Note 10 - Debt

9 Months Ended

Sep. 30, 2012

10. Debt

Debt is classified on the balance sheet as follows:

	December 31, 2011		September 30, 2012
Current:
Capital lease obligations	$	544	$	548
Revolving credit agreement		2,477		1,564
		3,021		2,112
Non-current:
Capital lease obligations		897		569
Mandatorily redeemable preferred stock		12,673		14,670
Convertible subordinated note		-		2,022
		13,570		17,261

Total	$	16,591	$	19,373

Convertible Note

On August 20, 2012, the Company entered into a definitive agreement with its majority stockholder, Saints Capital Granite, L.P. (“Saints”), for the issuance and sale of $2,000 in principal amount of its 10% Convertible Note (the “Note”), due August 31, 2015. The transaction was completed and the Note was issued on August 21, 2012.

The note accrues interest at 10% per annum and matures on August 31, 2015. Interest on the note is payable in kind through increasing the outstanding principal amount of the note, or, at the Company’s option, it may pay interest quarterly in cash. The note will not be convertible prior to March 31, 2013. After March 31, 2013, at Saints’ option, the note is convertible, in whole or in part, into shares of Common Stock of Merisel at a conversion price that is the greater of (a) $0.10 or (b) an amount equal to (x) EBITDA for the twelve months ended March 31, 2013 multiplied by six and one-half (6.5), less amounts outstanding under the PNC Agreement, and liabilities relating to the outstanding redeemable Series A Preferred Stock and the Note or other indebtedness for borrowed money and (y) divided by the number of shares of Common Stock outstanding as of the conversion date.[1] The note is unsecured. It may be redeemed, in whole or in part, at any time prior to March 31, 2013, so long as the Company’s outstanding Series A Preferred Stock has been redeemed, at a redemption price equal to two and one-half times the outstanding principal amount of the Note, plus accrued interest.

The Company incurred financing costs of $107 on this transaction and has recorded the costs in other assets and will amortize this amount over the life of the Note to interest expense.

The gross proceeds from the transaction are used for working capital purposes.

[1] “EBITDA” means the net income of the Company from continuing operations before interest expense (income), income taxes, depreciation and amortization expense, adding back non-cash charges including, without limitation, compensation charges for equity grants and charges for unconsolidated losses (gains), determined directly or indirectly from the financial statements of the Company contained in the Quarterly Report on Form 10-Q or Annual Report on Form 10-K of the Company for the applicable periods.

Mandatorily Redeemable Preferred Stock

On February 4, 2011, the Company issued 140,000 shares of a Series A Preferred Stock, par value $.01 per share, at an original issue price of $100 per share. The Series A Preferred must be redeemed by the Company on or before February 4, 2017 and may be redeemed by the Company, in whole or in part, at any time after February 4, 2013, in each case at a price of $100 per share, plus any accrued but unpaid dividends. Based on the guidance in ASC 480, “Distinguishing Liabilities from Equity,” the Company has classified the Series A Preferred as a liability because it is mandatorily redeemable on February 4, 2017. Accordingly, the Company records the dividends as interest expense over the life of the Series A Preferred.

The Series A Preferred earns cumulative cash or stock dividends at the rate of 12% per annum, payable quarterly in arrears and accruing regardless of whether they are declared by the Board of Directors of the Company or funds are legally available to pay them. Any dividends accrued and not paid by the Company in cash shall be paid in additional shares of Series A Preferred valued at $100 per share. If the Company does not pay dividends in cash equal to at least 8% per share per annum, the rate of the dividend will increase by 4% per annum to 16% per annum.

As of December 31, 2011, the Company had accrued $434 for the fourth quarter dividend payment. On March 27, 2012, the Company’s Board approved the payment for the three month period ended December 31, 2011 to be made with additional Series A Preferred shares in lieu of cash. As noted above, given 100% of the payment was made in kind, the dividend rate for the payment increased to 16% and the Company issued 5,781.1222 shares of Series A Preferred at an original issue price of $100 per share in payment of the dividend during the first quarter. The incremental interest expense that was incurred as a result of the Board decision was recorded during the first quarter. During each quarterly period of 2012 the Company has not met the requirements under the PNC Revolving Credit Agreement which provided the Company the ability to pay the quarterly dividend payment in cash. As such, the Company has accrued dividends at the 16% annual rate during 2012 and has issued 12,134.8745 shares of Series A Preferred at an original issue price of $100 per share in payment of the first and second quarter dividend. Until the Company meets the requirements, it will accrue and pay future dividends in additional shares of preferred stock at the annual rate of 16%. As of September 30, 2012, the Company has accrued $649 for this dividend payment.

