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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended December 31, 2012

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 1-32543

 

FORTUNE INDUSTRIES, INC.

(Exact name of Registrant as specified in its charter)

 

INDIANA 20-2803889
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)

 

6402 Corporate Drive 46278
Indianapolis, IN (Zip Code)
(Address of principal executive offices)  

 

(317) 532-1374

(Registrant’s telephone number, including area code)

 

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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

Large accelerated filer      ¨ Accelerated filer                                ¨
   
Non-accelerated filer        ¨  Smaller reporting company              x
(Do not check if a smaller reporting company)  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

 

As of February 11, 2013, 12,287,290 shares of the Company’s $0.10 per share par value common stock were outstanding.

  

 
 

 

FORTUNE INDUSTRIES, INC.

FORM 10-Q

For The Quarterly Period Ended December 31, 2012

 

INDEX

 

  Page
PART I. Financial Information  
  ITEM 1. Financial Statements  
    Consolidated Balance Sheets as of December 31, 2012 (unaudited) and June 30, 2012 (audited) 2
    Consolidated Statements of Operations for the three and six month periods ended December 31 , 2012 (unaudited) and December 31, 2011 (unaudited) 4
    Consolidated Statement of Changes in Shareholders’ Equity for the six month period ended December 31, 2012 (unaudited) 5
    Consolidated Statements of Cash Flows for the six month periods ended December 31, 2012 (unaudited) and December 31, 2011 (unaudited) 6
    Notes to the Unaudited Interim Consolidated Financial Statements 8
  ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
  ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 15
  ITEM 4. Controls and Procedures 15
PART II. Other Information  
  ITEM 1. Legal Proceedings 15
  ITEM 1A. Risk Factors 16
  ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
  ITEM 3 Defaults Upon Senior Securities 16
  ITEM 4. Mine Safety Disclosures 16
  ITEM 5. Other Information 16
  ITEM 6. Exhibits 16
Signatures 17

 

 
 

 

PART 1 - FINANCIAL INFORMATION

Item 1. Financial Statements.

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS)

 

   December 31,   June 30, 
   2012   2012 
         
ASSETS          
CURRENT ASSETS          
           
Cash and equivalents  $6,430   $5,312 
Restricted cash (Note 1)   2,123    2,397 
Accounts receivable, net of allowance for doubtful accounts of $147 and $15   2,814    3,092 
Deferred tax asset   1,500    1,500 
Prepaid expenses and other current assets   502    483 
Total Current Assets   13,369    12,784 
           
OTHER ASSETS          
Property, plant & equipment, net of accumulated depreciation of $1,850 and $1,799   173    139 
Deferred tax asset   1,250    1,250 
Goodwill   12,379    12,379 
Other intangible assets, net of accumulated amortization of $2,755 and $2,609   1,841    2,044 
Other long-term assets   59    66 
Total Other Assets   15,702    15,878 
           
TOTAL ASSETS  $29,071   $28,662 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

2
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (CONTINUED)

(DOLLARS IN THOUSANDS)

 

 

   December 31,   June 30, 
   2012   2012 
         
LIABILITIES AND SHAREHOLDERS' EQUITY          
CURRENT LIABILITIES          
           
Accounts payable  $508   $881 
Workers' compensation reserves   558    632 
Customer deposits   92    92 
Accrued expenses   7,425    7,085 
Total Current Liabilities   8,583    8,690 
           
LONG-TERM LIABILITIES          
Workers' compensation reserves   624    624 
           
Total Liabilities   9,207    9,314 
           
SHAREHOLDERS' EQUITY (NOTE 3)          
           
Common stock, $0.10 par value; 150,000,000 authorized; 12,287,290 issued and outstanding at December 31, 2012 and June 30, 2012   1,226    1,226 
Series C preferred stock, $0.10 par value; 1,000,000 authorized; 296,180 issued and outstanding at December 31, 2012 and June 30, 2012   27,133    27,133 
Treasury stock, at cost, 214,444 shares at December 31, 2012 and June 30, 2012   (809)   (809)
Additional paid-in capital and warrants outstanding   20,383    20,383 
Accumulated deficit   (28,069)   (28,585)
Total Shareholders' Equity   19,864    19,348 
           
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $29,071   $28,662 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

3
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

   For the Three Months Ended   For the Six Months Ended 
   December 31,   December 31,   December 31,   December 31, 
   2012   2011   2012   2011 
                 
