10QSB 1 q904.txt U. S. Securities and Exchange Commission Washington, D. C. 20549 FORM 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from to -------------- --------------- Commission File No. 000-26695 MICHELEX CORPORATION -------------------- (Name of Small Business Issuer in its Charter) UTAH 87-0636107 ---- ---------- (State or Other Jurisdiction of (I.R.S. Employer I.D. No.) incorporation or organization) 63 Trade Road Massena, New York 13662 ----------------------- (Address of Principal Executive offices) Issuer's Telephone Number: (315) 769-6616 APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Not applicable. Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes No --- --- APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date: November 22, 2004 17,434,938* * This figure does not reflect a split of the Company's issued and outstanding common stock in the ratio of three shares for one, which was effectuated on November 8, 2004. PART I - FINANCIAL INFORMATION Item 1. Financial Statements. The Financial Statements of the Registrant required to be filed with this 10-QSB Quarterly Report were prepared by management, and commence on the following page, together with Related Notes. In the opinion of management, the Financial Statements fairly present the financial condition of the Registrant for the periods then ended. MICHELEX CORPORATION Index to Financial Statements Consolidated Balance Sheets F-2 - F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Cash Flows F-5 - F-6 Notes to Consolidated Financial Statements F-7 - F-12 F-1 MICHELEX CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, December 31, 2004 2003 ASSETS 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 ============ ============= See notes to consolidated financial statements F-2 MICHELEX CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, December 31, 2004 2003 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Note payable to bank $ 2,134,464 $ 2,724,291 Current portion of long-term debt 1,508,862 755,646 Current portion of capital leases 377,933 528,385 Convertible debenture 493,250 -- Accounts payable 2,787,756 3,720,150 Accrued expenses 473,998 468,324 Payroll taxes payable 419,063 146,987 ----------- ----------- Total current liabilities 8,195,326 8,343,783 Other liabilities: Long-term debt less current maturities 4,974,196 5,448,912 Note payable officers 562,082 385,979 Capital leases less current maturities 69,775 889,597 Note payable related parties 25,488 199,997 ----------- ----------- Total liabilities 13,826,867 15,268,268 ----------- ----------- Commitments and contingencies Shareholders' equity Common stock - $.001 par value, 100,000,000 shares authorized, 14,706,666 and 12,990,000 shares issued and outstanding, respectively 14,706 12,990 Additional paid-in-capital 356,803 4,850 Retained earnings 998,109 2,605,026 ----------- ----------- Total shareholders' equity 1,369,618 2,622,866 ----------- ----------- Total liabilities and shareholders' equity $15,196,485 $17,891,134 =========== =========== See notes to consolidated financial statements F-3 MICHELEX CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS Nine Months Ended Seven Months Ended Three Months Ended September 30, September 30, September 30, 2 0 0 4 2 0 0 3 2 0 0 4 2 0 0 3 (Unaudited) (Unaudited) (Unaudited)(Unaudited) Net sales-unrelated parties $10,887,083 $12,272,873 $2,795,237 $5,209,809 Net sales-related parties 260,264 20,002 72,685 20,002 ----------- ----------- ---------- ---------- Net sales 11,147,347 12,292,875 2,867,922 5,229,811 Cost of goods sold 7,071,699 7,465,189 1,751,073 3,420,684 ----------- ----------- ---------- ---------- Gross profit 4,075,648 4,827,686 1,116,849 1,809,127 ----------- ----------- ---------- ---------- Operating expenses: Selling and shipping 387,141 346,971 224,688 177,155 General and administrative 4,602,447 4,091,773 1,330,261 1,735,339 Depreciation 905,607 784,451 292,419 321,748 ----------- ----------- ---------- ---------- Total operating expenses 5,895,195 5,223,195 1,847,368 2,234,242 ----------- ----------- ---------- ---------- (Loss) income before other income (expense) and income taxes (1,819,547) (395,509) (730,519) (425,115) ----------- ----------- ---------- ---------- Other income (expense): Other income 99,351 75,778 13,613 16,622 Interest expense (651,775) (405,775) (214,224) (166,300) Net income from rental properties 9,086 (14,988) 5,503 (10,647) ----------- ----------- ---------- ---------- Other income (expenses) (543,338) (344,985) (195,108) (160,325) ----------- ----------- ---------- ---------- Loss before income taxes (2,362,885) (740,494) (925,627) (585,440) Income tax (benefit) (755,967) (197,162) (276,810) (229,081) ----------- ----------- ---------- ---------- Net (loss) income $(1,606,918) $ (543,332) $ (648,817) $ (356,359) =========== =========== ========== ========== Weighted shares outstanding: Basic 13,586,776 11,472,477 14,263,007 12,990,000 Diluted 13,867,776 11,472,477 14,263,007 12,990,000 Basic and diluted (loss) per share: Loss per share $ (.12) $ (.05) $ (.05) $ (.03) =========== =========== ========== ========== See