U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended September 30, 2002
[_] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from ___________ to _________
Commission file number 000-31148
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PENNEXX FOODS, INC.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
Pennsylvania 23-3008972
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
5501 Tabor Avenue, Philadelphia, PA 19120
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(Address of Principal Executive Offices)
215-743-4331
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(Issuer's Telephone Number, Including Area Code)
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(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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
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APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required
to be filed by Section 12, 13 or 15(d) of the Exchange Act after the
distribution of securities under a plan confirmed by a court.
Yes No
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APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 25,324,822
Transitional Small Business Disclosure Format (check one):
Yes No X
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INDEX
Page
PART I -- FINANCIAL INFORMATION..............................................3
Item 1. Financial Statements.........................................3
Item 2. Management's Discussion and Analysis or Plan of Operation....8
Item 3. Controls and Procedures.....................................14
PART II - OTHER INFORMATION.................................................14
Item 1. Legal Proceedings...........................................14
Item 3. Defaults Upon Senior Securities............................16
Item 6. Exhibits and Reports on Form 8-K...........................17
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
PENNEXX FOODS, INC.
Balance Sheets
ASSETS
September 30, 2002 December 31, 2001
(Unaudited)
------------------------- -----------------------
Current Assets:
Cash $1,560,325 $ 2,415,785
Trade Receivables, net of allowance for doubtful
accounts (2002, $163,651; 2001, $25,525) 3,340,147 2,595,495
Inventory 2,269,354 1,142,223
Prepaid Expenses 268,452 201,843
------------ ------------
Total Current Assets 7,438,278 6,355,346
Fixed Assets:
Land, Property and Equipment 16,805,367 4,186,944
Less Accumulated Depreciation 1,241,428 947,232
------------ ------------
Total Fixed Assets 15,563,939 3,239,712
Other Assets 40,144 61,772
------------ ------------
Total Assets $23,042,361 $ 9,656,830
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current Installments on Capital Lease Obligations $ 255,368 $ 233,000
Accounts Payable, Operating 5,494,476 2,100,254
Accrued Expenses 375,060 266,784
------------ ------------
Total Current Liabilities 6,124,904 2,600,038
Long Term Liabilities:
Capital Lease Obligations less Current Installments 488,594 677,790
Accounts Payable, Construction 736,114
Notes Payable 16,165,684 2,500,000
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Total Long Term Liabilities 17,390,392 3,177,790
------------ ------------
Shareholders' Equity (Deficit):
Common Stock 264,249 264,249
Additional Paid-in Capital 12,097,881 12,097,881
Deficit (12,599,574) (8,169,140)
Deferred Compensation (235,491) (313,988)
------------ ------------
Total Shareholders' Equity (Deficit) (472,935) 3,879,002
------------ ------------
Total Liabilities and Shareholders' Equity (Deficit) $23,042,361 $ 9,656,830
============ ============
See notes to condensed financial statements.
PENNEXX FOODS, INC.
Statements of Operations
(Unaudited)
For the Three Month For the Nine Month
Period Ended September 30, Period Ended September 30,
---------------------------------- -----------------------------------
2002 2001 2002 2001
Sales $ 13,078,296 $ 11,919,282 $ 37,628,219 $ 30,887,775
Cost of Goods Sold
Meat 9,538,454 8,781,043 26,434,250 22,042,532
Labor 1,726,622 1,665,001 4,757,194 5,048,432
Supplies 1,712,095 1,468,014 4,994,975 3,480,933
Depreciation 145,342 111,892 401,581 326,410
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Total Cost of Goods Sold 13,122,513 12,025,950 36,588,000 30,898,307
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Gross Profit (Loss) (44,217) (106,668) 1,040,219 (10,532)
Operating Expenses 2,135,338 1,174,800 5,309,307 2,550,703
-----------------------------------------------------------------------------------
Loss from Operations (2,179,555) (1,281,468) (4,269,088) (2,561,235)
Interest (Net of Interest Income) 64,502 18,826 161,346 135,880
-----------------------------------------------------------------------------------
Net Loss $ (2,244,057) $ (1,300,294) $ (4,430,434) $ (2,697,115)
===================================================================================
Loss Per Share
Basic $ (0.09) $ (0.05) $ (0.17) $ (0.16)
Weighted Average Shares Outstanding
Basic 25,324,822 26,006,988 25,324,822 17,217,513
See notes to condensed financial statements.
