UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One) |
[X] | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2009
[ ] | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT |
For the transition period from _______________ to _______________.
Commission file number 0-32341
M Line Holdings, Inc.
(Exact Name of Company as Specified in its Charter)
Nevada (State or other jurisdiction of incorporation or organization) | 88-0375818 (I.R.S. Employer Identification No.) |
2672 Dow Avenue Tustin, CA (Address of principal executive offices) | 92780 (Zip Code) |
(714) 630-6253 | |
(Registrant’s telephone number, including area code) | |
Gateway International Holdings, Inc. | |
(Former name, former address and former fiscal year, if changed since last report) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No ___.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | Accelerated filer | |||||
Non-accelerated filer | Smaller reporting company | X |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes No X .
Applicable only to issuers involved in bankruptcy proceedings during the preceding five years
2
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:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 14, 2009, there were 27,611,956 shares of common stock, par value $0.001, issued and 30,861,356 shares outstanding.
M LINE HOLDINGS, INC.
TABLE OF CONTENTS
PART I
ITEM 1. | Financial Statements (unaudited). | 4-6 |
ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 15 |
ITEM 3. | Quantitative and Qualitative Disclosures About Market Risk. | 26 |
ITEM 4T. | Controls and Procedures. | 27 |
PART II
ITEM 1. | Legal Proceedings. | 30 |
ITEM 1A. | Risk Factors. | 30 |
ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 30 |
ITEM 3. | Defaults Upon Senior Securities. | 30 |
ITEM 4. | Submission of Matters to a Vote of Security Holders. | 31 |
ITEM 5. | Other Information. | 31 |
ITEM 6. | Exhibits. | 33 |
3
PART I-FINANCIAL INFORMATION
M LINE HOLDINGS, INC. | ||||||||
(FORMELY KNOWN AS GATEWAY INTERNATIONAL HOLDINGS, INC.) | ||||||||
CONSOLIDATED BALANCE SHEETS | ||||||||
(UNAUDITED) | ||||||||
Assets | ||||||||
March 31, 2009 | June 30, 2008 | |||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 899,537 | $ | 1,024,643 | ||||
Accounts receivable, net of allowances of $81,947 at March 31, 2009 and $82,000 at June 30, 2008, respectively. | 552,913 | 1,648,217 | ||||||
Inventories | 1,313,646 | 1,721,289 | ||||||
Due from related party | - | 81,000 | ||||||
Prepaid and other | 106,931 | 180,011 | ||||||
Deferred income taxes | 83,959 | 179,316 | ||||||
Total current assets | 2,956,985 | 4,834,476 | ||||||
Property and equipment, net | 1,320,678 | 1,603,675 | ||||||
Intangible assets, net | 832,948 | 928,439 | ||||||
Goodwill | 194,378 | 392,547 | ||||||
Deposits and other | 153,801 | 61,146 | ||||||
Deferred income taxes | 25,790 | 245,497 | ||||||
Total assets | $ | 5,484,580 | $ | 8,065,780 | ||||
Liabilities and Shareholders’ Equity | ||||||||
Current liabilities: | ||||||||
Line of credit | $ | 520,000 | $ | 330,000 | ||||
Accounts payable | 1,278,956 | 1,646,871 | ||||||
Income taxes payable | 800 | 187,954 | ||||||
Accrued expenses and other | 313,749 | 213,752 | ||||||
Accrued interest due to related party | - | 82,173 | ||||||
Customer deposits | 29,039 | 149,500 | ||||||
Notes payable | 211,708 | 244,635 | ||||||
Notes payable, related party | - | 734,880 | ||||||
Deferred income taxes | - | 11,263 | ||||||
Capital leases | 154,351 | 85,533 | ||||||
Deferred rent | 10,115 | - | ||||||
Shares to be issued | 650,000 | - | ||||||
Total current liabilities | 3,168,718 | 3,686,561 | ||||||
Notes payable | 177,940 | 429,493 | ||||||
Notes payable, related party | - | 31,526 | ||||||
