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M LINE HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) This quarterly report on Form 10-Q of M Line Holdings, Inc. (referred to herein as "us, "we" or the "Company") for the three month period ended March 31, 2013 contains forward-looking statements, principally in this section and in the section herein titled "Business." Generally, you can identify these statements because they use words like "anticipates," "believes," "expects," "future," "intends," "plans" and similar terms. These statements reflect only our current expectations. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy, and actual results may differ materially from those we anticipated due to a number of uncertainties, many of which are unforeseen, including, among others, the risks we face as described in this filing. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report. These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbors created thereby. To the extent that such statements are not recitations of historical fact, such statements constitute forward-looking statements that, by definition, involve risks and uncertainties. In any forward-looking statement where we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be accomplished. We believe it is important to communicate our expectations to our investors. There may be events in the future, however, that we are unable to predict accurately or over which we have no control. The risk factors listed in our Annual Report on Form 10-K, as well as any cautionary language in our Annual Report on Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Factors that could cause actual results or events to differ materially from those anticipated include but are not limited to: our ability to successfully develop new products; the ability to obtain financing for product development; changes in product strategies; general economic, financial and business conditions; changes in and compliance with governmental healthcare and other regulations; changes in tax laws; and the availability of key management and other personnel. Overview Our business consists of two segments, our Machine Sales Group and our Precision Manufacturing Group. Our Machine Sales Group is in the business of acquiring and selling computer numerically controlled ("CNC") machines and related tools to manufacturing customers. We specialize in the purchase, refurbishment and sales of used CNC machines. We also serve as a manufacturer sales representative firm selling new CNC machines that we purchase from third party manufacturers into certain geographic territories. Our Precision Manufacturing Group is a manufacturer of precision components used in equipment and machinery in the commercial aviation, medical, aerospace and defense industries. Sales within this segment are highly concentrated with one customer, Panasonic Avionics Corporation ("Panasonic"). The loss of all or a substantial portion of sales to this customer would cause us to lose a substantial portion of our sales within this segment and on a consolidated basis and would have a corresponding negative impact on our operating profit margin due to the operating leverage this customer provides. This could lead to sales volumes not being high enough to cover our current cost structure or to provide adequate operating cash flows. Panasonic has been a customer of ours for approximately 19 years, and we believe our relationship is good. The Company added and upgraded its manufacturing base from mainly aircraft interiors to a combination that includes aircraft structures. The Company incurred considerable startup costs relating to development and staff training, downtime in manufacturing and other costs, including newer materials, such as titanium, hard steels, etc. and overhead. Management entered into agreements with engineering services companies in Canada and in India, upgraded the Company's software and purchased new software, such as Catia. Our commitment to excellence and the new direction to make the Company an "Aerospace" Company has helped us develop and solidify a contact with Rohr, Inc., and its subsidiary, Goodrich Aerostructures. We had, but did overcome, considerable problems with production, which resulted from a staff knowledge limitation, the requirement for additional training, engineering staff contracts and so on. -17- All costs relating to this development have been expensed under Research and Development costs in our financial statements for the fiscal year ended June 30, 2012. Trends Affecting Our Business Although the recent tightening of the capital markets has eased, customers' limited access to capital still hurt our ability to sell used CNC machines. Historically, as capital markets tighten, companies that purchase large machines on credit, such as CNC machines, have more difficulty in obtaining credit and, therefore, are unable to purchase machines that they may be able to purchase in better financial times. The credit markets have improved slightly but may have an impact on our customers' ability to purchase machines, which could negatively impact our business. The primary components sold by our Precision Manufacturing Group during the nine month period ended March 31, 2013 and 2012 were parts sold to Panasonic, a leading provider of in-flight entertainment systems for