PENNEXX FOODS, INC.
Statements of Cash Flows
(Unaudited)
Nine Month Period Ended September 30,
---------------------------------------
2002 2001
Cash flows from operating activities:
Net Loss $ (4,430,434) $ (2,697,115)
Adjustments:
Depreciation and Amortization 2,188,660 449,466
Deferred Compensation 78,497 78,497
Provisions for Doubtful Accounts 267,000
Common Stock issued for:
Interest 31,318
Consulting 128,000
Changes in assets and liabilities
Trade Receivables (1,011,652) (2,438,079)
Other Receivables 95,410
Inventory (1,127,131) (448,560)
Prepaid Expenses (66,609) (81,281)
Accounts Payable 3,394,222 (590,262)
Accrued Expenses 108,276 137,813
------------ ------------
Net cash used for operating activities (599,171) (5,334,793)
Cash flows from investing activities:
Purchase of land, property and equipment (13,776,773) (868,331)
Other Assets 21,628 (3,347)
------------ ------------
Net cash used for investing activities (13,755,145) (871,678)
Cash flows from financing activities:
Proceeds from issuance of stock, net 5,909,567
Proceeds from issuance of debt 13,665,684 2,500,000
Repayments on capital lease obligations (166,828) (233,128)
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Net cash provided by financing activities 13,498,856 8,176,439
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Net increase (decrease) in cash (855,460) 1,969,968
Cash, beginning of year 2,415,785 ___
------------ ------------
Cash, end of period $ 1,560,325 $ 1,969,968
============ ============
Supplemental disclosure of cash flow information:
Interest paid during the period $ 371,898 $ 116,512
Non-cash items:
Purchase of equipment under capital lease agreements $ 181,775
Debt converted into common stock $ 400,000
Increase in land, property and equipment and accounts $ 736,114 ___
payable, construction
Interest expense capitalized $ 125,910 ___
See notes to condensed financial statements
5
Pennexx Foods, Inc.
Statement of Shareholders' Equity (Deficit)
Nine Month Period ended September 30, 2002
(Unaudited)
Common Stock
$.01 par value
50,000,000 shares authorized
Shares issued Additional Deferred
or issuable Amount paid-in capital Deficit Compensation Total
----------------------------------------------------------------------------------------------------
Balance, January 1, 2002 26,424,822 $264,249 $12,097,881 $(8,169,140) $(313,988) $3,879,002
Net loss (4,430,434) (4,430,434)
Amortization of
Compensatory Options 78,497 78,497
----------------------------------------------------------------------------------------------------
Balance, September 30, 2002 26,424,822 $264,249 $12,097,881 $(12,599,574) $(235,491) $ (472,935)
====================================================================================================
6
Pennexx Foods, Inc.
Notes to Condensed Financial Statements
September 30, 2002
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, 2001. In the opinion of the Company, all
adjustments, including normal recurring adjustments necessary to present fairly
the financial position of the Company as of September 30, 2002 and the results
of its operations and cash flows for the three and nine 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 September 30, 2002.
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 first-in,
first-out cost or market. Inventories consist of the following (amounts in
thousands):
September 30, 2002 December 31, 2001
Unfinished beef, pork, veal, lamb $660 $682
Packaging supplies 914 344
Finished Goods 695 116
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TOTAL $2,269 $1,142
================= =================
5. Notes payable.
The Company has established a $30 million credit line, with its 50%
shareholder, Smithfield Foods, Inc. ("Smithfield"). The Company's outstanding
balance under the line of credit bears interest at 1% above prime and is secured
by all of the Company's assets. The loan will mature in 2006.