Capital leases | 186,777 | 130,361 | ||||||
Deferred income taxes | - | 303,801 | ||||||
Deferred rent | 69,167 | 79,126 | ||||||
Total liabilities | 3,602,602 | 4,660,868 | ||||||
Shareholders’ equity: | ||||||||
Common stock, $0.001 par value: 100,000,000 shares authorized | ||||||||
27,611,956 and 28,378,645 shares issued and outstanding | ||||||||
at March 31, 2009 and June 30, 2008, respectively | 27,612 | 28,379 | ||||||
Additional paid-in capital | 8,857,321 | 8,921,354 | ||||||
Accumulated deficit | (7,002,955 | ) | (5,544,821 | ) | ||||
Total shareholders’ equity | 1,881,978 | 3,404,912 | ||||||
Total liabilities and shareholders' equity | $ | 5,484,580 | $ | 8,065,780 | ||||
The accompanying notes form an integral part of these consolidated financial statements |
4
M LINE HOLDINGS, INC | ||||||||||||||||
(FORMERLY KNOWN AS GATEWAY INTERNATIONAL HOLDINGS, INC) | ||||||||||||||||
CONSOLIDATED STATEMENT OF OPERATIONS | ||||||||||||||||
(UNAUDITED) | ||||||||||||||||
Three Months ended March 31, | Nine Months ended March 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net sales | $ | 1,814,526 | $ | 4,521,789 | $ | 9,945,282 | $ | 13,279,306 | ||||||||
Cost of sales | 1,458,438 | 3,399,254 | 7,538,198 | 9,965,664 | ||||||||||||
Gross Profit | 356,088 | 1,122,535 | 2,407,084 | 3,313,642 | ||||||||||||
Operating expenses: | ||||||||||||||||
Selling, general and administrative | 852,778 | 1,187,793 | 3,495,114 | 3,618,134 | ||||||||||||
Amortization of intangible assets | 31,831 | 31,831 | 95,492 | 81,565 | ||||||||||||
Impairment of goodwill | - | - | 198,169 | - | ||||||||||||
Total operating income | 884,609 | 1,219,624 | 3,788,775 | 3,699,699 | ||||||||||||
Operating loss | (528,521 | ) | (97,089 | ) | (1,381,691 | ) | (386,057 | ) | ||||||||
Other income (expense): | ||||||||||||||||
Interest Income | (2,923 | ) | 2,574 | 1,827 | 4,237 | |||||||||||
Interest expenses | (26,776 | ) | (33,431 | ) | (94,127 | ) | (108,296 | ) | ||||||||
Gain on sale of assets | - | (1,537 | ) | 16,657 | 43,437 | |||||||||||
Total other expense | (29,699 | ) | (32,394 | ) | (75,643 | ) | (60,622 | ) | ||||||||
Loss before income tax | (558,220 | ) | (129,483 | ) | (1,457,334 | ) | (446,679 | ) | ||||||||
Income tax provision (benefit) | (800 | ) | 24,049 | (800 | ) | 156,639 | ||||||||||
NET LOSS | $ | (559,020 | ) | $ | (105,434 | ) | $ | (1,458,134 | ) | $ | (290,040 | ) | ||||
Net loss per share | ||||||||||||||||
Basis | $ | (0.02 | ) | $ | (0.00 | ) | $ | (0.05 | ) | $ | (0.01 | ) | ||||
Dilutive | $ | (0.02 | ) | $ | (0.00 | ) | $ | (0.05 | ) | $ | (0.01 | ) | ||||
Weighted average number of common shares outstanding | 27,611,956 | 28,378,645 | 27,874,721 | 28,287,630 | ||||||||||||
The accompanying notes form an integral part of these consolidated financial statements |
5
M LINE HOLDINGS. INC. | ||||||||
(FORMERLY KNOWN AS GATEWAY INTERNATIONAL HOLDINGS, INC) | ||||||||
CONSOLIDATED STATEMENT OF CASH FLOWS | ||||||||
(UNAUDITED) | ||||||||
For the Nine Months Ended March 31, | ||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (1,458,134 | ) | $ | (290,040 | ) | ||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
Depreciation | 330,945 | 371,460 | ||||||
Amortization of intangible assets | 95,491 | 81,565 | ||||||
Stock-based compensation | 13,743 | - | ||||||
Imputed interest on related party notes | 2,458 | - | ||||||
Impairment of goodwill | 198,169 | - | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | 1,095,304 | 348,189 | ||||||
Inventories | 407,643 | (799,025 | ) | |||||
Prepaid expenses and other assets | (19,575 | ) | 27,370 | |||||
Accounts payable and accrued expenses | (180,990 | ) | (97,778 | ) | ||||
Customer deposits | (120,461 | ) | 583,522 | |||||