REVENUES  $13,739   $14,836   $27,499   $30,631 
COST OF REVENUES   10,551    11,726    21,065    24,272 
                     
GROSS PROFIT   3,188    3,110    6,434    6,359 
                     
OPERATING EXPENSES                    
Selling, general and administrative expenses   2,523    2,553    4,768    4,916 
Depreciation and amortization   131    133    261    267 
Total Operating Expenses   2,654    2,686    5,029    5,183 
OPERATING INCOME   534    424    1,405    1,176 
                     
OTHER INCOME (EXPENSE)                    
Interest income   4    6    10    17 
Interest expense   (1)   (3)   (1)   (7)
Other income   -    (4)   -    - 
Total Other Income (Expense)   3    (1)   9    10 
INCOME BEFORE PROVISION FOR INCOME TAXES   537    423    1,414    1,186 
Provision for income taxes   15    6    84    39 
NET INCOME   522    417    1,330    1,147 
Preferred stock dividends   407    339    814    678 
                     
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS  $115   $78   $516   $469 
                     
BASIC INCOME PER COMMON SHARE  $0.01   $0.01   $0.04   $0.04 
                     
Basic Weighted Average Shares Outstanding   12,287,290    12,270,790    12,287,290    12,270,790 
                     
DILUTED INCOME PER COMMON SHARE  $0.01   $0.01   $0.04   $0.03 
                     
Diluted Weighted Average Shares Outstanding   14,593,290    14,593,290    14,593,290    14,593,290 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

4
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(DOLLARS IN THOUSANDS)

 

               Additional         
               Paid-in Capital       Total 
   Common   Preferred   Treasury   and Warrants   Accumulated   Shareholders' 
   Stock   Stock   Stock   Outstanding   Deficit   Equity 
                         
BALANCE AT JUNE 30, 2012 (Audited)  $1,226   $27,133   $(809)  $20,383   $(28,585)  $19,348 
                               
Net income   -    -    -    -    1,330    1,330 
Preferred stock dividends   -    -    -    -    (814)   (814)
                               
BALANCE AT DECEMBER 31, 2012 (Unaudited)  $1,226   $27,133   $(809)  $20,383   $(28,069)  $19,864 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

5
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

(UNAUDITED)

 

   For the Six Months Ended 
   December 31,   December 31, 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net Income  $1,330   $1,147 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   260    267 
Provision for losses on accounts receivable   132    29 
Changes in certain operating assets and liabilities:          
Restricted cash   274    (1)
Accounts receivable   146    (703)
Prepaid assets and other current assets   (19)   338 
Other long-term assets   7    (34)
Accounts payable   (373)   188 
Workers' compensation reserves   (74)   235 
Customer deposits   -    (2,426)
Accrued expenses   340    2,012 
Net Cash Provided by Operating Activities   2,023    1,052 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Capital expenditures   (91)   (7)
Net Cash Used in Investing Activities   (91)   (7)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Payments on term debt   -    (250)
Dividends paid on preferred stock   (814)   (678)
Net Cash Used in Financing Activities   (814)   (928)
           
NET INCREASE IN CASH AND EQUIVALENTS   1,118    117 
           
CASH AND EQUIVALENTS          
Beginning of Period   5,312    6,036 
           
End of Period  $6,430   $6,153 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

6
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(DOLLARS IN THOUSANDS)

(UNAUDITED)

 

   For the Six Months Ended 
   December 31,   December 31, 
   2012   2011 
SUPPLEMENTAL DISCLOSURES          
Interest paid  $1   $8 
           
Income taxes paid  $84   $40 

 

See Accompanying Notes to the Unaudited Interim Consolidated Financial Statements

 

7
 

 

FORTUNE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(DOLLARS IN THOUSANDS UNLESS OTHERWISE INDICATED,

EXCEPT PER SHARE DATA)

(UNAUDITED)

 

NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

General

 

Basis of Presentation: The financial data presented herein is unaudited and should be read in conjunction with the consolidated financial statements and accompanying notes included in the 2012 Annual Report on Form 10-K filed by Fortune Industries, Inc. (which, together with its subsidiaries unless the context requires otherwise, shall be referred to herein as the “Company”). The consolidated balance sheet at June 30, 2012 has been derived from the audited financial statements at that date, but does not include all of the information or footnotes required by accounting principles generally accepted in the United States for complete financial statements. The Company’s consolidated balance sheet at December 31, 2012 and the consolidated statements of operations, cash flows and shareholders’ equity for the period ended December 31, 2012 have been prepared by the Company without audit. These unaudited financial statements contain, in the opinion of management, all adjustments (consisting of normal accruals and other recurring adjustments) necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States. The Company has evaluated subsequent events through the time these financial statements in the Form 10-Q report were filed with the Securities and Exchange Commission. The operating results for the six month period ended December 31, 2012 are not necessarily indicative of the operating results to be expected for the full fiscal year.

