PART II - OTHER INFORMATION..............................................19
Item 1. Legal Proceedings.......................................19
Item 3. Defaults Upon Senior Securities.........................20
Item 6. Exhibits and Reports on Form 8-K........................21
3
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
PENNEXX FOODS, INC.
Balance Sheets
ASSETS
March 31, 2003 December 31, 2002
(Unaudited)
------------------------- -------------------
Current Assets:
Cash $ 327,756 $ 187,540
Receivables:
Trade net of allowance for doubtful accounts 2,360,748 2,563,115
(2003, $298,000; 2002, $ 264,000)
Other 158,373 11,899,178
Inventory 2,121,631 2,086,023
Prepaid expenses 645,768 751,065
----------- -----------
Total current assets 5,614,276 17,486,921
Fixed Assets:
Property and equipment 13,036,008 12,780,503
Less accumulated depreciation 1,708,584 1,434,175
----------- -----------
Net property and equipment 11,327,424 11,346,328
Other Assets 67,394 145,293
----------- -----------
Total Assets $17,009,094 $28,978,542
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Note payable $ 11,280,182 $ 10,115,421
Current installments on capital lease obligations 269,610 262,431
Accounts payable 3,894,525 5,490,195
Accounts payable, construction 552,480 3,341,408
Accrued expenses 836,248 684,436
------------ ------------
Total Current Liabilities 16,833,045 19,893,891
Long Term Liabilities:
Capital lease obligations less current installments 349,270 420,962
Note Payable 0 10,698,746
------------ ------------
Total Long Term Liabilities 349,270 11,119,708
------------ ------------
Shareholders' Deficit:
Common Stock 317,249 288,749
Additional Paid-in Capital 19,790,557 14,845,899
Deficit (20,097,867) (16,960,379)
Deferred Compensation (183,160) (209,326)
------------ ------------
Total Shareholders' Deficit (173,221) (2,035,057)
------------ ------------
Total Liabilities and Shareholders' Deficit $ 17,009,094 $ 28,978,542
============ ============
See notes to condensed financial statements.
4
PENNEXX FOODS, INC.
Statements of Operations
(Unaudited)
For the Three Month Period Ended
March 31
----------------------------------
2003 2002
------------ ------------
Sales $ 12,780,132 $ 10,924,971
------------ ------------
Cost of Goods Sold
Meat 9,667,453 7,031,091
Labor 1,374,875 1,258,048
Supplies 1,029,763 874,415
Other 688,872 187,482
------------ ------------
Total Cost of Goods Sold 12,760,963 9,351,036
------------ ------------
Gross Profit 19,169 1,573,935
Operating Expenses 2,895,969 1,516,232
------------ ------------
Income (Loss) from Operations (2,876,800) 57,703
Interest Expense (Net of Interest Income) 260,688 50,253
------------ ------------
Net Income (Loss) $ (3,137,488) $ 7,450
============ ============
Income (Loss) Per Share
Basic $ (0.11) $ 0.00
Diluted $ 0.00
Weighted Average Shares Outstanding
Basic 28,664,822 25,825,655
Diluted 28,664,822 27,208,342
See notes to condensed financial statements
5
PENNEXX FOODS, INC.
Statements of Cash Flows
(Unaudited)
For the Three Month Period Ended
March 31
2003 2002
-------------------------------------------
Cash Flows From Operating Activities
Net income (loss) $ (3,137,488) $ 7,450
Adjustments
Depreciation and amortization 252,442 165,744
Provision for doubtful accounts 75,000
Amortization of compensatory stock options 26,166 26,166
Changes in assets and liabilities:
Trade receivables 127,367 65,190
Other receivables (158,373)
Inventory (35,608) (432,479)
Prepaid expenses 105,297 (39,257)
Accounts payable (1,595,670) 1,010,944
Accrued expenses 151,812 201,881
------------ ------------
Net Cash Provided By (Used In) Operating Activities (4,189,055) 1,005,639
------------ ------------
Cash Flows From Investing Activities
Purchase of property and equipment (353,639) (787,604)
Construction accounts payable (2,590,928)
Other assets 1,527
------------ ------------
Net Cash Used for Investing Activities (2,944,567) (786,077)
------------ ------------
Cash Flows From Financing Activities
Proceeds from issuance of stock, net 4,973,158
Other Receivables 11,899,178
Repayments of notes payable, net (9,533,985)
Repayments on capital lease obligations (64,513) (48,976)
------------ ------------
Net Cash Provided by (Used in) Financing Activities 7,273,838 (48,976)
------------ ------------
Net Increase in Cash 140,216 170,586
Cash, Beginning of Period 187,540 2,415,785
------------ ------------
Cash, End of Period $ 327,756 $ 2,586,371
Supplemental Disclosures of Cash Flow Information ============ =============
Interest Paid during the Period $ 149,860 $ 25,622
See notes to condensed financial statements
6
Pennexx Foods, Inc.