Deferred rent | 157 | 76,856 | ||||||
Deferred income taxes | ||||||||
Net cash provided by operating activities | 364,751 | 302,119 | ||||||
Cash flows from investing activities: | ||||||||
Capital expenditures | (128,162 | ) | (302,933 | ) | ||||
Proceeds from sale of assets | 74,790 | - | ||||||
Net cash used in investing activities | (53,373 | ) | (302,933 | ) | ||||
Cash flows from financing activities: | ||||||||
Net borrowings on line of credit | 190,000 | 249,868 | ||||||
Proceeds from /(payment to) notes payable | 365,520 | 15,721 | ||||||
Payments on related party notes payable | (848,579 | ) | (109,891 | ) | ||||
Capital leases | (143,426 | ) | (122,131 | ) | ||||
Net cash provide by/(used in) financing activities | (436,485 | ) | 33,567 | |||||
Net change in cash and cash equivalents | (125,106 | ) | 32,753 | |||||
Cash and cash equivalents at beginning of period | 1,024,643 | 972,546 | ||||||
Cash and cash equivalents at end of period | $ | 899,537 | $ | 1,005,299 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid for interest | $ | 94,127 | $ | 84,260 | ||||
Cash paid for income taxes | $ | - | $ | - | ||||
Conversion of portion of line of credit to term loan | $ | - | $ | 500,000 | ||||
Stock issued for creditor settlement | $ | - | $ | 63,000 | ||||
Stock issued for acquisition of CNC Repos, Inc. | $ | - | $ | 440,000 | ||||
The accompanying notes form an integral part of these consolidated financial statements |
6
M LINE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. | Business |
M Line Holdings, Inc formerly Gateway International Holdings, Inc. (The “Company”, “us”, “we” or “our”) and its subsidiaries are engaged in the following businesses which represent its business segments:
· | Acquiring, refurbishing and selling new and used CNC machine-tool equipment through our All American CNC Sales, Inc. (“All American”) and EM Tool Company, Inc. dba Elite Machine Tool (“Elite”) subsidiaries (Machine Sales segment). |
· | Manufacturing precision metal component parts for the defense, automotive, aerospace and medical industries through its Eran Engineering, Inc. (“Eran”) subsidiary (Precision Manufacturing segment). |
Effective December 9, 2008, three affiliate shareholders of the Company, Timothy D. Consalvi, our former Chief Executive Officer and Director, Joseph Gledhill, an Executive Vice President, Director and 10% shareholder, and Lawrence A. Consalvi, a former officer and Director, and a 10% shareholder, entered into a Stock Purchase Agreement (the “Agreement”) with a non-related party, Money Line Capital, Inc. (“Money Line”), whereby Money Line agreed to purchase an aggregate of 11,850,000 shares of the Company’s common stock held by the above named shareholders. These shares represent approximately 43% of our outstanding common stock. The Company did not issue any new shares of stock.
The Company was not a party to the above transactions, however, did acknowledge certain representations and warranties. The Company entered into several ancillary agreements as a result of the above transaction. First, we terminated our employment agreement with Timothy D. Consalvi for serving as our Chief Executive Officer and agreed to pay him one of the two years of severance required under his employment agreement, and entered into a new employment agreement with Mr. Consalvi whereby he is currently employed by us as the President of All American. Second, we consolidated the amounts owed to Mr. Gledhill under previously issued promissory notes and accrued interest into one $650,000 promissory note. As of March 31, 2009, the Company accrued $94,854 for unpaid amounts severance due which has been included in accrued expenses in the accompanying consolidated balance sheet.
