NOTE 8—LINES OF CREDIT AND OTHER BORROWINGS

Lines of Credit

During the year ended December 31, 2012, the Company entered into and amended two revolving credit facility agreements with Comerica Bank (the “Credit Agreements”), which provide for borrowings against certain domestic accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Domestic Revolver”), and borrowings against certain export related accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Ex-Im Revolver”), for a combined aggregate commitment of borrowings up to $8.0 million. On May 7, 2013, the Company amended the Credit Agreements (“Amendment No. 2”) with Comerica Bank to increase the borrowing capacity under the Domestic Revolver from $4.0 million to $6.0 million, resulting in a combined aggregate commitment of borrowings up to $10.0 million. On September 6, 2013, the Company amended the Credit Agreements (“Amendment No. 3”) with Comerica Bank which decreased the borrowing capacity under the Domestic Revolver from $6.0 million to $4.0 million, resulting in a combined aggregate commitment of borrowings up to $8.0 million. The lines of credit mature on May 1, 2014, at which date any remaining borrowings and accrued interest under the lines of credit become due and payable. As of September 30, 2013, the Company had aggregate outstanding borrowings totaling approximately $5.5 million, which included $3.5 million under the Domestic Revolver and $2.0 million under the Ex-Im Revolver, as compared with aggregate outstanding borrowings totaling approximately $1.6 million as of December 31, 2012.

Lockbox arrangements under the revolving bank facilities provide that substantially all of the income generated is deposited directly into lockbox accounts and then swept into cash management accounts for the benefit of Comerica Bank. Cash is disbursed from Comerica Bank to the Company only after payment of the applicable debt service and principal. At September 30, 2013 and December 31, 2012, there were no restricted cash amounts. The Company’s obligations are generally secured by substantially all of the Company’s assets now owned or hereinafter acquired.

The outstanding principal balance of the Credit Agreements bears interest at annual percentage rates equal to the daily prime rate, plus 2.00% for the Domestic Revolver and 1.50% for the Ex-Im Revolver. The daily prime rate is subject to a floor of the daily adjusting LIBOR rate plus 2.50% per annum, or if LIBOR is undeterminable, 2.50% per annum. The Company is also required to pay an unused commitment fee of 0.25% based on a portion of the undrawn lines of credit, payable quarterly in arrears. During the three and nine months ended September 30, 2013, the Company incurred interest expense associated with the credit facilities of $181,000 and $381,000, respectively, including $71,000 and $152,000, respectively, of amortization of deferred debt issuance costs and $43,000 and $79,000, respectively, of amortization of the discount on lines of credit. During the three and nine months ended September 30, 2012, the Company incurred interest expense associated with the credit facilities of $98,000 and $133,000, respectively, including $38,000 and $53,000, respectively, of amortization of deferred debt issuance costs and $18,000 and $25,000, respectively, of amortization of the discount on lines of credit. Interest expense payable was approximately $9,000 and $19,000 at September 30, 2013 and December 31, 2012, respectively, and was included in accrued liabilities in the accompanying consolidated financial statements.

The Credit Agreements require the Company to maintain compliance with certain financial and non-financial covenants, as defined therein. Amendment No. 3 resulted in certain new and amended financial covenants for the quarters ending September 30, 2013 and December 31, 2013. As of September 30, 2013, the Company was in compliance with these covenants with the exception of the earnings before income tax, depreciation, and amortization (“EBITDA”) covenant. On November 8, 2013, the Company amended the Credit Agreements (“Amendment No. 4”) with Comerica Bank to waive the noncompliance with the minimum EBITDA covenant, reset the EBITDA covenant for the quarter ending December 31, 2013, and establish covenants for the remaining term of the agreements. Amendment No. 4 includes liquidity ratio and liquid asset covenants, and an equity raise requirement that established March 1, 2014 as the latest date the Company is required to raise at least $3.0 million. Any future noncompliance with these covenants may result in default interest rates and penalties, and Comerica Bank could declare the amounts outstanding immediately due and payable. Management is considering alternative financing solutions to mitigate any future liquidity constraints this may impose on the Company. 

During the year ended December 31, 2012, the Company issued and amended a warrant to Comerica Bank (“2012 Comerica Warrant”) to purchase up to 80,000 shares of the Company’s common stock at an amended exercise price per share of $2.00. During the three months ended March 31, 2013, Comerica Bank exercised all 80,000 of the 2012 Comerica Warrant shares on a cashless basis pursuant to the Notice of Exercise resulting in a net issuance of 40,465 shares of common stock.

On September 6, 2013, the Company issued an additional warrant to Comerica Bank (the “September 2013 Comerica Warrant”) to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The September 2013 Comerica Warrant vests in four equal quarterly tranches commencing on December 31, 2013 and shares are exercisable once vested. The 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on September 6, 2018. The fair value of the September 2013 Comerica Warrants was estimated using the Black-Scholes option-pricing model with the following assumptions: expected term of 5.00 years; volatility of 105.32%; annual dividend per share of $0.00; and risk-free interest rate of 1.77%; and resulted in an estimated fair value of $143,000 which was recorded as equity and resulted in a discount to the credit facilities at issuance. The discount is being amortized on a straight-line basis to interest expense over the remaining term of the Credit Agreements.

In connection with Amendment No. 4, the Company incurred an amendment fee of $10,000 and issued an additional warrant to Comerica Bank (the “November 2013 Comerica Warrant”) to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The November 2013 Comerica Warrant includes an accelerated vesting clause that may be triggered by certain events described therein, but otherwise vests in four equal quarterly tranches commencing on December 31, 2013, and shares are exercisable once vested. The November 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on November 8, 2018.

Other Borrowings

The Company finances a portion of its annual insurance premiums which it pays in installments over nine months. As of September 30, 2013 and December 31, 2012, $0 and $379,000 at an annual interest rate of 3.0%, respectively, was outstanding under this arrangement and was included in accrued liabilities in the accompanying consolidated financial statements. The Company incurred interest expense associated with the financed insurance premiums of approximately $1,000 and $5,000 during the three and nine months ended September 30, 2013, respectively, and approximately $0 and $4,000 during the three and nine months ended September 30, 2012, respectively.