Computer Software Innovations, Inc.

NOTE 5 – LONG-TERM AND SHORT-TERM DEBT, INCLUDING RELATED PARTY TRANSACTIONS, AND OFF-BALANCE SHEET INSTRUMENTS

Bank Credit Facilities

The Company maintains a line of credit facility with its bank. The terms of the facility are as follows:

• the principal amount of the facility is $8.0 million;
• the latest renewal was on March 6, 2012, with a maturity date of July 31, 2013;
• permissible purposes of the funds borrowed under the revolving facility include funding short-term working capital and general corporate purposes of the Company; and
• the definition of the borrowing base includes 50% of eligible inventory (with a maximum borrowing ability of $2.0 million against eligible inventory of $4.0 million), in addition to 80% of eligible accounts receivable.

On March 6, 2012, the Company refinanced its line of credit with another financial institution on substantially the same terms as its prior line, except that the funding limit was increased to $8.0 million for the line of credit, at a slightly lower interest rate (LIBOR plus 2.25% versus the former LIBOR plus 2.5%) with a termination date of July 31, 2013. Costs associated with the refinancing of $58 were incurred and deferred in Other assets and amortization expense of $11 and $14 were recorded for three and six months ended June 30, 2012, respectively.

Under the Company's bank facility, eligible accounts receivable balances essentially include all of the Company's trade accounts receivable except, in most cases, those accounts which are more than 90 days past due. Certain other accounts are excluded from eligibility for borrowing including: (i) accounts due from affiliates; (ii) accounts which the Company's management have determined to be of doubtful collectability; and (iii) accounts due from any one of the Company's customers to the extent such accounts constitute more than 30% of the total eligible accounts. The loans bear interest at LIBOR plus 2.25%, payable monthly. LIBOR plus 2.25% was 2.50% at June 30, 2012 and LIBOR plus 2.50 was 2.77% at December 31, 2011.

Pursuant to the "Debt-Classification of Revolving Credit Agreements Subject to Lock-Box Arrangement and Subjective Acceleration Clauses" subtopic of the FASB's ASC (the "Revolving Credit Subtopic"), a revolving credit facility which includes both a subjective acceleration clause and a lock-box arrangement should be classified as a current liability. The Company's revolving credit facility provides for a lock-box arrangement, whereby cash received is used to reduce the balance on a daily basis. Also, the Company's revolver includes a subjective acceleration clause, providing for acceleration upon a material adverse change in the Company's business or financial condition. This is a customary provision for revolving credit agreements. In accordance with the Revolving Credit Subtopic, the balance outstanding under the Company's revolving credit facility has been classified as a current liability.

The Company maintains an equipment term loan which has been modified and increased from time to time with a term of three to four years. The term loan is used periodically to refinance the Company's capital expenditures initially financed through its bank credit facility and improve its availability under its bank credit facility for working capital purposes. The latest modification was March 6, 2012 in conjunction with the line of credit facility refinancing discussed above. Pursuant to the modification, the equipment loan was increased from $0.5 million to $0.7 million, and bore interest at 30-day LIBOR plus 2.25%. Principal and interest are payable in twenty consecutive monthly payments of $40 beginning April 1, 2012 and continuing until October 6, 2013.

The amount outstanding on the equipment notes payable to the bank was $584 at June 30, 2012 and $619 at December 31, 2011.

Scheduled principal payments under the Company's bank notes payable for the years ending December 31 are presented below:

 

The loans under the revolving credit facility and the equipment facility, as well as all other obligations owed by the Company to the bank (such as accrued interest and service charges), are secured by a first priority security interest in substantially all of the Company's assets. Also, the Company is required to comply with certain covenants, including: providing periodic financial statements to the bank, compliance with SEC reporting requirements, allowing the bank to inspect its secured assets, and the Company maintaining its assets in good operating condition and maintaining sufficient insurance. Also, the Company is required to comply with certain financial covenants. The first financial covenant is a "Debt Service Coverage Ratio," which is measured at the end of each year. This ratio is calculated by adding certain nonrecurring special items to EBITDA ("Adjusted EBITDA"), and then dividing by current maturities of long term debt plus interest expense. For the purposes of the loan agreement, "EBITDA" means the total of (i) net income or loss from continuing operations (excluding extraordinary gains or losses), and to the extent deducted in determining net income or loss (ii) interest expense, (iii) income taxes, and (iv) depreciation, depletion and amortization expenses. The Company is required to maintain a Debt Service Coverage Ratio of not less than 1.2 to 1.0. The second financial ratio is Funded Debt to EBITDA, which is also measured annually. A ratio of not greater than 2.5 to 1.0 is required. For the purposes of the ratio, "Funded Debt" generally means all obligations for borrowed money or for the deferred purchase price of property, and all capitalized lease obligations. Management is not aware of any debt covenant violations at June 30, 2012 and December 31, 2011.