2. | Basis of Presentation and Significant Accounting Policies |
Basis of Presentation
The consolidated financial statements of M Line are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission.. The results of operations for the three and nine month periods ended March 31, 2008 and 2009 are not necessarily indicative of the results to be expected for the full year. All accounts and intercompany transactions have been eliminated in consolidation. In the opinion of management, the consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary to present fairly the Company's financial position, results of operations and cash flows. These statements should be read in conjunction with the financial statements and related notes which are part of the Company's Annual Report on Form 10-K for the year ended June 30, 2008.
7
Valuation of Long-lived Assets and Other Intangible Assets
Long-lived assets consist primarily of our property, plant, and equipment. Purchased intangible assets include customer relationship. Intangible assets are amortized using the straight-line method over estimated useful lives. Because all of intangible assets are subject to amortization, the Company reviews these intangible assets for impairment in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of”.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the amount of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those results.
Income Taxes
The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. At March 31, 2009 and December 31, 2008, there was no significant book to tax differences.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has determined its deferred tax assets resulting from net operating losses will be utilized in future periods to offset taxable income.
The Company reviews its individual intangible assets for impairment on an annual basis or whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. A long-lived asset or other intangible asset is considered impaired when its anticipated undiscounted cash flow is less than its carrying value. In making this determination, the Company uses certain assumptions, including, but not limited to: (i) estimates of the fair market value of these assets; and (ii) estimates of future cash flows expected to be generated by these assets, which are based mainly on sales projections. As of March 31, 2009, the Company evaluated its intangible asset acquired in connection with the CNC Repos, Inc. (“CNC Repos”). Due to the recent decline in the Company’s estimated stock price and economic downturn, an impairment test was performed and based on that analysis, no impairment was required.
8
Net Income (Loss) per Share
Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average common shares outstanding during the period. Diluted net income (loss) per share reflects the potential dilution to basic earnings per share that could occur upon conversion or exercise of securities, options or other such items to common shares using the treasury stock method, based upon the weighted average fair value of our common shares during the period.
3. | Concentrations |
The 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 within 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 have a corresponding negative impact on our operating profit margin due to operation leverage this customer provides. This could lead to sales volumes not being high enough to cover our current cost structure or provide adequate operating cash flows. Panasonic has been a customer of ours for approximately 14 years and we believe our relationship is good.
Sales to this customer accounted for consolidated sales for the three and nine months ended March 31, 2008 and 2009 as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||||||
2008 | 2009 | 2008 | 2009 | |||||||||||||
Percent of sales | 89 | % | 67 | % | 86 | % | 70 | % | ||||||||
Number of customers | 1 | 1 | 1 | 1 |
Account receivable from the customer amounted to $178,884 and $691,624 as of March 31, 2009 and June 30, 2008, respectively.
4. | Inventories |
Inventories consist of the following at:
June 30, | March 31, | |||||||
2008 | 2009 | |||||||
Finished components and parts | $ | 612,825 | $ | 670,945 | ||||
CNC machines held for sale | 740,421 | 201,167 | ||||||
Work in process | 116,832 | 207,107 | ||||||
Raw materials and parts | 251,211 | 234,427 | ||||||
$ | 1,721,289 | $ | 1,313,646 |
9
5. | Goodwill |
Goodwill represents the excess of the purchase price of an acquired business or assets over the fair value of the identifiable assets acquired and liabilities assumed. The Company evaluates its goodwill for impairment in the period in which the anniversary date for the transaction which gave rise, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. During the three months ended March 31, 2009, the Company tested for impairment of its goodwill arising from the acquisition of CNC Repos, Inc. (“CNC Repos”).
The Company performed it impairment test for CNC Repos as prescribed by SFAS No. 142, “Goodwill and Other Intangible Assets” which provided an indicator that goodwill impairment is probable. Accordingly, the Company performed step two of the SFAS 142 impairment analysis to determine the amount of goodwill impairment to be recorded. The amount was calculated by comparing the implied fair value of the goodwill to its carrying amount. This exercise required the Company to allocate the fair value determined in step one to the individual assets and liabilities of the reporting unit. Any remaining fair value would be the implied fair value of goodwill on the testing date. Based on its analysis, the Company determined that the carrying value exceeded the fair value, and therefore, an impairment charge of $198,169 was recognized during the nine months ended March 31, 2009.
