Current assets: Cash $ 77,956 $ 225,825 Accounts receivable, net 1,868,633 3,575,495 Accounts receivable related party 962,677 760,748 Inventory, net 2,065,821 2,446,633 Restricted cash 121,729 -- Prepaid expenses and income taxes 585,183 160,840 ------------ ------------- Total current assets 5,681,999 7,169,541
Fixed assets net of accumulated depreciation and amortization of $20,772,383 and $20,318,859, respectively 7,849,377 9,573,153
Other assets: Land and building held for investment 148,429 148,429 Loans receivable related party 18,195 90,772 Other assets 164,021 286,730 Deferred taxes 1,334,464 622,509 ------------ ------------- Total assets $ 15,196,485 $ 17,891,134 ============ =============
Plan of Operation.
Based on a review of the Company's operations performed by management during the fourth quarter of 2003, management developed a turnaround plan designed to return the Company to profitability. During the first nine months of 2004, management has initiated several of the strategies enumerated in the Company's plan of operation, which is summarized in the following pages. An integral part of management's review included an evaluation of the Company's strengths that could be employed in the execution of the turnaround plan. The Company's strengths identified by management include:
* a loyal and diverse customer base;
* infrastructure capable of producing, importing and selling at more than double the current volumes;
* well established channels of distribution;
* management and technical personnel with a broad base of diverse industry experience;
* a diverse and well established network of industry contacts, vendors and suppliers; and
* a broad range of products with strong market demand.
To facilitate the Company's return to profitable operations, management has formulated the following turnaround plan for the 2004 fiscal year:
* Increase the percent of import products in the overall product mix;
* Improve profit margins on low margin products;
* Focus financial and operational resources on high margin products;
* Increase sales to existing customers through cross selling of products;
* Implement divisional sales plans to increase sales to new customers;
* Reduce operating expenses through increased operational efficiencies;
* Optimize asset utilization through diversification and disposition of non-productive assets; and
* Maximize the utility of technology-based operational and sales tools.
Each of these strategies is discussed in greater detail below as they apply to each of the Company's three divisions. The elements of the plan incorporate fundamental business practices; however, the success of the plan depends on the implementation and monitoring of each strategy and the success of management in securing sufficient working capital and import letters of credit to facilitate the plan.
Michelex Plastics Division.
The Michelex Plastic Division imports, manufactures and sells plastic injection molded media packaging products. This is the largest of the three divisions in terms of revenues, personnel, and infrastructure. Actual revenues for this division accounted for 71.2%, 65.1%, and 66.4% of the total company revenues for the 12 month periods ended February 28, 2002, February 28, 2003 and December 31, 2003 respectively. Revenues for this division in the first quarter of 2004 accounted for 66.7% of total sales. Given the relative size of this division and the impact it has on the overall Company, returning it to profitability is a key objective of the Company's turnaround plan. Following is a brief description of the strategic elements of the plan devised for the Michelex Plastics Division.
Increase Product Imports. Although management identified the benefits of augmenting domestically produced products with a balance of imported products years ago. However, since 1999, a period in which raw material prices and production related expenses have increased dramatically, import product sales have declined from approximately 32.9% of the plastic division sales for the 12 months ended February 28, 2000 to approximately 24.5% of the plastic division sales for the 12 months ended December 31, 2003. Typically the imported products are specialty items that sell for higher prices per piece, require minimal additional expense by the Company, and produce higher profit margins.
Management believes increasing the amount of import products as a percent of the total Michelex Plastic Division sales is one of the most critical elements of the Company's overall turnaround strategy. For the 12 months January through December, 2004, the Company has projected total product sales of approximately $15,042,800 for this division. This represents an increase of approximately 10.8% as compared to the same period for 2003. Of this increase, 73.7% is from import product sales. Management has projected import product sales will constitute approximately 25.8% of the total division product sales for the 12 months ending December 31, 2004.
The advantage of import products varies within each product line of this division. Management has focused on changing the mix of imports and domestically produced products on the product lines where it believes the most benefit can be derived.
The most significant changes have been made in the Jewel Box and Tray product lines. Production of domestically produced Jewel Boxes and Trays are forecasted to decrease, while imported pieces are projected to increase. The projected declines in pieces of import C-0's and domestically produced Norelco Boxes are the result of a shrinking market for these products. Management has projected a small growth in Video boxes (3.4%) for 2004 due to the declining overall market. However, the Company is currently evaluating an opportunity that could result in a dramatic increase in domestically produced Video Box sales.
The significant projected increase in the domestically produced C-Shell product line is based on a strong market demand for the product. To meet the current demand the Company has ordered and will take delivery of two new molds in the first and second quarters of 2004 to enhance production.
Within the DVD product line management has projected an increase of both domestically produced pieces and imported pieces. As with the C-Shell product line, demand for the DVD boxes remains strong. The Company plans to maximize the production capacity of the one DVD mold it currently owns during 2004. The DVD boxes the Company imports are being produced on molds owned by Michelex. The cost of these molds is being amortized in the cost of the imported pieces purchased. It is anticipated this cost will be completely amortized in the third quarter of 2004 and the cost of imported DVD Boxes will drop significantly. No adjustment has been made in the projections to reflect the impact of this change. Management is confident that with import letters of credit available, the Company has the infrastructure and resources in place to effect the projected changes.