The Credit Agreement requires, among other things, that the Company
maintain positive shareholders' equity determined in accordance with generally
accepted accounting principles (the "Net Worth Covenant"). At September 30,
2002, the Company's shareholders' equity was not positive; however, Smithfield
waived any defaults relating to compliance with the Net Worth Covenant to and
including November 5, 2002. To avoid such a default, the Company raised $2.0
million by the sale of shares of common stock in a private placement of
securities. (See note 7.) By virtue of having raised this equity capital on or
before the expiration of the Smithfield waiver, the Company avoided a non-waived
Event of Default under the Credit Agreement at November 6, 2002.
Smithfield has agreed to allow the Company to use up to $18.3 million
of the $30 million credit line to allow the Company to purchase, renovate and
equip the Tabor Avenue Facility. The project is currently running $1.0 million
over budget. To cover this overrun, the Company will have to get incremental
funding approval from Smithfield, use internally generated funds, or secure
additional commercial financing. The principal balances of the Smithfield loan
at September 30, 2002 and at December 31, 2001 were as follows (amounts in
thousands):
September 30, 2002 December 31, 2001
Revolving Loan $ 4,300 $2,500
Tabor Avenue Facility Loan $11,866 0
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TOTAL $16,166 $2,500
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6. Net loss per share.
Basic earnings per share ("EPS") is computed using the weighted average
number of common shares outstanding during the period.
7. Subsequent Event.
In early November, 2002 the Company sold two million shares of common
stock in a private placement of securities to investors at a price of $1.00 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 2001 financial statements have been
reclassified to conform with the 2002 presentation.
Item 2. Management's Discussion and Analysis or Plan of Operation
Certain information contained in this Quarterly Report on Form 10-QSB
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
8
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, 2001.
Results of Operations
Three Months Ended September 30, 2002 compared to Three Months Ended
September 30, 2001
Sales for the three-month period ended September 30, 2002 were $13.1
million, which represents an increase of approximately $1.2 million or 10.1%
over sales of $11.9 million from the corresponding period of 2001. 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) but was also partially due to a change in the mix of products sold in
favor of higher 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 September 30, 2002
was $13.1 million which resulted in a small gross loss. By comparison, cost of
goods sold for the three-month period ended September 30, 2001 was $12.0
million, which resulted in a gross loss of $0.1 million. The Company's cost of
goods sold is comprised of four main components: meat, direct payroll, supplies,
and depreciation. These items accounted for approximately 73%, 13%, 13%, and 1%
of sales, respectively, in the three months ended September 30, 2002 as compared
to 74%, 14%, 12% and 1% 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 primal cuts from which
the customer's meat was processed) is a major determinant of the Company's
profit or loss. Concomitantly, the cost of meat as a percentage of sales is also
a major determinant of the Company's profit or loss.
Although meat cost declined slightly as a percentage of sales in the
current year as compared to the prior year, meat cost increased substantially as
a percentage of sales in the third quarter, 2002 (73%) as compared to its
percentage of sales in the first quarter, 2002 (64%). This increase was due in
large part to the substantial increase in the amount of whole muscle beef
processed by the Company, for which it was less able to obtain satisfactory
yields than has historically been true of its prior mix of meats. The principal
reasons why the yields were lower than has historically been the case were the
Company's commencement of case-ready beef processing prior to installation of
automated equipment, inadequate facility space prior to the move, and less
experience in dealing with whole muscle beef among Company employees, all of
which are, in the opinion of management, being corrected in the Tabor Avenue
Facility.