The determination as to whether a write-down of goodwill is necessary involves significant judgment based on the short-term and long-term projections of the future performance of the reporting unit to which the goodwill is attributed. The impairment was attributable to (i) lower internal sales forecast and cash flows attributable to the current economic environment which has negatively impacted the ability of our customers to obtain financing for capital purchases and (ii) a decline the Company’s stock price since the date of acquisition.
6. | Accrued Expenses |
Accrued expenses consist of the following at:
June 30, | March 31, | ||||||||
2008 | 2009 | ||||||||
Compensation, benefits and related | $ | 160,071 | $ | 60,689 | |||||
Severance due to Larry Consalvi | -- | 94,854 | |||||||
Other | 53,681 | 158,206 | |||||||
$ | 213,752 | $ | 313,749 |
7. | Line of Credit and Notes Payable |
Pacific Western Bank Credit Agreement
On August 21, 2006, the Company entered into credit agreement with Pacific Western Bank (“PWB”). The credit agreement provides for borrowings of up to $1,500,000 through a line of credit. On November 15, 2007, the credit agreement was amended to reduce the amount available under the line of credit to $1,000,000 and to convert $500,000 of outstanding principal into a term loan. On September 29, 2008, the Company renewed the credit agreement through September 21, 2009. Joseph Gledhill and Timothy Consalvi, are guarantors under the credit agreement.
10
The line of credit has a stated interest rate equal to the lender's referenced prime rate plus 1.5%. Interest is payable monthly with the outstanding principal balance due on September 21, 2009. The amount available for borrowings is determined based on a monthly basis based on 80% of eligible accounts receivable, as defined. As of March 31, 2009, the Company also has an irrevocable letter of credit outstanding of $100,000. The proceeds from the line of credit have been used for working capital needs.
The term loan provides for borrowings of up to $500,000. The loan has a stated interest rate equal to the lender's referenced prime rate plus 1.5%. Principal and interest payments are payable monthly.
The amount available for borrowings under the line of credit is determined on a monthly basis based on 80% of eligible accounts receivable, less the amount outstanding under the letter of credit, as defined. The term loan provides for borrowings of up to $500,000. The loan bears interest at the lender's referenced prime rate plus 1.5% with principal and interest payments due monthly. As of March 31, 2009, the balance outstanding under the line of credit exceeded the borrowing base amount by $90,508. On April 14, 2009, the Company repaid $80,000 to reduce the borrowing base amount. As of April 30, 2009, the Company was in compliance with it’s obligation under the borrowing base limit.
As of March 31, 2009, the Company met its minimum tangible net worth covenant, as set forth in the credit agreement.
However, as of March 31, 2009, the Company is in breach of a covenant under the Pacific Western Bank loan agreement that relates to losses in two consecutive quarters. The Company is currently negotiating with the Bank for a letter of forbearance.
Related Party Note Payable
On December 8, 2008, the Company amended the terms of a notes payable together with accrue interest due to Joseph Gledhill totaling $644,025 (“Original Note”) due January 31, 2009 into a note for $650,000 (“Amended Note”). Under the terms of the Amended Note, the principal balance is to be repaid as follows: (i) $200,000 on January 31, 2009, (ii) $100,000 per month from February 2009 through April 2009 and (iii) $150,000 on May 31, 2009. The Amended Note bears interest at a rate of 8% per annum in the event the Company does not make the principal payments in accordance with their due dates. The Company has imputed an interest rate of 8%.
On March 25, 2009, the Company entered into an Assignment of Promissory Note and Consent Thereto (the “Assignment”) with Money Line Capital, Inc., a California corporation (“MLCI”), its largest shareholder, under which MLCI agreed to assume the Company’s repayment obligations to Joseph Gledhill and Joyce Gledhill under that certain $650,000 principal amount Promissory Note dated December 8, 2008, in exchange for the issuance of 3,250,000 shares of the Company’s common stock (the “Shares”). Mr. Gledhill, one of the Company’s former directors, and Joyce Gledhill consented to the Assignment. Pursuant to the Assignment, MLCI and the Gledhill’s entered into a new $650,000 principal amount secured promissory note, a security agreement and a pledge agreement. The Company is not a party to the new promissory note. The Company has not issued the 3,250,000 shares to MLCI but is obligated to do so. The shares will be held in escrow pending MLCI’s repayment of the promissory note.