notes to consolidated financial statements F-4 MICHELEX CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended Seven Months Ended September 30, September 30, 2 0 0 4 2 0 0 3 (Unaudited) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(1,606,918) $(543,332) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 905,607 784,451 Stock issued for services rendered -- 20,000 Gain on sale of assets (9,648) -- Deferred taxes (711,955) (197,163) CHANGES IN OPERATING ASSETS AND LIABILITIES: Accounts receivable 1,504,933 (192,114) Inventory 380,812 87,696 Prepaid expenses and taxes (296,298) (123,363) Other assets 122,709 8,556 Accounts payable (932,394) 250,176 Accrued expenses and taxes 277,750 179,846 ----------- ----------- NET CASH FLOWS FROM OPERATING ACTIVITIES (365,402) 274,753 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of fixed assets (129,554) (116,927) Proceeds from sale of equipment 315,000 -- ----------- ----------- NET CASH FLOWS FROM INVESTING ACTIVITIES 185,446 (116,927) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of long-term debt (845,507) (666,333) Net borrowings from demand notes payable (664,827) 710,644 Proceeds from issuance of convertible debentures 493,250 -- Proceeds from long-term debt 800,000 -- Borrowings from related parties 74,171 189,711 Proceeds from issuance of common stock 175,000 -- ----------- ----------- NET CASH FLOWS BY FINANCING ACTIVITIES 32,087 234,022 ----------- ----------- NET INCREASE IN CASH (147,869) 391,848 CASH AT BEGINNING OF PERIOD 225,825 265,556 ----------- ----------- CASH AT END OF PERIOD $ 77,956 $ 657,404 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Income taxes paid $ 380 $ -- =========== =========== Interest paid $ 608,419 $ 397,897 =========== =========== NON-CASH INVESTING AND FINANCING ACTIVITIES: Financial consulting fees through issuance of common stock $ 100,000 $ -- =========== =========== Legal consulting fees through issuance of options to purchase common stock $ 153,669 $ -- =========== =========== See notes to consolidated financial statements F-5 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES In the opinion of management, the accompanying financial statements of Michelex Corporation ("Michelex") contain all adjustments necessary to present fairly the Company's financial position as of September 30, 2004 and December 31, 2003, the results of operations and cash flows for the periods ended September 30, 2004 and 2003. The results of operations for the periods ended September 30, 2004 and 2003 are not necessarily indicative of the results to be expected for the full year. Except as stated below, the accounting policies followed by the Company are set forth in Note 1 to the Company's financial statements included in its Annual Report on Form 10-KSB for the fiscal year ended December 31, 2003. Restricted Cash Restricted cash is comprised of funds which have been collected through a lockbox. These funds are used solely to pay down the credit line. These funds are not available to the Company for any other purpose. Reclassification Certain amounts in the prior period have been reclassified to conform to the current period presentation. F-6 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 2 COMMITMENTS During the 2003 fiscal year, Michele Audio Corporation of America (the "Company") entered into a Consulting Agreement with Investor Relations Services, Inc., a Delaware corporation whose address is 120 Flagler Avenue, New Smyrna Beach, Florida and simultaneously a Personal Services Agreement with Mr. Charles Arnold located at 2 Spur Lane, Rolling Hills, California. The agreements were effective June 1, 2003 and they both expire on May 31, 2004. The agreements called for certain services, which are enumerated in the agreements, to be provided by Mr. Arnold and Investor Relations Services for the benefit of the Company. As compensation for these services the Company agreed to issue both Investor Relations Services and Mr. Arnold preferred shares of stock in Michele Audio Corporation of America. Additionally, the preferred shares were to have conversion rights allowing Mr. Arnold and Investor Relations Services, Inc. each to convert their preferred shares to 4.9% undiluted of the common stock issued and outstanding following the first round of financing after the Company became a public entity. It was further agreed the stock when issued would be restricted pursuant to Rule 144. In March of 2004 Mr. Arnold and Investor Relations Services filed for arbitration, as called for in the agreements, against Michelex Corporation claiming they have not been compensated as called for in the agreements. The Company responded indicating that Michelex Corporation was not a party to the agreement and was therefore not bound to the arbitration and the filing was dismissed. In October of 2004, Mr. Arnold and Investor Relations Services filed a new claim for arbitration. The date of the arbitration has not yet been determined pending the resolution of several technical issues raised by the Company with the American Arbitration Association. The Company among other defenses contends