Increase Product Prices. A preliminary review of customer pricing in conjunction with a recent review of domestic and import product costs has indicated the need to selectively implement a price increase. Given the nature of the Company's existing customer base, management believes an across the board price increase on all products to all customers is not feasible. Management has initiated a program to review each customer to determine the cross section of products the customer purchases, the volume purchased of each product line and the customer's current pricing structure. Price increases will be based on the results of this review. Price increases have already been initiated on several customers, including two of the Company's largest customers. In conjunction with the price increase program, new guidelines have been established for new customer product pricing and two new accounts have been acquired at significantly better pricing than has been historically achieved. Management has included modest price increases in the sales projections for certain product lines.
Increase Sales to Existing Accounts. In conjunction with the customer file review noted above, each customer file is being reviewed for the potential to sell additional product lines from the plastic division as well as products from the other divisions. Management believes this will prove to be an efficient and cost effective tool to generate additional sales and promote improved customer relations. An important aspect of this and the other strategies related to increasing sales is a constant supply of all product lines. This aspect ties directly into the revisions of the import and production strategies.
Increase Sales Through New Business. Included as integral elements of this turnaround plan are the addition of two new sales staff positions, production of a new product catalog, upgrades to the Company's website, additional media advertising and trade show related expenses. The primary focus of these positions will be the acquisition of new accounts. Additionally, the Company is currently evaluating the feasibility and cost effectiveness of diversifying and domestically producing two new specialty products for two large retailers.
Reduce Production Related Expenses. Management is continually in the process of reviewing the Company's production operations and the costs associated with these operations. Increasing costs, especially in the areas of raw materials (primarily polystyrene), freight expense and insurance coverages couple with increasing cash flow constraints have negatively impacted the Company's ability to maintain efficient production operations. Although polystyrene prices are projected to continue to increase, management believes reducing inefficiencies in operations coupled with a consistent supply of polystyrene will result in reductions in the total cost per unit of the Company's domestically produced products in 2004.
Management's plan contemplates a reduction in the number of units of certain domestically produced products, securing a consistent supply, grade and quality of raw materials, and closer monitoring of the production processes. Management is continuing to monitor and evaluate the potential for future increases in the cost of styrene. In conjunction with this, management is also evaluating the feasibility and cost of importing a percentage of the standard jewel box and tray requirements that are currently produced domestically. Importing a portion of these product lines will reduce the Company's exposure to availability and price fluctuations of styrene and increasing production related expenses. Additionally, reducing the number of domestically produced units would enable the Company to contract and consolidate its production operations and concentrate on producing higher margin products (such as C-Shells and DVD Boxes) thereby optimizing the cost per unit of the remaining domestically produced products.
Reduce and Control Sales and Administrative Expenses. Management is currently in the process of reviewing all sales, general and administrative expenses. The Company intends to consolidate certain overlapping administrative functions within the divisions and streamline its financial and management reporting processes. The purpose of this review is not to arbitrarily eliminate expenses but rather to improve the productivity for the resources expended on these functions. This is especially true with respect to the sales and marketing expenses where management has projected increased expenses for fiscal 2004 to add additional personnel and increase media exposure. Management believes it is important for the Company to re-establish itself as a reliable supplier of quality products within the media packaging industry with existing, previous and new customers.
Optimize Asset Utilization. Although the Company has a substantial asset base, several of the assets are not currently generating revenues for the Company. Management has initiated a review of all of the Company's assets and will evaluate each one with respect to its potential to profitably generate revenues. Thus far, management has identified three properties that are being considered for disposition. Selling these three parcels could reduce the Company's total debt by approximately 10 to 15 percent and also enhance cash flow. Management is fairly confident two of three properties can be disposed of. However, the third parcel is located in Salt Lake City and may be more difficult to sell in the immediate future. The premises are leased however, and the lease payments help offset the carrying costs of the facility. The Company is also evaluating the feasibility and cost effectiveness of selling certain of its current production assets and replacing them with newer, more efficient and less labor-intensive equipment.
Michele Audio Division.
This division is involved primarily in the duplication and packaging of music and spoken word communication products. During the fiscal year ended February 28, 2003 this division accounted for approximately 34.5% of the total company sales. For the 12 months ended December 31, 2003, this declined to approximately 28.0% of total company sales, a level that more accurately reflects recent historical sales. The elements of the turnaround strategy for this division are in many ways similar to those proposed for the Michelex Plastics Division and are described below.
Revise The Divisions Product Mix. This is the single most important element of this division's turnaround strategy. Historically the principal product line for this division has been cassette-based products. For the 12 months ended February 28, 2002; February 28, 2003; and December 31, 2003, cassette-based products have accounted for 83.3%, 79.9%, and 72.5% respectively of the total division sales. Although management identified the changing market dynamics several years ago, the Company did not aggressively pursue the CD and DVD market segments.