11
In accordance with Emerging Issues Task Force 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”, the Company determined the change in the present value of the expected cash flows between the Amended Note and the Original Notes was less than 10%; therefore for financial reporting purposes, the amendment to the Original Note was treated as a modification of debt. Accordingly, no gain or loss was recorded as a result of the modification.
8. | Litigation |
1. Onofrio Saputo and Christopher Frisco v. Gateway International Holdings, Inc., Lawrence Consalvi, Timothy Consalvi and Joe Gledhill, Court of the State of California, County of Orange, Case No. 30-2008-00110905. Plaintiffs filed this action on August 21, 2008.
The Complaint, which has causes of action for securities fraud, breach of fiduciary duties, fraud and deceit, and rescission, alleges that the defendants intentionally misrepresented, or failed to disclose, certain facts regarding the company prior to the plaintiffs purchasing Gateway International Holdings, Inc. common stock. The Complaint seeks total monetary damages of approximately $188,415, plus interest, and punitive damages. The Company filed an Answer to the Complaint on October 17, 2008, denying the allegations of the Complaint, denying that plaintiffs are entitled to any relief whatsoever and asserting various affirmative defenses. A trial date has not yet been scheduled and the Court has set a Case Management Conference for February 23, 2009. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
2. Voicu Belteu v. Mori Seiki Co., Ltd.; Mori Seiki U.S.A., Inc.; All American CNC Sales, Inc. dba Elite Machine Tool Company; Ellison Manufacturing Tech., Superior Court for the State of California, County of Orange, Case No. 30-2008-00103710. Plaintiff filed this action on March 7, 2008.
The Complaint, which has causes of action for strict products liability and negligence, alleges that a CNC machine manufactured by Mori Seiki and sold through the Company’s subsidiary, All American CNC Sales, Inc. dba Elite Machine Tool Company, was defective and injured the plaintiff. The Complaint seeks damages in excess of $6,300,000 for medical expenses, future medical expenses, lost wages, future lost wages and general damages. The Company filed cross-complaints against several individuals and entities involved in the machine purchase and sales transaction, seeking indemnity, contribution, and damages based on other legal theories. The Company filed an Answer to the Complaint along with the various aforementioned cross-complaints. Currently the parties are involved in the meet and confer process to resolve outstanding discovery issues. The Court has set a Case Management Conference for May 7, 2009. No trial date has been set. The Company’s management believes it has meritorious defenses to plaintiff’s claims and plans to vigorously defend against the lawsuit and pursue Mori Seiki, and possibly other entities or individuals, for any damages the Company incurs. However, there can be no assurance as to the outcome of the lawsuit. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
3. James M. Cassidy v. Gateway International Holdings, Inc., American Arbitration Association, Case No. 73-194-32755-08. The Company was served with a Demand for Arbitration and Statement of Claim, which was filed on September 16, 2008.
12
The Statement of Claim alleges that claimant is an attorney who performed services for the Company pursuant to an agreement dated April 2, 2007 between the Company and the claimant. The Statement of Claim alleges the Company breached the agreement and seeks compensatory damages in the amount of $195,000 plus interest, attorneys’ fees and costs. The Company denies the allegations of the Statement of Claim and will vigorously defend against these allegations. An arbitrator has not yet been selected, and a trial date has not yet been scheduled. The parties have informally agreed to attend mediation in order to discuss a potential resolution of the matter, which should occur in the next 60 days. The parties have agreed to stay arbitration pending completion of mediation. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
4. Elite Machine Tool Company v. ARAM Precision Tool and Die, Avi Amichai, Superior Court for the State of California, County of Orange, Case No. 30-2008-00090891. Elite Machine filed this action on August 8, 2008.
The Complaint alleges breach of contract for the defendants failing to pay Elite Machine for a machine the defendants purchased from Elite Machine, and seeks damages totaling $16,238. ARAM Precision Tool and Die filed its Answer and Cross-Complaint on October 1, 2008. The Cross-Complaint alleges that Elite Machine failed to deliver certain parts of the machine per the sales contract and seeks damages totaling $25,000. Plaintiff and Defendant have both served and responded to discovery, and are now preparing for trial, currently set for June 8, 2009. . No amounts have been accrued for this matter in the accompanying consolidated financial statements.