 

Nature of Business: Fortune Industries, Inc. is an Indiana corporation comprised of Professional Employer Organizations (PEOs) which provide full-service human resources outsourcing services through co-employment relationships with its clients.  Wholly owned subsidiaries operating in this industry include Professional Staff Management, Inc. and related entities (“PSM”); CSM, Inc. and related subsidiaries (“CSM”); and Employer Solutions Group, Inc. and related subsidiaries (“ESG”).

 

The Company bills its clients under Professional Services Agreements as licensed PEOs.  The billing includes amounts for the client’s gross wages, payroll taxes, employee benefits, workers’ compensation insurance and an administration fee.  The administration fee charged by the Company is typically a percentage of the gross payroll and is sufficient to allow the Company to provide payroll administration services, human resources consulting services, worksite safety training, and employment regulatory compliance.

 

The component of the administration fee related to administration varies, in part, according to the size of the client, the amount and frequency of payroll payments and the delivery method of such payments.  The component of the administration fee related to health, workers’ compensation and unemployment insurance is based, in part, on the client’s historical claims experience.  Charges by the Company are invoiced along with each periodic payroll delivered to the client.

 

Through the co-employment contractual relationship, the Company becomes the employer of record for all payroll related taxes and, as such, all payroll-related taxes are filed on the Company’s federal, state, and local tax identification numbers with the exception of states that require client identification for state unemployment taxes.  PEO clients are not required to file any payroll related taxes on their own behalf.  The calculations of amounts the Company owes and pays the various government and employment insurance vendors are based on the experience levels and activity of the Company and its clients.

 

Restricted Cash: Restricted cash includes certificates of deposits for letters of credit issued to collateralize the Company’s obligations under its various workers’ compensation programs and state licensing requirements. At December 31, 2012, the Company had $2,123 in total restricted cash. Of this amount, $1,850 is restricted for its various workers’ compensation programs in accordance with terms of insurance carrier agreements, and the remainder is restricted for certain standby letters of credit in accordance with various state regulations.

 

Goodwill and Other Indefinite-Lived Intangible Assets: Goodwill and other intangible assets with indeterminate lives are assessed for impairment at least annually and more often as triggering events occur. In making this assessment, management relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and market place data. There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of both goodwill and other intangible assets impairment. Since management’s judgment is involved in performing goodwill and other intangible assets valuation analyses, there is risk that the carrying value of the goodwill and other intangible assets may be overstated or understated.

 

The Company has elected to perform the annual impairment assessment of recorded goodwill and other indefinite-lived intangible assets as of the end of its fiscal year. Management has assessed qualitative factors, to determine whether it is necessary to perform the two-step quantitative impairment test, and determined it is more likely than not that its fair value exceeds the carrying amount.

8
 

 

Workers’ Compensation: The Company's PSM, CSM and ESG subsidiaries maintain fully funded, high deductible workers compensation insurance programs. Under the insurance policies established at each company, PSM and CSM’s deductible liability is limited to $250 per incident, with an aggregate liability limit of approximately $2,000. Under the insurance policy established at ESG, the deductible liability is limited to $350 per incident, with no aggregate liability limit.

 

NOTE 2– EQUITY INCENTIVE PLANS AND OTHER STOCK COMPENSATION

 

Restricted Share Units

 

Effective April 13, 2006, the Company’s shareholders approved the 2006 Equity Incentive Plan. Under terms of the 2006 Equity Incentive Plan, the Company may grant options, restricted share units and other stock-based awards to its management personnel as well as other individuals for up to 1.0 million shares of common stock. During the six month period ended December 31, 2012, no restricted share units were issued under this plan.

 

NOTE 3- SHAREHOLDERS’ EQUITY

 

Common Stock

 

The Company did not issue any shares of common stock during the six month period ended December 31, 2012.

 

Preferred Stock

 

On September 25, 2009, the Company reached an agreement with the Chairman to amend the dividend rates on the Series C Preferred Stock with an effective date of July 1, 2009. From the effective date forward the Series C Preferred Stock will bear an annual dividend of $2 per share in the years ending June 30, 2010 and 2011, $5 per share in the year ending June 30, 2012, $6 per share in the year ending June 30, 2013 and $7 per share thereafter. All other items of the Series C Preferred Shares remained unchanged. Dividends of $814 and $678 were declared for the six months ended December 31, 2012 and December 31, 2011 respectively.