commercial aircraft. Although the market for in-flight entertainment systems has improved and is expected to continue to improve over the next two to three years, business is still inconsistent, and this may affect our business over the next several months. In addition, if there is a decrease in work, this may have an impact with the Machine Sales Group, as many of our customers that purchase machines from us do business with airline manufacturers. Critical Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of sales and expenses during the reporting period. Significant estimates made by management are, among others, realization of inventories, collectability of accounts receivable, litigation, impairment of goodwill and long-lived assets other than goodwill. We regularly evaluate our estimates and assumptions based on historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent actual results differ from these estimates, our future results of operations may be affected. Inventories Within our Precision Manufacturing Group, we seek to purchase and maintain raw materials at sufficient levels to meet lead times based on forecasted demand. We generally manufacture parts based on purchase orders. Within our Machine Sales Group, we purchase machines held for resale based on management's judgment of current market conditions and demand for both new and used machines. If forecasted demand exceeds actual demand, we may need to provide an allowance for excess or obsolete quantities on hand. We also review our inventories for changes in demand patterns and in the market prices of machines held in inventory and provide reserves as deemed necessary. If actual market conditions are less favorable than those projected by management, additional inventory reserves for CNC machines and parts may be required. We state our inventories at the lower of cost, using the first-in, first-out method on an average costs basis, or market. -18- Results of Operations for the Three Months Ended March 31, 2013 compared to the Three Months Ended March 31, 2012. For the three For the three month period month period ended March 31, ended March 31, 2013 2012 Change Sales by segment: Machine Sales $ 1,431,482 $ 1,675,940 (244,458 ) Precision Engineering 888,337 814,450 73,887 2,319,819 2,490,390 (170,571 ) Gross Profit by segment: Machine Sales 239,390 322,593 (83,203 ) Precision Engineering 119,720 389,690 (269,970 ) 359,110 712,283 (353,173 ) Sales Sales in the three month period ended March 31, 2013 decreased 7% compared to the three month period ended March 31, 2012. The change is attributable to a decrease in sales in both the Machine Sales Group and the Precision Manufacturing Group. Sales decreased by 15% in the Machine Sales Group and decreased by 9% in the Precision Manufacturing Group. Our Machine Sales Group primarily sells pre-owned CNC machinery manufactured by Mori Seiki. The average sale price of the machinery changes based on the equipment that is available to purchase in the market place and the prevailing market conditions that affect the price that equipment can be sold for. The average sale price of the 20 pieces of equipment sold in the three months ended March 31, 2013 was $69,225 compared to the comparable period in fiscal 2012 of 27 pieces of equipment sold at an average sale price of $59,596. In addition, service work for the three months ended March 31, 2013 was $33,365 compared to the comparable period in fiscal 2012 of $3,546. Market conditions reflect not only the price that equipment can be purchased for but also the price at which that equipment may be sold. During good economic times when the business climate is improving, particularly in areas such as aerospace, the demand for equipment can result in a change in the purchase price. However, the need for that equipment by customers is generally reflected in the sale price. Therefore, as a general rule margins are reasonably consistent even though average sale prices may change. As a result, we do not expect future results to be materially impacted by these conditions. The decrease in sales in the Precision Manufacturing Group is the result of a decrease of $78,997 in sales of precision metal component parts from Rockwell Collins, in the three months ended March 31, 2013, to $28,991 from $107,988 in fiscal 2012. Furthermore, new customer sales resulted in an increase of $78,694 during the three months ended March 31, 2013 as compared to $9,018 for new customers in the comparable period in fiscal 2012. Our Precision Manufacturing Group has approached a new major customer. As a result, we have upgraded our manufacturing operations from primarily interiors work to a combination of interiors and structures and therefore were and are able to quote for work with major new customers. We have manufactured parts for the aircraft structure segment, and this move helped us obtain new customers and thus contribute to an increase in sales and profitability of the Precision Manufacturing Group. The addition of this and other new customers should result in a positive effect on the future results of the Company. -19- We anticipate that, as a result of an increase in activity in the aerospace industry, we will continue to grow the revenues of both the Machine Sales Group and the Precision Manufacturing Group. Gross Margin Gross profit decreased by 50% in the fiscal period