5. RACL, Inc. v. All American CNC Sales, Inc., Elite Machine Tool Company/Sales & Services, CNC Repos, Superior Court for the State of California, County of Riverside, Case No. RIC 509650. Plaintiff filed this Complaint on October 2, 2008.
The Complaint alleges causes of action for breach of contract and rescission and claims All American breached the agreement with RACL by failing to deliver a machine that conforms to the specifications requested by RACL, and requests damages totaling $138,750. Elite Machine filed a timely Answer, on January 15, 2009. Discovery has commenced in this matter but is not expected to be concluded for several months. The Court has set a Case Management Conference for September 29, 2009. Management intends to aggressively defend itself against this claim. No trial date has been set. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
6. All American CNC v. Sunbelt Machine, Orange County Superior Court, Case No. 0-2008-00112502. All American filed the Complaint on September 25, 2008. No trial date has been set.
This case involves a dispute between All American and Sunbelt regarding the sale of a Makino MC 98 HMC machine by All American to Sunbelt. Sunbelt has claimed that it received a machine that does not conform to the specifications it ordered. The amount at issue is approximately $140,000 at this stage. Subsequent to filing of the above-referenced suit, Sunbelt filed a similar action in Federal District Court in Houston, Texas. All American plans to seek to transfer and consolidate the federal case into the State of California case in Orange County, California. Discovery has not commenced. All American anticipates substantial law and motion activity in this case prior to commencement of discovery. Management believes that the machine delivered to Sunbelt was conforming and Sunbelt’s claims are without merit. Management intends to vigorously defend this claim. The Court has scheduled a Case Management Conference for May 29, 2009. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
13
9. | Common Stock |
During the quarter ended September 30, 2008, the Company cancelled 416,689 shares of common stock previously issued to secure a repaid promissory note.
On October 6, 2008, Mr. Lawrence Consalvi returned and the Company cancelled shares 400,000 shares of common stock in exchange for the cancellation of amounts due to the Company.
10. | Related Party Transactions |
In connection with the close of the Company’s financial statements for the year ended June 30, 2008, the Company discovered it paid Lawrence Consalvi for certain expenses submitted for reimbursement. Due to the lack of documentation surrounding the nature of the expense, Mr. Consalvi agreed to reimburse the Company $81,000 or return 400,000 shares of the Company’s common stock. On October 6, 2008, Mr. Consalvi returned 400,000 shares of common stock in exchange for the cancellation of amounts due to the Company. There was no gain or loss recognized on this transaction.
11. | Segments and Geographic Information |
The Company’s segments consist of individual companies managed separately with each manager reporting to the Board. “Other” represents corporate functions. Sales, and operating or segment profit, are reflected net of inter-segment sales and profits. Segment profit is comprised of net sales less operating expenses and interest. Income taxes are not allocated and reported by segment since they are excluded from the measure of segment performance reviewed by management.
Machine Sales | Precision Manufacturing | Corporate | Total | |||||||||||||||||||||||||||||
Three Months Ended March31, | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | ||||||||||||||||||||||||
Revenues | $ | 2,783,248 | $ | 987,013 | $ | 1,738,541 | $ | 827,513 | $ | - | $ | - | $ | 4,521,789, | $ | 1,814,526 | ||||||||||||||||
Income (loss) | (256,049 | ) | (433,825 | ) | 45,364 | (275,870 | ) | (105,251 | ) | 150,675 | (105,434 | ) | (559,020 | ) |
Machine Sales | Precision Manufacturing | Corporate | Total | |||||||||||||||||||||||||||||
Nine Months Ended March 31, | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | ||||||||||||||||||||||||
Revenues | $ | 8,975,607 | $ | 6,115,432 | $ | 4,305,699 | $ | 3,829,850 | $ | - | $ | - | $ | 13,279,306 | $ | 9,945,282 | ||||||||||||||||
Income (loss) | (73,668 | ) | (1,234,432 | ) | (39,005 | ) | (492,903 | ) | (177,367 | ) | 269,202 | (290,040 | ) | (1,458,134 | ) |
Sales are derived principally from customers located within the United States.