 

Effective December 31, 2010, the Company revised its estimate regarding the collectability of its $2,500 term note receivable with a related party. Based on this change in estimate, the Company reclassified the note receivable as a reduction to its outstanding preferred stock as prescribed by a Security Agreement between the Company and the related party. Under terms of this Security Agreement and in the event of default of the term note receivable, the Company obtains the right to equal value of the preferred stock as defined including but not limited to title, interest and dividends. As of December 31, 2012 and the date of this filing, the Company has no intention to convert the note receivable in the foreseeable future.

 

NOTE 4- INCOME TAXES

 

ASC 740 requires a valuation allowance to reduce the deferred tax assets reported, if at December 31, 2012, the Company had federal tax operating losses based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

This evidence includes consideration of various uncertainties that management has identified as risk factors to the Company. Recent events, including significant turmoil within the domestic and foreign financial markets, healthcare legislation and increasing unemployment tax rates and taxable wage thresholds, more than likely are expected to contribute to atypical customer attrition and decreased gross profits. Additionally, since the divesture of certain segments in fiscal 2009 unrelated to the Company’s current focus of full service human resources, the Company has had positive results for the last five fiscal periods for financial reporting purposes including the current period. However, the Company has not evidenced a similar trend for income tax reporting purposes, experiencing net operating losses in four of prior seven fiscal periods, with the current, 2012 and 2011 fiscal years as the exception. These taxable losses are primarily the result of permanent timing differences related to the amortization of certain intangible assets for income tax purposes through 2022. The Company’s deferred tax assets and liabilities are susceptible to erratic changes due to the inherent unpredictable nature of the Company’s insurance claim liabilities and sensitivity to unemployment and wage volatility. Changes in the economy and federal and state legislature, both favorable and unfavorable, will impact management’s assumptions and estimates in future periods.

 

After consideration of the evidence, both positive and negative, management has determined that a $4.8 million and $5.3 million valuation allowance at December 31, 2012 and June 30, 2012, respectively, is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The change in the valuation allowance is $0.5 million for the six months ended December 31, 2012. The Company has federal net operating loss carry forwards of approximately $9.5 million and $10.8 million at December 31, 2012 and June 30, 2012, respectively, which expire between 2021 and 2030. The Company has state net operating loss carry forwards of approximately $9.7 million and $11.0 million at December 31, 2012 and June 30, 2012, respectively.

 

9
 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

Statements contained in this document, as well as some statements by the Company in periodic press releases and oral statements of Company officials during presentations about the Company constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”).  Forward-looking statements include statements that are predictive in nature, depend on or refer to future events or conditions, which include words such as “expect,” “estimate,” “anticipate,” “predict,” “believe” and similar expressions. These statements are based on the current intent, belief or expectation of the Company with respect to, among other things, trends affecting the Company’s financial condition or results of operations.  These statements are not guaranties of future performance and the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Actual events and results involve risks and uncertainties and may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors.  Factors that might cause or contribute to such differences, include, but are not limited to, the risks and uncertainties that are discussed under the heading “Risk Factors” disclosed within Form 10-K for the year ended June 30, 2012. Readers should carefully review the risk factors referred to above and the other documents filed by the Company with the Securities and Exchange Commission.

 

OVERVIEW

 

Fortune Industries, Inc. is a holding company of providers of full service human resources outsourcing services through co-employment relationships with the company’s clients. The terms “we”, “our”, “us”, “the Company”, and “management” as used herein refers to Fortune Industries, Inc. and its subsidiaries unless the context otherwise requires.

 

Our operations are largely decentralized from the corporate office. Autonomy is given to subsidiary entities, and there are few integrated business functions (i.e. sales, marketing, purchasing and accounting). Day-to-day operating decisions are made by subsidiary management teams. Our Corporate management team assists in operational decisions when deemed necessary, selects subsidiary management teams and handles capital allocation among our operations.

 

We were incorporated in the state of Delaware in 1988, restructured in 2000 and re-domesticated to the state of Indiana in May 2005.

 

On September 20, 2012, the Company announced that it has reached an agreement in principal to restructure its current merger agreement by planning to enter into an amended merger agreement with Ide Management Group, LLC (“Ide”), a skilled nursing facility management group headquartered in Greenfield, Indiana (the “Amended Agreement”). However, on December 28, 2012, the Company announced that it had entered into a Termination of Escrow Agreement with Ide whereby the Company determined not to go forward with the negotiations of a definitive agreement and agreed to terminate the Escrow Agreement entered into on September 19, 2012. The escrow funds deposited by Ide pursuant to the Escrow Agreement have been disbursed to Ide.