ended March 31, 2013 compared to the comparable period in fiscal 2012. The gross profit for the Machine Sales Group decreased by 26% due to an decrease in margins as a result of lower prices received for product sold and higher machine and freight costs. The decrease within the Precision Manufacturing Group of 69% resulted from lower sales as a result of a weakness in the scheduling of work in the factory. Management has recognized this weakness and is taking steps to correct the relevant weakness in the production area. Selling, General & Administrative Selling, general and administrative costs increased by $283,546 to $863,060 for the fiscal period ended March 31, 2013 compared to $579,514 for the three months ended March 31, 2012. The change is due primarily to incurring approximately $124,298 in costs in the current quarter for consulting and financing fees for investor relations, public relations and loan fees. Amortization of Intangible Assets Amortization expense for intangible assets for the three months ended March 31, 2013 was $0 compared to $0 in the comparable period in fiscal 2012. There was no charge for amortization for the three months ended March 31, 2013, as the intangible assets had been fully amortized. Interest Expense Interest expense increased by $71,187 for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The change is attributable to a higher usage of our credit line for accounts receivable finance and interest payable on a new inventory line of credit. Gain on Debt Settlement There was no gain or loss for debt settlement during the three month periods ended March 31, 2013 and 2012. Interest Income During the three month period ended March 31, 2013, there was no interest income, as compared to the three month period ended March 31, 2012 in which there was interest income in the amount of $15,932. -20- Results of Operations for the Nine Months Ended March 31, 2013 compared to the Nine Months Ended March 31, 2012. For the nine For the nine month period month period ended March 31, ended March 31, 2013 2012 Change Sales by segment: Machine Sales $ 3,891,147 $ 4,537,095 (645,948 ) Precision Engineering 2,850,145 3,158,779 (308,634 ) 6,741,292 7,695,874 (954,582 ) Gross Profit by segment: Machine Sales 753,614 835,595 (81,981 ) Precision Engineering 905,223 1,476,445 (571,222 ) 1,658,837 2,312,040 (653,203 ) Sales Sales in the month period ended March 31, 2013 decreased 12% compared to the nine month period ended March 31, 2012. The change is attributable to a decrease in sales in the Machine Sales Group and the Precision Manufacturing Group. Sales decreased by 14% in the Machine Sales Group and decreased by 10% in the Precision Manufacturing Group. Our Machine Sales Group primarily sells pre-owned CNC machinery manufactured by Mori Seiki. The average sale price of the machinery changes based on the equipment that is available to purchase in the market place and the prevailing market conditions that affect the price that equipment can be sold for. The average sale price of the 58 pieces of equipment sold in the nine months ended March 31, 2013 was $62,347 compared to the comparable period in fiscal 2012 of 68 pieces of equipment sold at an average sale price of $63,323. In addition, service work for the nine months ended March 31, 2013 was $48,131 compared to the comparable period in fiscal 2012 of $153,013. Market conditions reflect not only the price that equipment can be purchased for but also the price at which that equipment may be sold. During good economic times when the business climate is improving, particularly in areas such as aerospace, the demand for equipment can result in a change in the purchase price. However, the need for that equipment by customers is generally reflected in the sale price. Therefore, as a general rule margins are reasonably consistent even though average sale prices may change. As a result, we do not expect future results to be materially impacted by these conditions. The decrease in sales in the Precision Manufacturing Group is the result of a decrease of $627,303 in sales of precision metal component parts from our major customer, Panasonic Avionics, in the nine months ended March 31, 2013, to $1,208,897 from $1,836,280 in fiscal 2012, offset in sales from our new customer, Goodrich Aerostructures, and increases from our other customers. Furthermore, new customer sales resulted in an increase of $141,423 during the nine months ended March 31, 2013 as compared to $9,018 for new customers in the comparable period in fiscal 2012. Our Precision Manufacturing Group approached a new major customer. As a result, we have upgraded our manufacturing operations from primarily interiors work to a combination of interiors and structures and therefore were and are able to quote for work with major new customers. We have manufactured parts for the aircraft structure segment, and this move helped us obtain new customers and thus contribute to an increase in sales and profitability of the Precision Manufacturing Group. The addition of this and other new customers should result in a positive effect on the future results of the Company. -21- We anticipate that, as a result of an increase in activity in the aerospace industry, we will continue to grow the revenues of both the Machine Sales Group and the Precision Manufacturing Group. Gross Margin Gross profit