9
Direct payroll declined slightly as a percentage of sales in 2002
compared to 2001 due to increasing labor efficiencies. Supplies increased as a
percentage of sales in 2002 as compared to 2001 due to increased freight costs
and materials pricing. Freight costs increased in 2002, in part, due to the
necessity for temporary off-site storage of goods resulting from the Company's
having outgrown its Pottstown plant, but are expected to return to historical
levels (measured as a percent of sales) now that the move to Tabor Avenue has
been completed. Depreciation expense has been escalating as additional equipment
has been purchased. Management expects depreciation expense to increase as a
percentage of sales due to the equipping of the Tabor Avenue Facility.
Operating expenses for the three months ended September 30, 2002 were
$2.1 million (16.0% of sales) as compared to $1.2 million (10.1% of sales) for
the corresponding period of 2001. This increase of $0.9 million resulted from
increased payroll expenses, increased maintenance expenses, increased insurance
expenses, increased expenses due to sales volume and continued growth, and the
write-off of approximately $162,000 of leasehold improvements pertaining to the
former Pottstown plant. Moreover, substantial costs were incurred and charged to
operating expenses relative to the move to the Philadelphia facility and its
start-up, in accord with accounting policies of the Company.
Interest expense (net of interest income) for the three-month period
ended September 30, 2002 was approximately $0.1 million compared to
approximately $19,000 for the comparable period of 2001. The increase in
interest expense (net of interest income) is principally due to interest on the
borrowings for working capital under the Smithfield Credit Agreement; the
working capital balance at September 30, 2001, was $2.5 million compared to the
September 30, 2002 balance of $4.3 million. Management expects interest expense
to continue to increase due to the large borrowings required to purchase and
equip the Tabor Avenue Facility.
The net loss for the three-month period of 2002 was approximately $2.2
million as compared to a net loss of $1.3 million for the third quarter of 2001.
Nine Months Ended September 30, 2002 compared to Nine Months Ended
September 30, 2001
Sales for the nine-month period ended September 30, 2002 were $37.6
million, which represents an increase of approximately $6.7 million or 21.7%
over sales of $30.9 million from the corresponding period of 2001. 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) but was also partially due to a change in the mix of products sold in
favor of higher priced items.
Cost of goods sold for the nine-month period ended September 30, 2002
was $36.6 million which resulted in a gross profit of approximately $1.0 million
or 2.7% of sales. By comparison, cost of goods sold for the nine-month period
ended September 30, 2001 was $30.9 million, which resulted in a negligible gross
loss. The Company's cost of goods sold is comprised of four main components:
meat, direct payroll, supplies and depreciation. These items accounted for
approximately 70%, 13%, 13% and 1% of sales, respectively, in the nine months
ended September 30, 2002 as compared to 72%, 16%, 11% and 1% of sales for the
corresponding period of the prior year. Direct payroll declined as a percentage
of sales in 2002 as compared to 2001 due to increasing labor efficiencies.
Supplies increased as a percentage of sales in 2002 as compared to 2001 due to
10
increased material costs as well as increased freight charges. Depreciation
expense has been escalating as additional equipment has been purchased.
Management expects depreciation expense to increase as a percentage of sales due
to the equipping of the Tabor Avenue Facility.
Operating expenses for the nine months ended September 30, 2002 were
$5.3 million (14.1% of sales) as compared to $2.6 million (8.4% of sales) for
the corresponding period of 2001. This increase of $2.7 million resulted from
increased payroll expenses, increased maintenance expenses, increased insurance
expenses, and increased expenses due to sales volume and continued growth, and
the write-off of approximately $162,000 of leasehold improvements pertaining to
the former Pottstown plant. Moreover, substantial costs were incurred and
charged to operating expenses relative to the move to the Philadelphia facility
and its start-up, in accord with accounting policies of the Company.
Interest expense (net of interest income) for the nine-month period
ended September 30, 2002 was approximately $0.2 million compared to
approximately $0.1 million for the comparable period of 2001. The increase in
interest expense (net of interest income) is principally due to interest on the
borrowings for working capital; the working capital balance at September 30,
2001, was $2.5 million compared to the September 30, 2002 balance of $4.3
million.