Statement of Shareholders' Deficit
Three Month Period ended March 31, 2003
(Unaudited)
Common Stock
$.01 par value
50,000,000 shares authorized
Shares issued or Additional paid-in Deferred
issuable Amount capital Deficit Compensation Total
----------------------------------------------------------------------------------------------------
Balance, January 1, 2003 28,874,822 $288,749 $14,845,899 $(16,960,379) $(209,326) $(2,035,057)
Net loss ( 3,137,488) (3,137,488)
Amortization of Compensatory
options 26,166 26,166
Common Stock issued or issuable
for cash, net 2,850,000 28,500 4,944,658 4,973,158
----------------------------------------------------------------------------------------------------
Balance, March 31, 2003 31,724,822 $317,249 $19,790,557 $(20,097,867) $(183,160) $ (173,221)
====================================================================================================
7
See notes to condensed financial statements.
Pennexx Foods, Inc.
Notes to Condensed Financial Statements
March 31, 2003
1. Basis of presentation.
The unaudited condensed financial statements have been prepared by
Pennexx Foods, Inc. (the "Company") pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted pursuant to such rules and
regulations; nevertheless, the Company believes that the disclosures are
adequate to make the information presented not misleading. These financial
statements and the notes hereto should be read in conjunction with the financial
statements and notes thereto included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2002. In the opinion of the Company, all
adjustments, including normal recurring adjustments necessary to present fairly
the financial position of the Company as of March 31, 2003 and the results of
its operations and cash flows for the three months then ended, have been
included. The results of operations of the interim period are not necessarily
indicative of the results for the full year.
2. Accounting policies.
There have been no changes in accounting policies used by the Company
during the period ended March 31, 2003.
3. Summary of business.
The Company, incorporated on July 20, 1999 in the Commonwealth of
Pennsylvania, prepares case-ready meat for distribution to food retailers in the
Northeastern United States.
4. Inventory.
The Company's inventories are valued at the lower of cost or market.
Inventories consist of the following (amounts in thousands):
March 31, 2003 December 31, 2002
-------------- -----------------
Unfinished beef, pork, veal, lamb $1,127 $ 873
Packaging supplies 814 759
Finished Goods 181 454
-------------- -----------------
TOTAL $2,122 $2,086
============== =================
8
5. Note payable.
The Company has established a $30 million credit line with its largest
shareholder, Smithfield Foods, Inc. ("Smithfield"). However, the Company is in
default under the Smithfield Credit Agreement (the "Credit Agreement"). The
Company's outstanding balance under the Credit Agreement bears interest at 1%
(3% during periods of default) above the prime rate announced from time to time
by J.P. Morgan Chase & Co. and is secured by all of the Company's assets. The
loan would have matured in 2006 in the absence of default, but because of the
Company's default, Smithfield has exercised its right to demand that all amounts
under the Credit Agreement become due and payable immediately. Consequently, the
note payable is carried as a current liability.
The Company's defaults under the Credit Agreement have resulted
primarily from the Company's extremely large and continuing losses during the
past 12 months.
Smithfield had, prior to the Company's default, agreed to allow the
Company to use a portion of the $30 million credit line to purchase, renovate
and equip the Tabor Avenue Facility. Although the plant is substantially
complete, some work is still ongoing. The project is currently running
approximately $2.2 million over budget. To cover this overrun, the Company had
requested the use of additional amounts under the line of credit and, although
Smithfield had originally agreed to this request, it has, after the Company's
default, declined to provide the requested funding. The Smithfield loan balance
was as follows on the respective dates set forth below (amounts in thousands):
April 30, 2003 March 31, 2003 December 31, 2002
-------------- -------------- -----------------
Principal Advances:
Inventory and Receivables $ 4,420 $ 4,266 $ 4,073
Capital Expenditures 7,014 7,014 16,741
Accrued Interest 45 51 0
------------ ------------- -----------------
TOTAL $ 11,479 $11,331 $ 20,814
============ ============= =================
6. Net loss per share.
Basic earnings per share is computed using the weighted average number
of common shares outstanding during the period.
7. Common Stock.
In February, 2003 the Company sold 2,850,000 shares of common stock in
a private placement of securities to investors at a price of $1.75 per share.
The common stock which was sold was not registered under the Securities Act of
1933 (due to an available exemption from registration) and, consequently, the
investors must hold the stock for an indefinite time period.
8. Reclassification.
Certain amounts reported in the 2002 financial statements have been
reclassified to conform with the 2003 presentation.