decreased by 28% in the fiscal period ended March 31, 2013 compared to the comparable period in fiscal 2012. The gross profit for the Machine Sales Group declined by 10%. Margins were lower during the current period due to lower prices obtained for machines sold as compared to that in the prior period and higher machine and freight costs. The decrease within the Precision Manufacturing Group of 39% resulted from lower sales as a result of a weakness in the scheduling of work in the factory. Management has recognized this weakness and is taking steps to correct the relevant weakness in the production area. Selling, General & Administrative Selling, general and administrative costs increased by $820,724 to $2,711,324 for the fiscal period ended March 31, 2013 compared to $1,890,600 for the nine months ended March 31, 2012. The change is due primarily to incurring approximately $124,298 in costs in the current quarter for consulting and financing fees for investor relations, public relations and loan fees, $65,731 in salaries, a net bad debt recovery of $0 in the current period to $62,902 in the prior period and increases in selling, general and administrative costs not allocated to cost of goods sold in the current nine month period. Amortization of Intangible Assets Amortization expense for intangible assets for the nine months ended March 31, 2013 was $0 compared to $31,952 in the comparable period in fiscal 2012. There was no charge for amortization for the six months ended December 31, 2012, as the intangible assets had been fully amortized. Interest Expense Interest expense increased by $168,252 for the nine months ended March 31, 2013 compared to the nine months ended March 31, 2012. The change is attributable to a higher usage of our credit line for accounts receivable finance and interest payable on a new inventory line of credit. Gain on Debt Settlement During the nine month period ended March 31, 2013, the gain on debt settlements was $0 compared to $85,184 during the nine month period ended March 31, 2012. The Company negotiated various settlements of debts due by the Company, which resulted in a net gain in the sum of $85,184 for the nine month period ended March 31, 2012. Interest Income During the nine month period ended March 31, 2013, there was no interest income, as compared to the nine month period ended March 31, 2012 in which there was interest income in the amount of $45,083. Liquidity and Capital Resources Our principal sources of liquidity consist of cash and cash equivalents, cash generated from operations and borrowing from various sources, including Main Credit, our accounts receivable lender. As of March 31, 2013, our working capital (current assets less current liabilities) totaled ($1,288,353) compared to $(78,981) as of March 31, 2012, a decrease of $1,209,372. -22- Main Credit provides a $750,000 accounts receivable line of credit with advances up to 80% of the outstanding receivables of Precision Aerospace and Technologies, Inc. (fka Eran Engineering, Inc.). This finance bears loan interest at the lender's rate at 2% per month with the loan being paid on a revolving basis when our customers make their payments against their outstanding receivable balances. The total of repayments during the three month period ended March 31, 2013 was $911,470 and represented payments received from customers of Precision Aerospace and Technologies, Inc. (fka Eran Engineering, Inc.). Borrowings totaled $1,075,703 for this period and represented cash borrowed from Main Credit under our line of credit with Main Credit, including interest costs. In addition, Main Credit has provided a line of credit in the sum of $250,000 against inventory. This finance bears loan interest at lender's rate at 2% per month. Cash Flows The following table sets forth our cash flows for the nine month periods ended March 31, 2013 and 2012, respectively: Provided by (used in) 2013 2012 Change Operating activities 73,698 (656,172 ) (729,871 ) Investing activities (53,651 ) (9,905.00 ) 43,746 Financing activities 115,212 468,969 353,757 135,259 (197,108 ) (332,368 ) Operating Activities Operating cash flows during the nine month periods ended March 31, 2013 and 2012, respectively, reflect our results of operations, offset by net cash provided by operating assets and liabilities and non-cash items (depreciation, amortization and stock-based compensation). During the nine month period ended March 31, 2013, non-cash expenses included in our net income and in operating activities totaled $515,578 compared to $543,736 in nine month period ended March 31, 2012. The increase (decrease) in operating assets and liabilities for the nine month period ended March 31, 2013 and 2012 were $915,620 and $(599,181), respectively. During the nine month period ended March 31, 2012, the increase was primarily attributable to an increase in accounts receivable, inventory and in litigation payable. Investing Activities We made capital expenditures of $(53,651) and $(9,905) during the nine month period ended March 31, 2013 and 2012 respectively. Financing Activities During the nine months of the fiscal 2013 and 2012 periods, our borrowings decreased by (net of repayments) $175,950 and increased our borrowings (net of repayments) by $507,204, respectively. Off Balance Sheet Arrangements We have no off balance sheet arrangements. -23- |