Liquidity and Capital Resources
General
By any measure, the Company had a shortage of liquidity at September
30, 2002. At that date, the Company had only $1.6 million of cash, approximately
66% of the amount of cash it had at December 31, 2001. The Company's ratio of
current assets to current liabilities at September 30, 2002 was 1.2, down from
2.4 at December 31, 2001. The Company's debt-to equity ratio at September 30,
2002 was less than zero as compared to approximately 0.9 to 1 at December 31,
2001. All such changes are primarily the result of the Company's net loss in the
nine months ended September 30, 2002 and, in the case of the debt-to-equity
ratio, the increase in borrowings to support the Tabor Avenue project and
increasing need for working capital commensurate with an increase in Company
sales.
Generally, the Company maintains an unfinished inventory of meat
supplies equal to approximately 60-75% of estimated weekly sales volume.
Purchases are made using the trade credit programs of suppliers which allow the
Company to purchase meat supplies with payment due within seven days. 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 because of the short payment terms required by
suppliers.
The Company's working capital decreased from $3.8 million at December
31, 2001 to $1.3 million at September 30, 2002, principally as a result of the
net loss in the nine months ended September 30, 2002 but also partially as a
result of the purchase of property and equipment. If the Company's losses
11
continue, and the Company does not succeed in raising additional equity (see
discussion below), the Company will deplete its remaining cash resources.
Moreover, the Smithfield Credit Agreement requires that the Company maintain
positive shareholders' equity (computed in accordance with generally accepted
accounting principles). Although the Company's shareholders' equity was not
positive at September 30, 2002, Smithfield waived compliance with this covenant
until November 5, 2002. By such date, the Company was in compliance with this
requirement. See Part II. - - Other Information, Item 3, Defaults Upon Senior
Securities. If the Company fails to maintain positive shareholders' equity (or
otherwise defaults under the Credit Agreement), Smithfield could declare the
outstanding loan to be due and to terminate its commitment to lend additional
amounts.
Accounts Payable, Operating increased from $2.1 million at December 31,
2001 to $5.5 million at September 30, 2002 as a result of the Company's increase
in sales but also as a result of the Company's increasing the amount of time
taken to pay some outstanding invoices. The Company estimates that as a result
of this increase in time of payment, approximately 30% of accounts payable at
September 30, 2002 were within suppliers' terms.
In early November, 2002 the Company sold two million shares of common
stock in a private placement of securities to investors at a price of $1.00 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. Although the
private placement relieves short-term liquidity issues for the Company,
Management believes that the Company's high debt-to-equity ratio and historical
shortage of liquidity will require the infusion of additional equity.
Consequently, the Company is considering alternatives to raise the needed
capital to strengthen the Company's balance sheet.
For a discussion of the potential financial effect on the Company's
liquidity of an adverse ruling in litigation to which the Company is a party,
see, Part II. Other Information, Item 1. Legal Proceedings.
Tabor Avenue Facility
On April 2, 2002 the Company purchased a 145,000 square foot facility
on ten acres of land located at 5501 Tabor Avenue in Philadelphia, Pennsylvania
(the "Tabor Avenue Facility") from QF Acquisition Corp., the equitable owner,
and PIDC Financing Corp., the legal owner. The purchase price of the Tabor
Avenue Facility was $2 million which was negotiated at arms length by the
parties.
The Company has consolidated all operations in the new plant and has
nearly completed the renovation and equipping of the plant. The Company's
current estimate to renovate and equip the Tabor Avenue Facility is as follows:
12
Renovation Costs $3.2 million
Equipment Costs $13.3 million
Other Costs $0.5 million
----------------
Total $17.0 million
================
In addition to these expenses, the Company has incurred moving expenses
and other costs associated with the move to the new plant. As a result of the
move, the Company is experiencing certain lost efficiencies among workers and is
incurring additional costs to train new employees. Management expects these
effects of the move to ameliorate over time.