The Company used the March 21, 2011 Stonington and Saints sale transaction as the basis for measuring fair value of the Series A Preferred. Stonington sold its 5,000,000 common shares and all 140,000 shares of the Series A Preferred to Saints for $14,500. The Company determined the fair value of the Series A Preferred Stock of $11,750 using the difference between the total transaction price and the fair value of the common stock as of the date of the Stock Purchase Agreement on February 18, 2011. The unamortized discount of $2,250 on the preferred stock will be amortized using the interest method over the 72 month term of the Series A Preferred. The amortization of the discount for the three and nine month periods ended September 30, 2012 of $71 and $205, and for the three and nine month periods ended September 30, 2011 of $59 and $155, respectively, was recorded as interest expense for the periods then ended. The Company also incurred $1,061 of costs in relation to this transaction, which were recorded as deferred financing cost to be amortized over the term of the Series A Preferred.

The Series A Preferred has no conversion rights and will have no voting rights except (i) the right to elect a single additional member to the Company’s Board of Directors upon the Company’s failure for at least four consecutive quarters to pay at least an 8% cash dividend per annum. The Company has not paid at least an 8% cash dividend per annum since August, 2011. As such Saints currently has the right to elect an additional member to the Company’s Board of Directors; and (ii) to separately vote or consent to alter the terms of the Series A Preferred, create or increase the number or terms of shares of any class that is senior to or in parity with the Series A Preferred or to incur debt securities senior to the Series A Preferred, other than the Company’s existing credit facility or any replacement thereof if the incurrence of debt pursuant to such debt securities would cause the ratio of the Company’s total indebtedness to EBITDA to be greater than 3.5:1 excluding the Series A Preferred. The Certificate of Designation limits the ability of the Company to pay dividends on its common stock.

Revolving Credit Agreement

During the second quarter of 2010, the Company entered into a Revolving Credit and Security Agreement (the “PNC Agreement”) with PNC Bank (“PNC”). The PNC credit facility (the “Facility”) consists of a $14,000 revolving loan, or revolver, including up to $3,000 in letters of credit secured by separate cash collateral.

The maturity date of the Facility is August 13, 2013. The interest rate of the Facility is 3% over a “Base Rate,” which is a floating rate equal to the highest of (a) PNC’s publicly announced prime rate then in effect, (b) the Federal Funds Open Rate plus 0.5%, or (c) the LIBOR Rate plus 1%; or, at the advance election of the Company, 4% over PNC’s 30, 60 or 90 day Eurodollar Rate. As of September 30, 2012 the Base Rate plus 3% is 6.25%. The revolver is also subject to a 0.75% fee per annum payable quarterly on the undrawn amount.

The PNC Agreement requires that all customer receivables collected shall be deposited by the Company into a lockbox account controlled by PNC. All funds deposited into the lockbox will immediately be used to pay down the Facility. Additionally, the PNC agreement contains provisions that allow PNC to accelerate the scheduled maturities of the Facility for conditions that are not objectively determinable. As such, the Company has classified the PNC balance as a current liability.

The Facility includes one financial covenant requiring that the Company maintain a fixed charge coverage ratio for the trailing twelve month period (defined as EBITDA less unfinanced capital expenditures, less cash dividends, less cash paid for taxes over all debt service) of not less than 1.1 to 1.0 beginning in the quarter ending March 31, 2011, going forward. The Company has not been in compliance with this requirement beginning in the period ended March 31, 2012 and does not anticipate being in compliance for the foreseeable future. On October 3, 2012, the Company received a notification from PNC stating that the following events of default have occurred and are continuing under the Agreement: (i) failure to comply with the requirement to maintain a fixed charge coverage ratio of at least 1.1 to 1.0 for the quarters ended March 31, 2012 and June 30, 2012; and (ii) incurring indebtedness owing to Saints during August, 2012. The notification stated that PNC has determined not to exercise its option to charge interest at default rate under the Agreement and they shall continue to make advances at their discretion provided that the foregoing determinations shall not constitute a waiver of any rights related thereto. PNC has engaged in discussions with the Company to amend the current agreement and waive the events of default. Based on the discussions, the Company anticipates this to be completed during the fourth quarter of 2012, however, there are no assurances that this will take place.

The Company’s borrowing base under the Facility is the sum of (i) 85% of its eligible accounts receivable, including up to $500 of unbilled accounts receivable for work performed within the previous 30 days plus (ii) 50% of eligible raw material inventory up to $1,000. The borrowing base is reduced by an Availability Reserve which was reduced to $1,000 from $2,000 at February 3, 2011 pursuant to the PNC Amendment and by outstanding letters of credit in the amount of $2,000 as of June 30, 2012. The Facility must be prepaid when, and to the extent of, the amount of the borrowings exceed the borrowing base. In addition, borrowings under the Facility must be prepaid with net cash proceeds of certain insurance recoveries, at the option of PNC. Early voluntary termination and prepayment will incur a fee $30 from August 13, 2012 through August 12, 2013.

As of September 30, 2012, the Company has letters of credit under the Facility in the amount of $2,000, which reduces the availability under the Facility by that amount. The letters of credit were used to provide security deposits on the real estate leases for the facilities in Carlstadt, NJ and New York, NY.

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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