9
9. Operating Lease.
On December 31, 2002 the Company entered into an operating lease
program with Commerce Commercial Leasing, LLC, ("Commerce") wherein Commerce
purchased from the Company approximately $11.9 million of equipment and leased
it back to the Company for a term of 90 months with the Company having an option
to terminate the lease after the 78th month. At the end of the lease, the
Company also has the option of purchasing the equipment at fair market value,
returning the equipment to Commerce or renewing the lease on a month-to-month
basis. This program is guaranteed by Smithfield, for which, the Company is
required to pay Smithfield 2% of the amount guaranteed. If the Company is in
default, Commerce has several remedies including, but not limited to, canceling
or terminating the lease program. By virtue of the failure to make a payment on
May 1, 2003 in the amount of approximately $151,000, the Company is in default
of the Commerce lease.
10. Going Concern.
The Company's (a) default under the Smithfield Credit Agreement and the
Commerce lease, (b) continuing losses, (c) increasing difficulty in obtaining
meat and other necessary supplies, and (d) uncertain ability to secure
additional funds from debt or equity transactions has created doubt concerning
the Company's ability to continue as a going concern.
Management is addressing these problems in three ways. First,
management is seeking a loan or investment from third parties sufficient in
amount to allow the Company to reach a forbearance agreement with Smithfield, or
alternatively, an amount sufficient to repay the Smithfield indebtedness in its
entirety. Although several potential investors have expressed preliminary
interest in the Company, thus far, no one has committed any funds and there is
no assurance that the Company will succeed in this effort. Second, management
has identified principal sources of the losses in the past three months and has
implemented steps to improve and to remedy the problems completely. Once these
implementation steps are complete (estimated to be June 30, 2003), management
believes increasing efficiencies will improve gross profit margins. Finally,
management expects that sales growth based on expressions of interest from new
and existing customers will enable gross profit to expand to cover the overheads
incurred in operating the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain information contained in this Quarterly Report on Form 10-Q
represents "forward-looking" statements (as defined in Section 27A of the
Securities Act of 1933, as amended) that involve risks and uncertainties which
may cause actual results to differ materially from those predicted in the
forward-looking statements. If any of the Company's assumptions on which such
statements are based prove incorrect, or should unanticipated circumstances
arise, the Company's actual results could materially differ from those
anticipated by such forward-looking statements. The differences could be caused
by a number of factors or combination of factors, including, but not limited to,
those listed under Item 6, "Note Regarding Forward-Looking Statements" in the
Annual Report on Form 10-KSB filed with the Securities and Exchange Commission
for the year ended December 31, 2002.
10
Company Default Under Smithfield Credit Agreement and the Commerce
Operating Lease
The Company is in default under the Smithfield Credit Agreement (the
"Credit Agreement"). See, Part II - - Other Information, Item 3., Defaults Upon
Senior Securities. The defaults under the Credit Agreement have resulted
primarily from the Company's extremely large and continuing losses during the
past 12 months. As a result of the defaults, Smithfield has declared the
outstanding principal amount of all loans and other obligations owed to it by
the Company to be due and payable and has demanded immediate payment of all such
amounts. Moreover, Smithfield has terminated its commitment to lend additional
amounts under the Credit Agreement.
By letter received by Pennexx on May 15, 2003, Smithfield advised the
Company of its intention to sell the personal property collateral for its loan
on May 30, 2003 unless Smithfield receives immediate payment of all amounts due
under the loan or unless the parties reach another mutually satisfactory
resolution of this matter.
If the Company is unable to reach a forbearance agreement acceptable to
Smithfield or to repay the Smithfield obligations, the Company will be unable to
continue as a going concern.
The Company is in discussions with potential investors to determine
whether the Company can raise sums sufficient to obtain a Smithfield forbearance
agreement, or alternatively, to repay the Smithfield obligations in full.
Although certain investors have expressed preliminary interest in making such an
investment, no one has, thus far, committed to do so, and there is no assurance
that the Company will succeed in this effort. Moreover, even if the Company is
able to raise such funds, the terms on which such funds can be raised may be
dilutive to existing shareholders.
By letter dated April 30, 2003, the Company engaged Morgan Joseph &
Co., Inc. to render financial advisory and investment banking services to the
Company. The Company agreed to pay Morgan Joseph a fee equal to 6% of the
aggregate proceeds of junior capital raised by the Company and 1.5% of the
aggregate senior debt committed to the Company if the transaction does not
result in the sale of a contolling interest in the Company, or if the
transaction does result in the sale of a controlling interest in the Company, 2%
of the aggregate consideration; provided, however, that no compensation is
payable to Morgan Joseph for up to $5 million of new capital recieved from Lampe
Conway, LLC or its affiliates.
The Company also failed to pay its monthly operating lease payment to
Commerce which was due on May 1, 2003 in the amount of approximately $151,000.
The Company has commenced discussions with Commerce concerning remedying the
default if sufficient sums can be raised from investors.