The Company expects to amortize 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 will be
capitalized and depreciated over five years.
In the third quarter, the Company wrote off all remaining unamortized
leasehold improvements located at the Pottstown plant in the amount of $162,000.
As described below, the Company is in litigation with the landlord of the
Pottstown plant.
The new facility is intended to address space and automation issues.
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 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, should also
increase gross profits. These projected increases in gross profit, in turn, are
expected to help cover Company overheads. The Company expects that all work on
the Tabor Avenue Facility, including installation of remaining processing
equipment, will be completed by December 15, 2002.
Smithfield Loan
Smithfield has agreed to allow the Company to use up to $18.3 million
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 $1.0 million over budget. To cover this
overrun, the Company will have to get incremental funding approval from
Smithfield, use internally generated funds, or secure additional commercial
financing. The amount outstanding on the Smithfield line of credit was as
follows on the dates indicated (amounts in thousands):
Description September 30, 2002 December 31, 2001
Principal Advances $16,166 $ 2,500
Accrued Interest 0 58
------- -------
Total $16,166 $ 2,558
======= =======
13
The Company's cash on September 30, 2002 was $1.6 million. The
Company's line of credit with Smithfield (other than the portion usable for the
Tabor Avenue Facility) is based primarily on eligible inventories and eligible
accounts receivable. At September 30, 2002 the Company had borrowed $4.3 million
against approximately $4.6 million of eligible accounts receivable and eligible
inventory. As a result of additional draws on the line subsequent to September
30, 2002, the Company has no further availability on the Smithfield line
currently and, except as provided in the next sentences, must support its
liquidity needs through internally generated cash flow. The Company's borrowing
base for working capital will fluctuate with the level of eligible inventory and
eligible accounts receivable. Accordingly, as these amounts increase the Company
will be entitled to borrow additional sums. Conversely, if eligible inventories
and eligible accounts receivable were to decline, the Company would be required
to pay down the balance of the line of credit by the amounts of such decline.
For a discussion of the possible effects of continuing Company losses
under the Smithfield Credit Agreement, see the discussion above under this Item
2, Management's Discussion and Analysis or Plan of Operation - - Liquidity and
Capital Resources - - General, and Part II - Other Information, Item 3, Defaults
Upon Senior Securities.
Item 3. 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
Asousa Partnership v. Pennexx Foods, Inc.
The Company is the defendant in a lawsuit brought by its former
landlord at the Pottstown plant. Proceedings began almost two years ago in the
Montgomery County Court of Common Pleas. Since the commencement of the
litigation, the landlord filed a voluntary petition for protection from its
creditors under Chapter 11 of the Bankruptcy Code, and the case has been moved
to the Bankruptcy Court for the Eastern District of Pennsylvania. In the
lawsuit, the landlord has alleged that the Company failed to make timely rental
payments and is seeking damages. In addition, the landlord claims that it is
entitled to retain certain equipment purchased and installed by the Company but
not yet removed by the Company. The landlord also seeks to be paid the value of
the following items which the landlord alleges the Company improperly removed
upon its departure: (1) all but three of the fire extinguishers in the building;
(2) lockers; (3) the sign in front of the building; (4) refrigeration equipment;
(5) two large double bowl stainless steel sinks with sprayers; (6) four scales;
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(7) one large upright compressor; (8) two compressor line dryers; (9) two heavy
duty steel cabinets; (10) one Raymond Standup Fork Lift with charger; (11) three
heavy duty pallet jacks; (12) 11 pairs of swinging doors; (13) two stainless
steel horizontal freezers; (14) two large single bowl stainless steel sinks;
(15) two medium single bowl stainless steel sinks; (16) ten small stainless
steel pedestal sinks; (17) seven small stainless steel sinks without pedestals;
(18) five oak benches (one long, one medium, three short); (19) six freezer
units (one with three fans and five with two fans); (20) five Flexicon
conveyors; (21) 15 gray trash cans; (22) 6 white trash cans with lids; (23) one
Pitney-Bowes scale; (24) stainless steel tables; (25) stainless steel racks; and
(26) steel storage rack.