that neither Mr. Arnold nor Investor Relations Services, Inc. provided the quantity or quality of services contemplated under the agreements and intends to vigorously defend its position. Shares totaling 1,267,924 are being held in escrow pending the results of the arbitration. F-7 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 3 SEGMENT INFORMATION Michelex Michele Michelex Media Audio Plastics Products Total Nine months ended September 30, 2004 Net sales $3,074,070 $7,092,816 $980,461 $11,147,347 Net (Loss)/Profit (155,348) (1,915,350) 463,780 (1,606,918) Segment assets 3,419,007 11,463,331 314,147 15,196,485 Seven months ended September 30, 2003 Net sales $3,438,875 $8,126,089 $727,911 $12,292,875 Net (Loss)/Profit (147,632) (746,470) 350,770 (543,332) Segment assets 4,889,877 13,426,926 371,175 18,687,978 Corporate expenses totaling $111,856 are included in the net loss of the Michelex Plastics division in the nine months ended September 30, 2004. NOTE 4 DEPOSIT ON EQUIPMENT In July 2004, The Company entered into a sale agreement for the sale of certain of its equipment located in the Utah facilities for $675,000. The Company received $300,000 as a deposit on equipment. In September 2004, the distributor sold six machines for a total of $315,000. The Company reported a gain of $26,688 on the sale. In October of 2004 the Company terminated the contract and no further equipment was sold. F-8 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 5 TERMINATION OF CAPITAL LEASE In July 2004, the Company and the lessor of its Ogdensburg facilities reached an agreement whereby the lessor agreed to terminate the lease. The original agreement required the Company to make the past due May and June lease payments prior to the termination of the lease. In September 2004, the lessor waived the payment of the May and June payments and the lease was terminated. The Company had recorded the lease as a capital lease. The termination of the lease resulted in a loss of $25,039. NOTE 6 PROPOSED OFFERING OF SECURED CONVERTIBLE DEBENTURES In August and November of 2004, the Company agreed to issue $300,000 and $150,000 respectively of 12% Secured Convertible Debentures ("Convertible Debentures"). The Convertible Debentures will be due on November 30, 2005 and may be prepaid in whole at any time after giving 20 days advance notice. The holders of the Convertible Debentures may elect at any time to convert the principle balance due into shares of the Company's common stock at the lesser of $.1875 per share or 75% of the current market price at conversion. The Convertible Debentures are to be secured by a second security interest in all the Company's assets, the personal guarantees of 2 of the officers of the Company, and options to purchase 16,236,120 shares of the Company's common stock at a price of $.0001 per share in the event of a default as defined under the agreement. Additionally, the Convertible Debenture grants the Holders a warrant to purchase 50,000 shares of the Company's common stock at an exercise price of $.1875 per share and "piggy-back" registration rights. At September 30, 2004, the Company had not issued any of the Convertible Debentures. In October and November 2004, the Company issued $300,000 and $150,000 respectively of the Convertible Debentures. In November 2004, $300,000 of the debentures were converted into 1,600,000 shares of the Company's common stock at a price of $.1875 per share. F-9 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 7 PROPOSED PRIVATE PLACEMENT OF 5% CONVERTIBLE DEBENTURES Through September 30, 2004, the Company issued $493,250 of 5% Convertible Debentures ("5% Debentures"). The 5% Debentures require the Company to issue non-restricted shares of the Company's common stock within 41 days of funding at a conversion price of $.17 per share. In the event non-restricted shares of the Company's common stock is not issued with in the 41 days, then each debenture holder is entitled to 3 shares of restricted stock for each share of non- restricted shares required under the conversion provisions of the debenture. Additionally, if the Company fails to deliver non- restricted shares of the Company's common stock to the debenture holders within one year after the first closing date, the Company shall be required to deliver additional shares of restricted stock in sufficient quantities to guarantee the holders a 45% return on their investment. The Private Placement Memorandum further grants the Placement Agent the right of first refusal on all subsequent offerings by the Company for a period of 2 years. On October 1, 2004, the Company issued the final $10,000 5% Debentures, at which time the offering was closed. The Company aggregated net proceeds of $408,865 from the offering. NOTE 8 PROPOSED ACQUISITION OF MEDIA BOOKS In September 2004, the Company signed a letter of intent to acquire Media Books, LLC, an entity which is 50% owned by an officer/director of the Company. NOTE 9 PROPOSED STOCK SPLIT On November 5, 2004, the Company issued a 3 for 1 stock split. F-10 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 10 COMMITMENT TO