Results of Operations
The three months ended March 31, 2003 was the first fiscal period in
which the Tabor Avenue Facility was substantially complete. Operations during
this period have been extremely disappointing. Although certain labor
efficiencies have been achieved, the Company has experienced numerous
unanticipated operating difficulties which have increased costs beyond
management's expectations. In particular, the Company is finding that its meat
yielding
11
and tracking system is not performing as anticipated, with the concomitant
result that meat yields are unsatisfactory and that the cost of meat as a
percentage of sales is much higher than has historically been the case. In
addition, the Company has identified several parts of the new equipment lines
that are not working as had been anticipated. As a result, the Company has
experienced labor costs in excess of those anticipated. As a result of these
difficulties, and in particular as a result of the high cost of meat as a
percentage of sales, the Company had virtually no gross profit in the March,
2003 quarter. This decline in gross profit ($1.5 million year over year) was
made even more serious by the large increase in overhead expenses associated
with operating the Philadelphia plant compared to smaller overhead expenses
associated with operating the Pottstown plant.
As a result of the Company's losses, the Company is out of compliance
with the terms of virtually all of its vendors and is able to obtain supplies of
meat and other necessary products only on a "cash on delivery" (COD) basis.
Sales for the three-month period ended March 31, 2003 were $12.8
million, representing an increase of approximately $1.9 million or 17.4% over
sales of $10.9 million from the corresponding period of 2002. This increase was
primarily the result of the increase in the volume of products handled (due in
part to increasing sales to existing customers as well as sales to new
customers) which more than offset a change in the mix of products sold in favor
of lower priced items. As the diversity of services that the Company offers
continues to grow, customers are increasing both the range of products as well
as the quantity ordered.
Cost of goods sold for the three-month period ended March 31, 2003 was
$12.8 million which resulted in a gross profit of approximately $20,000 or 0.2%
of sales. By comparison, cost of goods sold for the three-month period ended
March 31, 2002 was $9.4 million, which resulted in a gross profit of $1.6
million or 14.7% of sales. The Company's cost of goods sold is comprised of four
main components: meat, direct payroll, supplies, and other. These items
accounted for approximately 76%, 11% and 8%, and 5% of sales, respectively, in
the three months ended March 31, 2003 as compared to 64%, 12%, 8% and 2% of
sales for the corresponding period of the prior year.
The Company typically negotiates a price for each cut of meat with each
customer based on the customer's needs. Because meat cost represents the highest
percentage of cost of goods sold, meat yield (the ratio of the weight of meat
shipped to the customer divided by the weight of the raw cuts from the
customer's meat was processed) is a major determinant of the Company's profit or
loss. The Company recently identified a design flaw in the ground beef lines
installed at the Tabor Avenue Facility. The design flaw has had the effect of
reducing ground beef yield, and thereby increasing ground beef cost as a
percentage of sales. Temporary steps have been implemented to reduce the effect
of the flaw and a more permanent solution has been designed and order. If the
Company survives, the replacement equipment (the aggregate cost of which is
approximately $26,000), is expected to be installed by June 30, 2003 and is also
expected to improve significantly the yield in the ground beef room.
In addition, a second design flaw has prevented the Company from
capturing critical real time yield data on all meat processed. This flaw allowed
operating inefficiencies to go undetected for approximately three months. Now
that this flaw has been identified, temporary
12
steps have been taken to obtain more accurate data which, in turn, has allowed
management to focus on the yield areas which need the most urgent attention. A
complete overhaul of the current yield tracking system is currently being
implemented. The new system is expected to provide the accurate detail necessary
to identify and correct remaining inefficiencies. Because meat cost is the
single biggest cost incurred by the Company, if the foregoing steps aimed at
improving meat yield are successful, the Company's results of operations will
improve significantly.
Direct payroll declined as a percentage of sales in 2003 compared to
2002 due to increasing labor efficiencies and economies of scale and an increase
in the volume of meat that is less labor intensive to cut, trim, and package.
Notwithstanding this improvement, management is implementing changes to its
packaging system to accommodate requests made by some of its key customers.
These changes are expected to cause temporary labor inefficiencies, but once the
change over to the new packaging system is complete, management expects direct
payroll as a percentage of sales to decline to less than 11%.
If the Company is able to remain in business, management believes that
the Company will increase its production of ground beef substantially in coming
fiscal periods. Although ground beef prices are lower than the average prices of
all products produced previously, the decrease is expected to be more than
offset by savings in labor, because the newly installed automated grinding
equipment requires much less labor compared to the labor required for other
products the Company produces. However, anticipated increases in gross profit
resulting from the increase in ground beef production will be offset in part by
higher quality control costs, and has thus far also been adversely affected by
the operating problems referred to above. Quality control and assurance plays an
important part in the Company's operations. The Company's planned modern
laboratory will create efficiencies of costs even though the number of tests and
additional types of tests will increase, and that is due to the cost savings
realized through the avoidance of costs of outside laboratories.