 

As a result of the termination of discussions with Ide, our board of directors has authorized the Company to resume the work necessary to complete the original merger transaction with CEP, Inc. and CEP Merger Sub, Inc.

 

Mr. Fortune has pledged his ownership holdings in the Company as collateral on certain personal debt obligations. Mr. Fortune passed away on August 25, 2012. If his estate were to default on these debt obligations and the collateral is called upon by the lending institution, it could result in a potential change in control of the Company if the default may not be cured by the majority shareholder through some other means.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s accounting policies, which are in compliance with accounting principles generally accepted in the United States, require application of methodologies, estimates and judgments that have a significant impact on the results reported in the Company’s financial statements. Those policies that, in the belief of management, are critical and require the use of complex judgment in their application, are disclosed on the Company’s Form 10-K for the year ended June 30, 2012. Since June 30, 2012, there have been no material changes to the Company’s critical accounting policies, except for the following:

 

New Accounting Pronouncements

 

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment”. The objective of this ASU is to simplify how an entity tests goodwill for impairment. The new guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

 

10
 

 

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment”. The objective of this ASU is to simplify how an entity tests indefinite-lived intangibles for impairment. The new guidance will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative indefinite-lived intangible assets impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

 

Other new pronouncements issued but not effective until after December 31, 2012, are not expected to have a significant effect on the Company’s consolidated financial statements.

 

Income Taxes

 

Deferred tax assets are recognized for taxable temporary differences, tax credit and net operating loss carry forwards. These assets are reduced by a valuation allowance, which is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. For this purpose, management considered evidence, both positive and negative, regarding various uncertainties identified as risk factors to the Company. Recent events, including significant turmoil within the domestic and foreign financial markets, healthcare legislation and increasing unemployment tax rates and taxable wage thresholds, more than likely are expected to contribute to atypical customer attrition and decreased gross profits. Additionally, since the divesture of certain segments in fiscal 2009 unrelated to the Company’s current focus of full service human resources, the Company has had positive results for the last five fiscal periods for financial reporting purposes, including the current period. However, the Company has not evidenced a similar trend for income tax reporting purposes, experiencing net operating losses in four of prior seven fiscal periods, with the current, 2012 and 2011 fiscal years as the exception. These taxable losses are primarily the result of permanent timing differences related to the amortization of certain intangible assets for income tax purposes through 2022. The Company’s deferred tax assets and liabilities are susceptible to erratic changes due to the inherent unpredictable nature of the Company’s insurance claim liabilities and sensitivity to unemployment and wage volatility. Changes in the economy and federal and state legislature, both favorable and unfavorable, will impact management’s assumptions and estimates in future periods.

 

As of December 31, 2012, management has determined that a 86% valuation allowance against the Company’s $3.8 million component of deferred tax assets generated by the net operating loss carry forward of $9.5 million is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. This represents a decrease from the prior fiscal year’s 87% allowance as the Company experienced positive taxable earnings in the current fiscal year for the third time in seven years. As a result, management elected to limit the valuation allowance release to 14% as the Company has not established a significant historical trend of taxable earnings. As of December 31, 2012, management has also determined that a $1.5 million valuation allowance against the Company’s $3.8 million of deferred tax assets generated by book versus tax differences of certain assets and liabilities is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. This 40% valuation allowance represents a decrease from the prior fiscal year’s 42% due to the aforementioned earnings trend. The Company released $0.5 million of the valuation allowance in fiscal 2013 due to the positive earnings in the Company’s operations and projected earnings for the remainder of fiscal 2013 and 2014.

 

As of June 30, 2012, management had determined that a 87% valuation allowance against the Company’s $4.3 million component of deferred tax assets generated by the net operating loss carry forward of $10.8 million was necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. This represented a decrease from the prior fiscal year’s 90% allowance as the Company experienced positive taxable earnings in the 2012 fiscal year for the second time in six years. As a result, management elected to limit the valuation allowance release to 13% as the Company had not established a significant historical trend of taxable earnings. As of June 30, 2012, management had also determined that a $1.6 million valuation allowance against the Company’s $3.8 million of deferred tax assets generated by book versus tax differences of certain assets and liabilities was necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. This 42% valuation allowance represented a decrease from the prior fiscal year’s 43% due to the aforementioned earnings trend. The Company released $0.9 million of the valuation allowance in fiscal 2012 due to the positive earnings in the Company’s operations and projected earnings for 2013 and 2014.