ACQUIRE EQUIPMENT In October 2004, the Company agreed to acquire approximately $270,000 of manufacturing equipment. In November 2004, a third party, issued a $278,000 letter of credit on behalf of the Company to secure the purchase of the equipment. Approximately $92,000 of the proceeds from the $150,000 12% convertible debenture (see Note 7) was used as cash collateral for the letter of credit. The Company expects to receive the equipment and begin production by the end of the current fiscal year. NOTE 11 ISSUANCE OF ADDITIONAL COMMON STOCK Payment of Legal Services In October 2004, the Company issued 29,654 shares of common stock to a law firm for legal services rendered. Extension of Legal Consulting Agreement In September 2004, the Company amended the agreement for legal services with one of its attorneys. The amendment extends the termination date of the original agreement from June 22, 2005 to January 22, 2006. The amendment requires the Company to issue the attorney options, with a term of 2 years, to purchase 500,000 shares of the Company's common stock at a price of $.32 per share, options also with a term of 2 years to purchase 200,000 shares of the Company's common stock at a price of $.20 per share, and 753,000 shares of the Company's common stock which will be registered under Form S-8. Common Share Issuance Agreement In October 2004, the Company issued 500,000 shares of common stock to an unrelated party in exchange for $160,000. F-11 MICHELEX CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 NOTE 12 LOAN PAYABLE In September 2004, one of the Company's law firms made an unsecured loan to the Company in the amount of $75,000. NOTE 13 CORNELL EQUITY LINE In November 2004, the Company signed a Standby Equity Distribution Agreement with Cornell Capital Partners, LP ("Cornell") whereby Cornell has agreed to purchase, during the next 2 years, up to $10,000,000 of the Company's common stock pursuant to the terms and conditions of the Standby Equity Distribution Agreement. NOTE 14 Business Development Company The management and directors of the Company have chosen a strategy to operate the Company as a Business Development Company and as such, in November 2004, the Company filed a notification with the Securities and Exchange Commission, that pursuant to Section 54(a) of the Investment Company Act of 1940, of its election to become subject to the provisions of Sections 55 through 65 of the Investment Company Act of 1940. NOTE 15 COLLATERAL SHARE AGREEMENT In October 2004, the Company entered into a Collateral Share Agreement (the "Agreement") with Ginette and Thomas Gramuglia the President and Vice President of the Company respectively. The Agreement calls for the Company to issue each Thomas Gramuglia and Ginette Gramuglia 3 million shares of the Company's common stock as consideration for their continuing personal guarantees of certain of the Company's loan obligations. Ownership of the collateral shares remains with the Company unless an event of default occurs under the guaranteed loans set forth in the Agreement, however Tom and Ginette Gramuglia have voting rights for the shares during the term of the Agreement. Additionally, the collateral share agreement stipulates that either Thomas or Ginette Gramuglia have the option to purchase the collateral shares at either $.24 per share or the average closing bid price for the shares for any 5 day trading period during the term of the agreement. The Agreement further indicates that the Company may from time to time transfer ownership of the collateral shares to Thomas Gramuglia pursuant to his employment agreement and applicable securities laws. The term of the agreement is the shorter of 10 years or the term of the loan guarantees. F-12 Item 2. Management's Discussion and Analysis or Plan of Operation. --------------------------------------------------------- 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. Forward-Looking Information. ---------------------------- Statements made in this Form 10-KSB which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expectations, financial condition, results of operations, future performance and business of our Company, including, without limitation, statements preceded by, followed by or that include the words "may", "would", "could", "should", "expects", "projects", "anticipates", "believes", "estimates", "plans", "intends", "targets" or similar expressions. Forward-looking statements involve inherent risks and uncertainties, and important factors (many of which are beyond our Company's control) that could cause actual results to differ materially from those set forth in the forward-looking statements, including the following, in addition to those contained in our Company's reports on file with the Securities and Exchange Commission: (i) general economic or industry conditions, nationally and/or in the communities in which our Company may conduct business; (ii) changes in the interest rate environment, legislation or regulatory requirements; (iii) conditions of the securities markets; (iv) changes in the industries in which the Company competes; (v) the development