For 2003, the "other" cost of goods component includes approximately
$452,000 (4% of sales) of leasing charges for production equipment. On December
31, 2002, the Company entered into an operating lease program with Commerce, the
obligations of which are guaranteed by Smithfield. See "Liquidity and Capital
Resources." The monthly lease payment approximates $151,000. If the Company had
purchased rather than leased the equipment, it would have incurred increased
interest and depreciation expense in approximately the same amount as the lease
payments. The leasing charges are for $11.9 million of equipment operating
leases through Commerce.
Operating expenses for the three months ended March 31, 2003 were $2.9
million (23% of sales) as compared to $1.5 million (14% of sales) for the
corresponding period of 2002. Of this $1.4 million increase, $1.1 million
resulted from significant increases in the following major areas (amounts in
thousands):
13
Three Months Ended March 31
---------------------------------------
2003 2002 Increase
---- ---- ---------
Salaries, wages and related expenses $902 $460 $442
Consulting fees 161 45 116
Professional Fees 145 56 89
Shipping and handling 395 285 110
Repairs and maintenance 191 75 116
Utilities 190 63 127
Cleaning 208 77 131
------------- ------------ -----------
Total $2,192 $1,061 $1,131
============= ============ ===========
The reasons for these increases are as follows:
Salaries, wages and related expenses included that for new
employees--the Chief Financial Officer, the Chief Operating Officer, and
information technology personnel--who were not with the Company in the first
quarter of 2002. In addition, due to the expansion undertaken after the first
quarter of 2002, many of the departments experienced significant additions of
personnel, such as maintenance, quality control, shipping and receiving, and
office.
For 2003, the Company engaged a marketing consultant whose fees are
higher than the fees of a general business consultant engaged by the Company in
2002.
Professional fees increased as a result of increased legal fees for
representation in litigation (See Part II - - Other Information, Item 1, Legal
Proceedings), preparation of documents between the Company and Smithfield, and
general increases due to the expansion of the business.
Shipping and handling charges increased because of the increase in
sales, because of hiring outside trucking firms that were not used in the prior
year, and because of increased distances in hauling product to the Company's
customers.
Repairs and maintenance expenses increased primarily due to the plant
expansion, whereby the size of the premises was increased to 151,000 square feet
and more than $12 million of new equipment was put into operation.
Utilities increased to accommodate the increase in production and to
supply the new, larger plant.
Cleaning expense increased as a result of the increase in the size of
the plant (compared to the Pottstown plant) as well as the increase in amount of
equipment which requires cleaning, and partially as a result of the increase in
sales (which requires more shifts and cleaning between shifts).
14
Interest expense (net of interest income) for the three-month period
ended March 31, 2003 was approximately $0.26 million compared to approximately
$0.05 million for the comparable period of 2002. This increase in interest
expense (net of interest income) is principally due to the increase in loan
balance owed to Smithfield for both the Tabor Avenue facility and the inventory
and accounts receivable loans. Also included in interest expense is a guarantee
fee payable to Smithfield to compensate it for its guaranty of the operating
lease obligations.
The net loss for the three-month period of 2003 was approximately $3.1
million as compared to net income of $0.007 million for the first three months
of 2002.
Liquidity and Capital Resources
General
-------
The Company has been chronically undercapitalized. In an effort to
address its capital needs, the Company sold $13.0 million of common stock since
June 2001 as follows:
Aggregate Consideration
Date of Sale Number of Shares Price Per Share (in thousands)
------------ ---------------- -------------- -------------
June, 2001 12,510,161 $0.48 $6,000
November, 2002 2,000,000 1.00 $2,000
February, 2003 2,850,000 1.75 $4,988
------------------ ------------ --------------
TOTAL 17,360,161 $0.75 $12,988
========== ===== =======
In 2001, the Company secured a $30 million revolving line of credit
from Smithfield and at the end of last year, a $11.9 million operating lease
from Commerce (see discussion below). Smithfield guaranteed Pennexx's
obligations to Commerce under operating leases for equipment installed at the
Tabor Avenue Facility in exchange for the Company's payment of a guaranty fee.
The amount of the guaranty reduced the $30 million Smithfield loan commitment.
The Company borrowed $7.0 million from Smithfield (net of the repaid
amount obtained from the leasing transaction early in 2003) to purchase,
renovate and equip the Tabor Avenue Facility in 2002-03. However, the Company is
now in default of the Smithfield loan. As a result, Smithfield has declared all
amounts due and payable immediately, and is refusing to make any additional
advances to the Company under the Credit Agreement. Because of substantial
losses in the past 12 months and because of Smithfield's refusal to fund
additional amounts under the Credit Agreement, the Company has depleted its cash
resources as of mid-May, 2003.