 

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RESULTS OF OPERATIONS: COMPARISON OF THE THREE MONTH PERIODS ENDED DECEMBER 31, 2012 AND DECEMBER 31, 2011

 

Executive Overview of Financial Results

 

Gross billings for the three month periods ended December 31, 2012 and December 31, 2011 were $129.7 million and $137.2 million, respectively.

 

Results of operations for the three and six month periods ended December 31, 2012 and December 31, 2011 are as follows:

 

   Revenue for the   Operating income for the 
   Three Months Ended   Three Months Ended 
   December 31,   December 31,   December 31,   December 31, 
   2012   2011   2012   2011 
   (Dollars in thousands) 
Business Solutions  $13,739   $14,836   $534   $424 
Holding Company   -    -    -    - 
Segment Totals  $13,739   $14,836   $534   $424 
                     
Net Income Available to Common Shareholders            $115   $78 

 

   Revenue for the   Operating income for the 
   Six Months Ended   Six Months Ended 
   December 31,   December 31,   December 31,   December 31, 
   2012   2011   2012   2011 
   (Dollars in thousands) 
Business Solutions  $27,499   $30,631   $1,405   $1,176 
Holding Company   -    -    -    - 
Segment Totals  $27,499   $30,631   $1,405   $1,176 
                     
Net Income Available to Common Shareholders            $516   $469 

 

Net income available to common stock shareholders was $0.12 million or $0.01 per diluted share on revenue of $13.7 million for the three month period ended December 31, 2012 compared with net income available to common stock shareholders of $0.08 million or $0.01 per diluted share on revenue of $14.8 million for the three month period ended December 31, 2011. This represents a $1.1 million or 7.4% decrease in revenue and a $0.04 million or 47.7% increase in net income.

 

The decrease in revenue for the three month period ended December 31, 2012 is primarily due to the loss of a major client at both CSM and ESG effective December 31, 2011. Both clients had been with CSM or ESG over ten years and had grown to the size that they could realize some material economies of scale by bringing the service in-house.

 

The increase in net income available to common shareholders for the three month period ended December 31, 2012 is due to an increase in gross profit from workers compensation, benefits and taxes which more than offset the increase in preferred dividends.

 

Net income available to common stock shareholders was $0.52 million or $0.04 per diluted share on revenue of $27.5 million for the six month period ended December 31, 2012 compared with net income available to common stock shareholders of $0.47 million or $0.04 per diluted share on revenue of $30.6 million for the six month period ended December 31, 2011. This represents a $3.1 million or 10.2% decrease in revenue and a $0.05 million or 10.0% increase in net income.

 

The decrease in revenue for the six month period ended December 31, 2012 is primarily due to the loss of a major client at both CSM and ESG effective December 31, 2011. Both clients had been with CSM or ESG over ten years and had grown to the size that they could realize some material economies of scale by bringing the service in-house.

 

The increase in net income available to common shareholders for the six month period ended December 31, 2012 is due to an increase in gross profit from workers compensation and benefits which more than offset the increase in preferred dividends.

 

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Results are described in further detail as follows:

 

Operating results for three and six month periods ended December 31, 2012 and December 31, 2011 are as follows:

 

   Three Month Period Ended 
   December 31, 2012   December 31, 2011 
   (Dollars in thousands) 
Revenues  $13,739    100.0%  $14,836    100.0%
Cost of revenues   10,551    76.8%   11,726    79.0%
Gross profit   3,188    23.2%   3,110    21.0%
                     
Operating expenses                    
Selling, general and admin   2,523    18.3%   2,553    17.2%
Depreciation and amortization   131    1.0%   133    0.9%
Total operating expenses   2,654    19.3%   2,686    18.1%
                     
Segment operating income  $534    3.9%  $424    2.9%

 

   Six Month Period Ended 
   December 31, 2012   December 31, 2011 
   (Dollars in thousands) 
Revenues  $27,499    100.0%  $30,631    100.0%
Cost of revenues   21,065    76.6%   24,272    79.2%
Gross profit   6,434    23.4%   6,359    20.8%
                     
Operating expenses                    
Selling, general and admin   4,768    17.3%   4,916    16.0%
Depreciation and amortization   261    1.0%   267    0.9%
Total operating expenses   5,029    18.3%   5,183    16.9%
                     
Segment operating income  $1,405    5.1%  $1,176    3.8%

 

Revenue

 

Revenue for the three month period ended December 31, 2012 was $13.7 million, compared to $14.8 million for the three month period ended December 31, 2011, a decrease of $1.1 million or 7.4%. Revenue decreased primarily due to the loss of a major client at both CSM and ESG effective December 31, 2011. Total worksite employee count is down 1,047 employees or 7.2% from December 31, 2011. We continue to focus on growing in our target client size of 5-100 employees.