of products or services that may be superior to products or services offered or developed by our Company; (vi) competition; (vii) changes in the quality or composition of products or services developed by our Company; (viii) our ability to develop new products or services; (ix) our ability to raise capital; (x) changes in accounting principals, policies or guidelines; (xi) financial or political instability; (xii) acts of war or terrorism; (xiii) other economic, competitive, governmental, regulatory and technical factors affecting our Company's operations, products, services and prices. Accordingly, results actually achieved may differ materially from expected results in these statements. Forward-looking statements speak only as of the date they are made. The Company does not undertake, and specifically disclaims, any obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of such statements. Item 3. Controls and Procedures. The Company's President and Treasurer are responsible for establishing and maintaining disclosure controls and procedures. (a) Evaluation of Disclosure Controls and Procedures Based on their evaluation as of September 30, 2004, the President and the Treasurer have concluded that the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) are effective to ensure that information required to be disclosed in reports that the Company files or submits under the Securities Exchange Act, as amended is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. (b) Changes in internal controls Based on their evaluation as of September 30, 2004, the President and the Treasurer have concluded that there were no significant changes in the Company's internal controls over financial reporting or in any other areas that could significantly affect the Company's internal controls subsequent to the date of his most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION Item 1. Legal Proceedings. Except as indicated below, the Company is not a party to any pending legal proceeding. To the knowledge of management, no federal, state or local governmental agency is presently contemplating any proceeding against the Company. No director, executive officer or affiliate of the Company or owner of record or beneficially of more than five percent of its common stock is a party adverse to the Company or has a material interest adverse to the Company in any proceeding. During the 2003 fiscal year, Michele New Jersey entered into a Consulting Agreement with an investor relations consultant, and simultaneously a entered into Personal Services Agreement with an individual. The agreements were effective June 1, 2003 and they both expired on May 31, 2004. The agreements called for certain services, to be provided by the consultants for the benefit of the Michele New Jersey. As compensation for these services, Michele New Jersey agreed to issue to both consultants preferred shares of stock in Michele New Jersey. In March of 2004, the consultants filed for arbitration, as called for in the agreements, against the Company, claiming they have not been compensated as called for in the agreements. The Company responded by indicating that it was not a party to the agreement and was therefore not bound to the arbitration, and the filing was dismissed. The consultants re-filed the arbitration in October, 2004. All parties are contesting the existence and validity of the arbitration clause in the first instance. The Company, among other defenses, plans to contend that neither consultant provided the quantity or quality of services contemplated under the agreements. The Company intends to vigorously defend its position. Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities. On August 10, 2004, the Company issued 400,000 "unregistered" and "restricted" shares of its common stock to Stock Communications Group, Inc., in consideration of investor relations services, in anticipation of the settlement of the Company's dispute with that entity. This dispute relates to whether the Company received the services that were to be the consideration for the issuance of the shares and whether certain triggering events had occurred that would require the issuance of the shares. We believe that the offer and sale of these securities was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Sections 4(2) and 4(6) thereof, and Rule 506 of Regulation D of the Securities and Exchange Commission and pursuant to various similar state exemptions. Item 3. Defaults Upon Senior Securities. None; not applicable. Item 4. Submission of Matters to a Vote of Security Holders. None; not applicable. Item 5. Other Information. None; not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 31.1 - 302 Certification Ginette Gramuglia. 31.2 - 302 Certification Thomas Gramuglia. 32 - 906 Certification. (b) Reports on Form 8-K. None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. MICHELEX, INC. Date: 11/22/04 /s/ Ginette Gramuglia ---------- ---------------------- Ginette Gramuglia Director and President Date: 11/22/04 /s/ Thomas Gramuglia ---------- --------------------- Thomas Gramuglia Director, Vice President and Treasurer