The Company does not have the ability to repay the Smithfield
obligations. Moreover, a default under the Smithfield loan constitutes a default
under the Company's obligation to Commerce. (However, the Company is
independently in default of the Commerce lease) If the Company does not succeed
in reaching a forebearance agreement with Smithfield or raising a sufficient sum
to repay the Company's obligations to Smithfield, Smithfield will be entitled to
take the Company's assets which it holds as collateral for the loan, and the
Company will have to cease operations.
15
The Company's purchases of supplies are made using the trade credit
programs of suppliers, which allow the Company to purchase meat supplies with
payment due within seven to ten days. As a result of the Company's losses and
the resulting lack of cash, the Company is out of compliance with the terms of
virtually all of its vendors and is currently able to obtain supplies of meat
and other necessary products only on a "cash on delivery" (COD) basis. Although
the Company's accounts payable decreased from $5.5 million at December 31, 2002
to $3.9 million at March 31, 2003 as a result of the cash raised from the
February, 2003 equity sale, accounts payable have increased subsequent to March
31, 2003. This increase has served as a way of funding essential cash
requirements during such time period.
The Company's capital needs have increased over time due to continuing
losses, increasing sales (necessitating increasing amounts of working capital),
and the capital requirements associated with the acquisition, renovation, and
equipping of the Tabor Avenue Facility. Even if the Company can survive the
current Smithfield and Commerce defaults, management expects that losses will
continue in the second quarter of 2003. Management bases this belief, in part,
on the preliminary results of operations for April, 2003 (sales of $2.8 million,
gross loss of $0.2 million, net loss of $1.2 million, and loss per share of
$0.04). Moreover, if the Company can survive, the addition of potential new
customers with which the Company has been negotiating for several months means
that sales may increase in such periods as well. The confluence of these two
trends will exacerbate the Company's liquidity difficulty. To remedy this
problem, the Company will require additional capital (in addition to the amount
necessary to satisfy Smithfield) or will need to seek the further indulgence of
its vendors. There is no assurance that such additional capital can be obtained,
or the terms on which it might be made available.
The Company generally tries to maintain an inventory of meat supplies
equal to between 60% and 75% of estimated weekly sales volume; however, at March
31, 2002, December 31, 2002, and March 31, 2003, inventory exceeded this range
which had a correspondingly negative effect on the Company's liquidity.
Inventory is purchased generally on a daily basis and in advance (i.e., in
anticipation) of customer orders. When customer orders do not correspond with
the Company's purchases, the Company sells the unordered meat through its
employee retail outlet, offers it for sale at a discounted price to customers,
or in some cases, freezes the unordered meat for later use. Misjudging customer
orders can have a negative effect on liquidity (and results of operations)
because of the short payment terms required by suppliers. Misjudging customer
orders can also result in write-offs of unsaleable frozen inventory from time to
time. In 2002, the Company wrote off $0.4 million of frozen inventory and in the
three months ended March 31, 2003, the Company wrote off an additional $40,000
of frozen inventory.
The Company's liquidity difficulty is made worse by the requirement
that it pay for meat supplies sooner than it is able to get paid by its
customers, and because, in the case of the Company's largest customer, its meat
supplier is also the paying agent for the customer. The paying agent deducts
current meat purchases from amounts owed to the Company by the customer before
remitting payment to the Company. Moreover, the Company owed suppliers which are
affiliates of Smithfield approximately $2.6 million, $0.2 million, and $0.5
million at December 31, 2002, March 31, 2003, and April 27, 2003, respectively.
16
By letter dated May 19, 2003, Smithfield has exercised its rights to
receive the proceeds of all Company accounts receivable. Because accounts
receivable have recently been the sole source of Company cash flow, the exercise
of this remedy will have an adverse effect on the Company; however, because the
Company has been required to change its operations to accommodate its current
straitened financial circumstances, such receivables are much lower than has
historically been the case, and an existing arrangement with a supplier is,
temporarily, allowing the Company to continue processing meat for its customers.
On December 31, 2002 the Company entered into an operating lease
program with Commerce pursuant to which the Company leased $11.9 million of
equipment; the leasing program enabled the Company to retire $9.8 million of the
Smithfield debt in January, 2003. The Company is obligated to pay Commerce
approximately $1.8 million per year as the rental for the equipment. By
contrast, the estimated interest savings on the repaid Smithfield debt and the
depreciation expense avoided is approximately $0.4 million and $1.4 million per
year, respectively. As discussed above, the Company has failed to make the most
recent monthly lease payment.
The Company's current ratio (current assets divided by current
liabilities) at March 31, 2003 was 0.3 compared to 0.9 at December 31, 2002. The
decrease in the current ratio primarily reflects the Company's net loss, the
reclassification of the Smithfield loan as current due to the default, but the
decrease was offset, in part, by the sale of equity in February, 2003.
Consequently, to continue funding day-to-day operations, the Company will need
to raise funds from a potential equity offering, but there is no assurance that
funds can be obtained on such a basis.