The landlord also claims that the Company left the Pottstown plant in a
damaged and unhealthy condition in violation of the lease; the landlord seeks
unspecified damages as a result of such alleged condition.
The Company vigorously disputes all claims. In particular, the Company
contends that its lease allowed removal of installed equipment. As a result, the
Company has not provided any loss contingency on account of the pending claim
because of management's belief that any award to the plaintiff will not
materially exceed the amount in escrow. The Company's defense to the claim for
additional rent is that the unpaid rent was withheld because of the landlord's
failure to honor its obligations to make certain improvements at the property.
Approximately $152,000, representing all rents due under the lease from the
commencement of the dispute to June 30, 2002, have been deposited into escrow.
However, the landlord contends that the Company owes rent at a rate higher than
the contract rent set forth in the lease from November 2000 to the date the
Company vacated the premises in July, 2002 as a result of the alleged breach
resulting from the Company's nonpayment of rent. The contract rent is
approximately $96,000 per year. The landlord has demanded approximately $750,000
in rent in excess of the amount in escrow, approximately $50,000 of interest due
on such demanded additional rent, $35,000 on account of property of a company
related to the landlord and allegedly taken and used by the Company, and
approximately $125,000 in counsel fees and other miscellaneous expenses.
On April 25, 2002, the landlord filed a motion for partial summary
judgment to evict, eject and dispossess the Company from the Pottstown plant. On
June 21, 2002, the Bankruptcy Court ruled in favor of the landlord.
Consequently, the Company accelerated its relocation to the Tabor Avenue
Facility. The acceleration of the timing of the move from Pottstown to Tabor
Avenue means that new equipment intended to automate the new plant is being
installed around the work schedule of the new plant. Moreover, the Company was
required to subcontract a portion of its pork processing work for a time through
a transition period until the new plant was configured and the necessary
equipment, completely installed.
These events have had an adverse financial effect on the Company.
Revenues and margins were reduced (and will continue to be reduced) until full
operations are established at the Tabor Avenue plant. The Company incurred key
employees' salaries and fixed operating costs despite the reduction of revenues
and margins during the time period of the move and its preparation. The Company
estimates that these expenses approximated $175,000 to $225,000 per month.
The Company believes the lawsuit with the landlord will come to trial
before March 31, 2003.
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Matthews v. Pennexx Foods, Inc.
On December 7, 2001, Robert V. Matthews, a shareholder of the Company,
filed a complaint against the Company in the United States District Court for
the District of Connecticut. The claims relate to an agreement dated November
22, 2000 pursuant to which Mr. Matthews agreed to assist the Company in
obtaining debt financing to be used for a potential expansion into New England
and for working capital purposes. In his complaint, Mr. Matthews alleges that
the Company breached the agreement by failing to issue and deliver to him (a)
2.2 million shares of common stock of the Company, (b) an option to purchase,
for no additional consideration, 2.0 million shares of common stock of the
Company, and (c) shares of common stock of the Company in payment of a $0.3
million loan he had made to the Company. He asserts various claims for breach of
contract, and has alleged that the Company engaged in unfair and deceptive
business practices, in violation of the Connecticut Unfair Trade Practices Act.
The District Court dismissed Mr. Matthews' statutory unfair trade
practices claim in September, 2002. The Company continues to deny the remaining
allegations in the Matthews complaint and is contesting them vigorously. The
Company has interposed numerous defenses to the complaint, including that the
agreement is void and unenforceable and that Mr. Matthews failed to use his best
efforts to assist the Company in finding debt financing. The parties are
currently engaged in litigation discovery, which should be concluded by the end
of 2002.