 

Revenue for the six month period ended December 31, 2012 was $27.5 million, compared to $30.6 million for the six month period ended December 31, 2011, a decrease of $3.1 million or 10.2%. Revenue decreased primarily due to the loss of a major client at both CSM and ESG effective December 31, 2011.

 

Gross Profit

 

Gross profit for the three month period ended December 31, 2012 was $3.2 million, representing 23.2% of revenue, compared to $3.1 million, representing 21.0% of revenue for the three month period ended December 31, 2011. Despite a 7.4% decrease in revenue, gross profit dollars increased 2.5% due to lower claims in our workers compensation programs and an increase in margin in our benefits and tax services.

 

Gross profit for the six month period ended December 31, 2012 was $6.4 million, representing 23.4% of revenue, compared to $6.4 million, representing 20.8% of revenue for the six month period ended December 31, 2011. Despite a 10.2% decrease in revenue, our gross margin dollars have held constant due to lower claims in our workers compensation programs and an increase in margin in our benefits services.

 

Operating Income

 

Operating income for the three month period ended December 31, 2012 was $0.53 million, compared to operating income of $0.42 million for the three month period ended December 31, 2011, an increase of $0.11 million or 25.9% due to improved gross margin as discussed above.

 

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Operating income for the six month period ended December 31, 2012 was $1.4 million, compared to operating income of $1.2 million for the six month period ended December 31, 2011, an increase of $0.2 million or 19.5% due to improved gross margin as discussed above.

 

Interest Expense

 

Interest expense was $0.001 million for the three and six month periods ended December 31, 2012, compared to $0.003 million and $0.007 million for the three and six month periods ended December 31, 2011 respectively. Our term loan was paid in full in April, 2012 so any current interest expense relates to short term vendor or government obligations.

 

Income Taxes

 

Income tax expense was $0.015 and $0.084 million for the three and six months ended December 31, 2012 compared to $0.006 and $0.039 for the three and six month periods ended December 31, 2011. The increase for both periods is due to increased profitability as compared to prior year.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our principal sources of liquidity include cash and equivalents and proceeds from debt borrowings. We had cash and equivalents of $6.4 million at December 31, 2012 and $5.3 million at June 30, 2012. The increase is primarily due to net income available to common shareholders for the first six months of $0.52 million and the reduction in restricted cash of $0.27 million which was transferred to our operating cash. Due to a reduction in projected claims in the PSM and CSM workers compensation programs, Liberty Mutual decreased the amount of collateral required to fund the programs which reduced our restricted cash requirements.

 

We had working capital of $4.8 million at December 31, 2012 compared with $4.1 million at June 30, 2012. The increase in working capital was a direct result of the first six months net income available to shareholders of $0.52 million. Current assets are primarily comprised of cash and equivalents and net accounts receivable. Current liabilities are primarily comprised of accounts payable, workers compensation reserves and accrued expenses.

 

The Company is required to collateralize its obligations under its workers’ compensation and state compliance requirements. The Company uses its cash and cash equivalents to collateralize these obligations. Restricted cash was approximately $2.1 million and $2.4 million at December 31, 2012 and June 30, 2012, respectively.

 

Cash Flows

 

Cash flows provided by operations for the six month periods ended December 31, 2012 and December 31, 2011 were $2.0 million and $1.1 million, respectively. The increase is primarily due to an increase in net income of $1.3 million.

 

Cash flows used in investing activities for the six month periods ended December 31, 2012 and December 31, 2011 were $0.091 million and $0.007 million, respectively. The increase is due to additional expenditures to strengthen our infrastructure and communication between subsidiaries and to prepare for the CSM conversion to the same operating platform as PSM and ESG during the fourth quarter. Once this conversion is completed, all subsidiaries will be on the same operating platform which will allow greater sharing of information and more efficiency between locations.

 

Cash flows used in financing activities was $0.81 million for the six month period ended December 31, 2012 compared to $0.93 million for the six month period ended December 31, 2011. The decrease is due to the payoff of the term debt in April, 2012 which saved $0.25 million which offset the increase in dividend expense of $0.14 million.

 

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

 

There have been no material changes to the Company’s contractual obligations from those disclosed in the Form 10-K for the year ended June 30, 2012 under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

OFF BALANCE SHEET ARRANGEMENTS

 

As is common in the industry we operate in, we have entered into certain off-balance sheet arrangements in the ordinary course of business that result in risks not directly reflected in our balance sheets. Our significant off-balance sheet transactions include liabilities associated with guarantees and letter of credit obligations.