Tabor Avenue Facility
---------------------
The Company has consolidated all operations in the Tabor Avenue
Facility and has substantially completed the renovation and equipping of the
plant. The cost of doing so was as follows:
Renovation Costs $ 4.9
Equipment Costs (Covered by Operating Lease) 11.9
Other Equipment and Costs 2.5
------------------------
Total 19.3
========================
In addition to these expenses, the Company incurred moving expenses and
other costs associated with the move to the new plant. The Company is amortizing
the acquisition, renovation and related construction interest and transaction
costs of the Tabor Avenue Facility over 39 years. The costs of moving and
installing equipment in the new plant was capitalized and is being depreciated
over five years.
The new facility is intended to address space and automation issues. If
the Company survives, Management believes that the new facility will allow the
Company to accommodate a substantial increase in production orders and, after
accounting for the increased costs associated
17
with the move (such as higher depreciation and debt service expenses),
Management expects that such increased volume, if achieved, will lead to higher
gross profits. In addition, the new plant offers the physical layout to improve
the Company's automation which, after accounting for the costs of equipment
acquisition, installation, and training, was intended to increase gross profits.
Although management believes it will ultimately do so, the operating
difficulties and design flaws referred to above have, thus far, decreased gross
profits (and in fact created a gross loss in April, 2003). These projected
increases in gross profit, in turn, are expected to help cover Company
overheads.
Prior to default Smithfield had agreed to allow the Company to use a
portion of the $30 million credit line (see note 5 to financial statements) to
allow the Company to purchase, renovate and equip the Tabor Avenue Facility. The
project is currently running approximately $2.2 million over budget.
As discussed above, the Company is planning to install new packaging
lines to accommodate the requests of certain key customers. The cost of these
lines, together with the costs of some additional grinding equipment, as well as
the costs to correct the design flaws referred to above approximated $1.5
million in the aggregate. Because of the Company's financial condition it will
need additional leeway on its operating lease with Commerce or will need to
raise additional equity to pay for this equipment.
Smithfield Loan
---------------
For a discussion of the Company's default under the Smithfield Credit
Agreement, see the discussion above under this Item 2, Management's Discussion
and Analysis of Financial Condition and Results of Operations, and Part II -
Other Information, Item 3, Defaults Upon Senior Securities.
The amount outstanding on the Smithfield line of credit was as follows
on the dates indicated (amounts in thousands):
April 30, 2003 March 31, 2003 December 31, 2002
-------------- ----------------- ------------------
Principal Advances:
Inventory and Receivables $ 4,420 $ 4,266 $ 4,073
Capital Expenditures 7,014 7,014 16,741
Accrued Interest 45 51 0
----------- ---------------- ------------------
TOTAL $11,479 $11,331 $ 20,814
=========== ================ ==================
The Company's line of credit with Smithfield (other than the portions
used for approved Capital Expenditures or to support the Smithfield guaranty of
the Commerce leases) was, prior to default, based primarily on eligible
inventories and eligible accounts receivable. At March 31, 2003 and April 27,
2003, respectively, the Company had borrowed $4.3 million and $4.4 million
against eligible accounts receivable and eligible inventory and, was
overadvanced by $0.2 million and $1.3 million, respectively, or based on an
ambiguity as interpreted by Smithfield, by $0.8 million and $1.8 million,
respectively.
The Company's working capital decreased by $8.8 million, from $(2.4)
million at December 31, 2002 to $(11.2) million at March 31, 2003. This decrease
resulted principally from the Company's net loss and the reclassification of the
Smithfield note as a current liability, offset, in part by the sale of equity in
February, 2003.
Off Balance Sheet Arrangements and Other
----------------------------------------
18
For a discussion of the operating lease with Commerce see footnote 9 of
the financial statements.
The Company has applied for up to $2.75 million of below-market rate
loans through the Philadelphia Industrial Development Corporation (PIDC) and
related entities with respect to the plant. The Company has agreed to pay down
borrowings on the Smithfield line of credit by all amounts received as a result
this application, and Smithfield has agreed to subordinate its mortgage and
security interests to the liens of the lender(s) making any such loans to the
Company. The Company does not know what effect, if any, the Company's defaults
under the Smithfield Credit Agreement and Commerce lease will have on these
applications.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's current assets are maintained exclusively in demand
accounts and money market accounts at a commercial bank. Despite the credit risk
associated with this concentration of assets, and the immaterial interest rate
risk associated with the Company's money market investments, the Company does
not believe it has any market risk from investment of assets.
Item 4. Controls and Procedures
The Company carried out an evaluation of the effectiveness of its
disclosure controls and procedures within 90 days prior to the filing of this
report. This evaluation was carried out under the supervision and with the
participation of the Company's management, including the Company's President and
Chief Executive Officer and the Chief Financial Officer. Based on that
evaluation, the Company's President and Chief Executive Officer and the Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective. There have not been any significant changes in the
Company's internal controls, or in other factors which would significantly
affect internal controls subsequent to the date the Company carried out its
evaluation, or any corrective actions taken with regard to significant
deficiencies or material weaknesses.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments in the Company's previously
reported litigation.