The loan agreement also contains certain restrictive covenants. These include general prohibitions on: disposing of property other than in the ordinary course of business; the Company changing its business; a change in control of the Company; mergers, acquisitions and the creation of new subsidiaries; the incurring of new indebtedness; the creation of new encumbrances or liens; investments, other than certain permitted investments in liquid investment grade paper; and the Company making loans, including loans to officers. Also, the loan agreement prohibits the Company from making any distributions (including any dividends on its common stock), or making any repurchases or redemptions of its capital stock, except to the extent there is no event of default either before or after any such distribution, repurchase or redemption. The bank may accelerate the Company's obligations under the loan agreement and the related promissory notes upon an event of default under the loan agreement. Events of default generally include the Company failing to make payments of principal or interest when due; defaults under loan covenants, subject to periods during which the Company may cure in certain cases; the Company becoming insolvent or being subject to certain bankruptcy proceedings, subject to certain time periods; and the occurrence of a material adverse change in the Company's business or financial condition. Upon an acceleration of the bank's loans to the Company, the bank, among other remedies, would have recourse to substantially all of the Company's assets through its security interest. There was $1,740 of draws outstanding as of June 30, 2012 and $1,312 as of December 31, 2011.

Subordinated Notes

The Company has subordinated notes payable to shareholders with amounts outstanding totaling $719 at June 30, 2012, and $763 at December 31, 2011. On June 25, 2010, the Company and each of the holders of certain Subordinated Promissory Notes dated February 11, 2005 (the "Subordinated Notes") entered into an Extension of Subordinated Notes and Waiver dated June 24, 2010 (the "Extension"). Pursuant to the Extension: 

• the maturity date of each Subordinated Note is no later than January 1, 2018, on which date all principal and accrued interest will be due and payable in full, if not earlier paid.
• the Company will make quarterly payments on the Subordinated Notes of principal and accrued interest in the amount of $50 in the aggregate to be applied pro-rata among the note holders, $25 on the Barron Subordinated Note and $5 each on the other Subordinated Notes.
• the Company expressed its intention to consider subsequent to each fiscal year end during the term of the Subordinated Notes whether it can make principal payments in addition to those expressly set forth in the Extension. Any such determination by the management and board of directors of the Company is in their sole discretion, and shall be based on factors they deem relevant, including but not limited to the financial performance of the Company during such fiscal year.
• at the discretion of management and the board of directors of the Company, the remaining balance on the Subordinated Notes can be repaid in full at any time without penalty.
• despite the Subordinated Notes not being in default, they will continue to bear interest at the Default Rate of 15% until repaid.
• except as modified by the Extension, all other terms and conditions of the Subordinated Notes were confirmed and shall remain in full force and effect.

The Subordinated Notes were issued on February 11, 2005 as a part of our reverse merger and recapitalization. The Subordinated Notes are unsecured and are subordinated to the Company's senior debt, including its revolving credit and term debt with its bank lender. The original principal of all of the Subordinated Notes aggregated $3,750. At June 25, 2010, immediately prior to the Extension, principal on the Subordinated Notes totaled $1,750 and accrued interest totaled $62. The Company has paid interest at the default rate of 15% per annum since the original maturity date of May 9, 2006, when the Company, with the support of its management, board of directors and its bank elected to defer the payment and pay the default interest rate to use the funds to support working capital needs and investments in acquisitions. The Subordinated Notes were extended several times, the latest being June 25, 2010, as described above, when the maturity date was extended to January 1, 2018. The history of the Subordinated Notes has been previously disclosed in the Company's Form 8-K dated September 3, 2009, as well as in its prior Forms 10-Q and Forms 10-K.

In addition to Barron, which owns all of our preferred stock, the Subordinated Notes are held by the five shareholders of our predecessor, Computer Software Innovations, Inc., a South Carolina corporation. Four of these note holders are currently executive officers of the Company, and include: Nancy K. Hedrick, President and Chief Executive Officer; Thomas P. Clinton, Senior Vice President of Strategic Relationships; Beverly N. Hawkins, Senior Vice President of Planning and Special Projects Financial Software Solutions; and William J. Buchanan, Senior Vice President of Technology Solutions and Cloud Services. The fifth holder, Joe G. Black, formerly served as chief financial officer of the Company. The Extension and the related restructuring of the Subordinated Notes were approved by the Company's three outside directors, none of whom have any interest in the Subordinated Notes.

Scheduled principal payments under the Company's subordinated notes payable for the years ending December 31 are presented below:

 

Off Balance Sheet Instruments

As of June 30, 2012, and for the periods reported, and through the filing date, the Company had no off-balance sheet instruments except for certain operating leases discussed in Note 8.

Related Party Transactions

During the first six months of 2012 the Company made principal and interest payments to the five former shareholders of CSI – South Carolina, all of whom are significant shareholders of the Company, and four of whom are executive officers, and Barron, who owns all of the Company's preferred shares. These payments were made on the subordinated notes payable which were associated with the reverse merger transaction which occurred in 2005, and represented an annual interest rate of 15% as of June 30, 2012. In 2012, principal and interest payments to the five original shareholders of CSI – South Carolina totaled $50 and principal and interest payments to Barron also totaled $50.