 

Guarantees

 

Significant portions of our letters of credit are personally guaranteed by the estate of the Company’s former Chairman. Future changes to these guarantees would affect financing capacity of the Company.

 

14
 

 

Restricted Cash

 

Certain states and vendors require us to post letters of credit to ensure payment of taxes or payments to our vendors under workers’ compensation contracts and to guarantee performance under our contracts. Such letters of credit are generally issued by a bank or similar financial institution. The letter of credit commits the issuer to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this situation were to occur, we would be required to reimburse the issuer of the letter of credit. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. We do not believe that it is likely that any claims will be made under a letter of credit in the foreseeable future. As of December 31, 2012, we had approximately $2.7 million in restricted cash primarily to secure obligations under our PEO contracts.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

There have been no material changes from the information previously reported under “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in the Form 10-K for the year ended June 30, 2012.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our President/Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our President/Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2012.

 

Management Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Under the supervision and with the participation of our management, including the President/Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our internal control over financial reporting as of December 31, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework.

 

Based upon this assessment, we determined that our internal control over financial reporting as of December 31, 2012 was effective.

 

This Quarterly Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the company to provide only management's report.

 

Changes in Internal Controls

 

There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Inherent Limitations on Effectiveness of Controls

 

Our management, including our President/Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Our disclosure controls and procedures and our internal controls over financial reporting have been designed to provide reasonable assurance of achieving their objectives. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

 

PART II—OTHER INFORMATION.

 

Item 1. Legal Proceedings.

 

The Company is a party to certain pending claims that have arisen in the ordinary course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the consolidated financial position, results of operations, or cash flows if adversely resolved.

 

15
 

 

On April 9, 2012, a putative class action complaint captioned Mark Haagen, individually v. Tena Mayberry, Carter M. Fortune, Paul J. Hayes, David A. Berry, Richard F. Suja, Fortune Industries, Inc., CEP, Inc., and CEP Merger Sub, Inc. was filed in the Superior Court of Indiana, Marion County Circuit, on behalf of an alleged class of the Company’s shareholders. In each case, the plaintiffs allege that members of the Board breached their fiduciary duties to the Company’s stockholders in connection with the proposed Merger (see Item 5, Other Information below) and that the Company aided and abetted the directors’ breaches of fiduciary duties. The complaint claims that the proposed Merger between the Company and Merger Sub involves an unfair price, an inadequate sales process, self-dealing and unreasonable deal protection devices. The complaints sought injunctive relief, including to enjoin or rescind the Merger, and an award of other unspecified attorneys’ and other fees and costs, in addition to other relief. On August 16, 2012 a Stipulation of Dismissal with Prejudice was filed in the Superior Court of Indiana, Marion County Circuit whereby both the plaintiff and defendant stipulated to the dismissal of this complaint.

 

Item 1A. Risk Factors

 

There have been no material changes with regard to the risk factors previously disclosed in our most recent Annual Report on Form 10-K for the year ended June 30, 2012.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

None

 

Item 3. Defaults upon Senior Securities.

 

None

 

Item 4. Mine Safety Disclosures.

 

Not Applicable

  

Item 5. Other Information.

 

On September 20, 2012, the Company announced that it has reached an agreement in principal to restructure its current merger agreement by planning to enter into an amended merger agreement with Ide Management Group, LLC (“Ide”), a skilled nursing facility management group headquartered in Greenfield, Indiana (the “Amended Agreement”). However, on December 28, 2012, the Company announced that it had entered into a Termination of Escrow Agreement with Ide whereby the Company determined not to go forward with the negotiations of a definitive agreement and agreed to terminate the Escrow Agreement entered into on September 19, 2012. The escrow funds deposited by Ide pursuant to the Escrow Agreement have been disbursed to Ide.

 

As a result of the termination of discussions with Ide, our board of directors has authorized the Company to resume the work necessary to complete the original merger transaction with CEP, Inc. and CEP Merger Sub, Inc.

 

Item 6. Exhibits

 

The following exhibits are included herein:

 

31.1 Rule 15d-14(a) Certification of CEO
31.2 Rule 15d-14(a) Certification of CFO
32.1 Section 1350 Certification of CEO
32.2 Section 1350 Certification of CFO

 

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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.

 

  Fortune Industries, Inc.
  (Registrant)
   
Date: February 14, 2013 By: /s/ Tena Mayberry  
  Tena Mayberry,
  Chief Executive Officer
   
   
Date: February 14, 2013 By: /s/ Randy E. Butler  
  Randy E. Butler,
  Chief Financial Officer

 

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