Under a Contribution Agreement dated December 27, 2002 between
Smithfield and the Company, Smithfield has the right for thirty days after any
shares are delivered to Mr. Matthews in settlement of the Matthews litigation to
purchase the number of shares issued to him at a price of $1.00 per share.
Item 3. Defaults Upon Senior Securities
At March 31, 2003, and as of the date of the filing of this Quarterly
Report on Form 10-Q the Company was in violation of certain requirements of the
Credit Agreement. See Part I - -
19
Financial Information, Item 2 "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
As a result of continuing losses, the Company was unable to pay
Smithfield the $45,251.38 of interest due on April 30, 2003 or to make, on May
12, 2003, a required prepayment of the excess loan advance ($1.3 million or $1.8
million depending upon an ambiguity in the loan documents) created as a result
of reductions in the Company's Eligible Inventory and Eligible Accounts
Receivable.
The Credit Agreement between the Company and Smithfield requires that
the Company maintain positive shareholders' equity determined in accordance with
generally accepted accounting principles (the "Net Worth Covenant"). At March
31, 2003, the Company's shareholders' equity was not positive; however,
Smithfield waived any defaults relating to compliance with the Net Worth
Covenant to June 30, 2003 provided that the Company remained current on all its
trade payables to Smithfield affiliates. Because of continuing losses, the
Company has failed to adhere to this condition and therefore, this waiver of the
Company's covenant violation expired.
The Credit Agreement prohibits the Company from making more than
$100,000 of capital expenditures in any fiscal year without Smithfield's
consent. This limitation was not practical in 2002 because of the acquisition of
the Tabor Avenue Facility. Moreover, capital expenditures, primarily related to
the Tabor Avenue Facility (through March 28, 2003), were $1.6 million.
Smithfield has formally waived compliance with this requirement for 2002, and
has also formally waived compliance for 2003 for expenditures of up to $137,974.
In addition, Smithfield has informally waived compliance for expenditures of up
to an additional $198,000. At March 31, 2003, the Company had incurred $354,000
of capital expenditures. However, payment for the equipment which has been
ordered to correct the design flaws referred to above will, in the absence of
Smithfield's consent, cause the Company to exceed the capital expenditure cap
for 2003 assuming the Company's continued survival and the continuing existence
of the Smithfield Credit Agreement.
Because of the default, Smithfield has advised the Company that it will
not make any further advances under the Credit Agreement, and has invited the
Company to discuss giving Smithfield "peaceful possession" of the collateral for
the loan (which represents substantially all of the Company's assets). By letter
received by the Company on May 15, 2003, Smithfield advised the Company of its
intention to sell the personal property collateral for its loan on May 30, 2003
unless Smithfield receives immediate payment of all amounts due under the loan
or unless the parties reach another mutually satisfactory resolution of this
matter. By letter dated May 19, 2003, Smithfield has exercised its rights to
receive the proceeds of all Company accounts receivable. Because accounts
receivable have recently been the sole source of Company cash flow, the exercise
of this remedy will have an adverse effect on the Company; however, because the
Company has been required to change its operations to accomodate its current
straitened financial circumstances, such receivables are much lower than has
historically been the case, and an existing arrangement with a supplier is,
temporarily, allowing the Company to continue processing meat for its customers.
Smithfield designed and engineered the operating lines at the Tabor
Avenue Facility and created the yield tracking computer program used at startup.
As stated above, the Company has discovered that there are certain flaws in the
designs of the operating lines and also that the yield tracking software was
ineffective. The Company believes that these flaws contibuted significantly to
the losses in the first four months of 2003 and therefore, that Smithfield bears
some responsibility for such losses (and the resulting Credit Agreement
default).
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certificate Pursuant to 18 U.S.C. ss.1350.
(b) Reports on Form 8-K
20
The Company filed Current Reports on Form 8-K dated May 8,
2003 and May 15, 2003. The information furnished therein was submitted under
"Item 9, Regulation FD Disclosure." However, the information was provided under
"Item 12, Disclosure of Results of Operations and Financial Condition" in
accordance with a recent SEC directive.
21
SIGNATURES
----------
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
PENNEXX FOODS, INC.
By: /s/ Michael D. Queen
--------------------------------------
Michael D. Queen, President
Date: May 19, 2003
I, Michael D. Queen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pennexx Foods,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
22
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Michael D. Queen
-----------------------------
Michael D. Queen
Chief Executive Officer
May 19, 2003
I, Joseph R. Beltrami, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pennexx Foods,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
23
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Joseph R. Beltrami
-----------------------------
Joseph R. Beltrami
Chief Financial Officer
May 19, 2003
24