During 2004, the Company has adopted a strategy to aggressively pursue the CD and DVD market segments and has projected an increase of approximately 23.5% in CD/DVD product sales for the 12 months ending December 31, 2004, as compared to actual sales for the same period ending December 31, 2003. No increase was projected for cassette-based sales. Management has established 2004 as the base year for aggressively initializing this shift in product mix and contemplates the 2005 fiscal year will involve a far more dramatic shift in the product mix. The items discussed in the next paragraph are an integral part of this overall strategy.
Increase New Customer Accounts. In order to achieve the objectives set forth in the previous paragraph it is imperative that the Company initiates a sales and marketing program to aggressively pursue new accounts in the CD and DVD marketplace. The Division is currently in the process of restructuring its catalog and updating the Company's website to emphasize the Company's CD and DVD replicating and packaging capabilities. Additionally management is currently interviewing candidates for two new sales positions, one each on the East and West coast to specifically pursue new accounts. Management believes it can also use the reputation it has established as a high-speed quality replication and packaging source for cassette products as an effective marketing tool in this strategy.
Increase Product Pricing. Simultaneously with the review of the Plastics division customer base previously discussed, management initiated a review of the Audio division customer account base. To date, price increases have been obtained from several existing Audio division accounts. Management believes there may also be another opportunity on the horizon for cassette-based products. Although the market for these products is shrinking, so is the source of reliable quality suppliers. Although this may be a short duration opportunity, it could prove to be a profitable source of revenue during the transition period.
Reduce and Control Production and Operating Expenses. Management is in the process of revising and implementing changes for controlling, monitoring and reporting cost and production data. Additionally, the Company is reviewing its production scheduling process to more efficiently and cost- effectively facilitate the production of customer orders. As with the plastics division, management is reviewing all administrative functions to eliminate duplication and overlap with other divisions.
Management believes the turnaround strategies applicable to the Michele Audio Division are going to be the most difficult to successfully implement and integrate into the Company's operations. Although the Company has experience in CD replication and packaging, this element of the strategy is the most aggressive in terms of changing existing operation strategies and deviation from existing business practices within this division.
Michelex Media Products Division.
This division began operations in February, 2003, when Michele Audio Corporation took over the operations of the EnpacK Company. Since that time, this division has been the fastest growing and most profitable division of the Company. This division's products consist primarily of paper, vinyl, tyvek and board mailer-based media packaging products for use with CD and DVD media. Although the strategies outlined below are not technically categorized as turnaround strategies for this division, they are an integral part of the overall corporate turnaround plan.
Increase Website Related Sales. The Company has contracted a website design Company to assist in designing and implementing an upgrade to the Company's website and its links to other websites. Various market survey data reviewed by the Company and contact with new and existing customers have indicated the website is a very effective tool in this segment of the media packaging industry. The Company contemplates the website will be fully functional by the end of the second quarter 2004 and has projected sales generated through this venue will constitute approximately 27.8% of the total projected sales for 2004.
Continue the Growth of Wholesale Sales. Management is confident the growth in this area will continue. Demand for the product remains strong and the Company believes it can successfully cultivate additional business from its existing customer base in the other two divisions as well as pursue new customers. Additionally, management has projected adding two additional personnel in the sales department, allocated resources to create a new product catalog, and projected an increase in advertising and trade show expenses. The critical element in this particular strategy will be the ability of the Company to secure ample quantities of inventory to satisfy the customer's demands in a timely manner.
The primary focus in this business segment will be to maintain the sales momentum the Company has generated during the first year of operation and capitalize on the opportunities that currently exist.
Although management has and continues to vigorously pursue various sources of additional capital for the Company, as of September 30th management had not secured the funding contemplated in the development of its turnaround plan. As a result, management has been unable to fully execute the strategies detailed in the turnaround plan and the actual sales and pre-tax net income as stated in the consolidated statements of operations for the first nine months of 2004 (detailed in Part I of this filing) are below those projected in the Company's turnaround plan. Although the Company continues to compete with increasing pressure from products produced offshore in its market segments and is faced with continuing costs increases in certain raw materials and operating expenses, demand for the Company's products and services remains strong. It is management's opinion the primary cause for the Company's failure to meet its projected results of operations for the nine months ended September 30, 2004 has been the Company's inability (due to the lack of adequate working capital) to obtain adequate quantities of products required to fill customers orders. Management is working diligently with the Company's investment banking firm and financial advisors to identify and secure sources for additional working capital to enable the Company to fully execute the strategies of the turnaround plan and return the Company to profitability.
It should be noted that although management is confident that through implementation and execution of the turnaround plan the Company can return to profitability there is no guarantee the Company will receive the additional capital resources required to implement and execute the turnaround plan. As additional time passes the Company will continue to lose market share, incur additional operating losses, and increase its working capital deficit which may negatively impact the value of the Company's stock thereby making it more difficult for the Company to raise the capital required to fully implement its turnaround plan and return to profitability. If additional capital is not secured by the Company and the Company continues to operate at a loss there exists some doubt as to the Company's ability to continue as a going concern (as noted in the December 31, 2003 notes to the audited financial statements) and the Company may be required to significantly alter or completely discontinue operations.
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