Item 3. Defaults Upon Senior Securities
The Credit Agreement between the Company and Smithfield Foods, Inc.
requires, among other things, that the Company maintain positive shareholders'
equity determined in accordance with generally accepted accounting principles
(the "Net Worth Covenant"). At September 30, 2002, the Company's shareholders'
equity was not positive; however, Smithfield waived any defaults relating to
compliance with the Net Worth Covenant to and including November 5, 2002,
although Smithfield advised the Company that, in the future, it would insist on
strict compliance with the terms of the Credit Agreement. In effect, the Company
was given thirty-six days in which to cure what would otherwise have been a
default.
To avoid such a default, the Company raised $2.0 million by the sale of
shares of common stock in a private placement of securities. The shares were
sold at a price of $1.00 per share. The shares which were sold were not
registered under the Securities Act of 1933 and must be held indefinitely by the
buyers in the absence of registration or an exemption from registration under
the appropriate securities laws. Although the average price of the Company's
common stock on the OTC Bulletin Board for the twenty trading days ending on
November 4, 2002 (the day before completion of the private placement) was $1.72,
and the price paid for the Company shares sold in the private placement
therefore represented a discount from the free-trading market price, a majority
of the Board of Directors nonetheless believed that the sale was in the best
interests of the Company because of the diminution in value of the shares sold
arising from the lack of securities law registration (which made the shares
temporarily unmarketable) and because of the Company's time critical need to
avoid a default of the Net Worth Covenant.
By virtue of having raised this equity capital on or before the
expiration of the Smithfield waiver, the Company avoided a non-waived Event of
Default under the Credit Agreement at November 6, 2002. If the Company were to
have net losses subsequent to September 30, 2002 in an amount which exceeded
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$1.5 million (representing the difference between the equity raised in the
private placement and the aggregate shareholders' deficit at September 30,
2002), the Company would again be in violation of the Net Worth Covenant.
Management believes that the net losses incurred by the Company in the three
months ended September 30, 2002 were primarily related to the move from
Pottstown to Philadelphia and the installation of automated processing equipment
in Philadelphia. Because the equipment installation will not be complete until
approximately December 15, 2002, Management expects continuing losses into the
fourth quarter of 2002.
The Credit Agreement with Smithfield also requires that the Company not
have an unreasonably small amount of capital with which to conduct its business
(the "Solvency Covenant"). Because the term "unreasonably small" is not precise,
there is no assurance that Smithfield might not claim at any time that the
Company has violated this provision, even after completion of the November 2002
private placement. Because the advance rate available to the Company for
eligible accounts receivable and eligible inventories is higher than would be
typical in an arms-length banking arrangement, the amount of capital which would
be "unreasonably small" would probably be lower than it would in the absence of
such a high advance rate. Nonetheless, the Company's debt-to-equity ratio on a
pro-forma basis after giving effect to the private placement as if it had been
completed at September 30, 2002, was still over 11 to 1 and will increase even
further as a result of the additional borrowings to complete the Tabor Avenue
project and the anticipated fourth quarter losses referred to in the preceding
paragraph. To address this problem and avoid (or reduce the likelihood) that
Smithfield will claim a default under the Solvency Covenant, Management is
considering available alternatives to raise additional equity capital for the
Company to strengthen its balance sheet.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certificate Pursuant to 18 U.S.C. ss.1350.
(b) The Company filed a Current Report on Form 8-K on September 25, 2002.
17
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
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: November 14, 2002
I, Michael D. Queen, certify that:
1. I have reviewed this quarterly report on Form 10-QSB 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
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;
18
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
November 14, 2002
I, Joseph R. Beltrami, certify that:
1. I have reviewed this quarterly report on Form 10-QSB 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
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;
19
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
November 14, 2002
20