14
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This quarterly report on Form 10-Q of M Line Holdings, Inc. (formerly known as Gateway International Holdings, Inc., and referred to herein as “MLH”, “we,” “us” or “Company”) for the three months ended March 31, 2009, contains forward-looking statements, principally in this Section and “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 of 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 this filing, 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 comprises 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 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 within 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 have a corresponding negative impact on our operating profit margin due to operation leverage this customer provides. This could lead to sales volumes not being high enough to cover our current cost structure or provide adequate operating cash flows. Panasonic has been a customer of ours for approximately 14 years and we believe our relationship is good.
15
Sales to this customer accounted for consolidated sales for the three and nine months ended March 31, 2009 and 2008 as follows:
Three Months Ended March 31, | Nine Months Ended March 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Percent of sales | 67 | % | 89 | % | 70 | % | 86 | % | ||||||||
Number of customers | 1 | 1 | 1 | 1 |
Trends Affecting Our Business
The recent tightening of the capital markets has adversely affected our sales of new and used CNC machines. Historically, as capital markets tighten, companies finance the purchases capital equipment on credit, such as the CNC machines we sell. Our customers are having more difficulty in obtaining credit and, therefore, are unable to purchase machines that they may be able to purchase in better financial times.
The primary components sold by our Precision Manufacturing segment are parts sold to Panasonic, a leading provider of in-flight entertainment systems for commercial aircraft. In early September 2008, Boeing Co.’s (“Boeing”) largest labor union went on strike, causing Boeing to immediately halt its production of aircraft. The strike was settled on November 1, 2008. As a result of the strike, Boeing delivered five commercial aircraft in October 2008 and 12 in September 2008, down from 36 in both July and August 2008. Although the strike has ended there is no timetable as to when production levels will be restored to pre-strike numbers. The Boeing strike and the current economic climate has an adverse affect on Panasonic’s orders to us, and has resulted in delays in scheduled shipment of products which has had a negative effect on our business during the three months ended March 31, 2009.
The operating results within our Precision Manufacturing segment are characterized by relatively high fixed costs. Increases and decreases in our production activity result in the allocation of fixed manufacturing costs over a larger or reduced number of parts, which yields lower or higher per unit costs. As a result, our manufacturing activity can significantly affect our gross profit margin and the valuation of our inventory. Our manufacturing rates have varied from period to period based on production capacity which is drive by market demand.
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, utilization of deferred tax assets, collectability of accounts receivable, litigation, impairment of goodwill, and long-lived assets other than goodwill. We regularly evaluate our estimates and assumptions based upon 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.
16
Inventories
Within our Precision Manufacturing segment, 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 Tools segment, we purchase machines held for resale based upon 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 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.
Accounting for Income Taxes
We account for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes”. Under this method, we determine deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year's financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pre-tax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or a liability and its reported amount on the consolidated balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and unless we believe that recovery is more likely than not, we must establish a valuation allowance.
Valuation of Long-lived Assets and Other Intangible Assets
Long-lived assets consist primarily of our property, plant, and equipment. Purchased intangible assets include customer relationship. Intangible assets are amortized using the straight-line method over estimated useful lives. Because all of intangible assets are subject to amortization, we review these intangible assets for impairment in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of”.
17
Goodwill
Goodwill represents the excess of the purchase price of an acquired business or assets over the fair value of the identifiable assets acquired and liabilities assumed. We evaluate our goodwill for impairment in the period in which the anniversary date for the transaction which gave rise, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. During the three months ended December 31, 2008, we tested for impairment of its goodwill arising from the acquisition of CNC Repos, Inc. (“CNC Repos”).
We performed our impairment test for CNC Repos as prescribed by SFAS No. 142, “Goodwill and Other Intangible Assets” which provided an indicator that goodwill impairment was probable. Accordingly, we performed step two of the SFAS 142 impairment analysis to determine the amount of goodwill impairment to be recorded. The amount was calculated by comparing the implied fair value of the goodwill to its carrying amount. This exercise required us to allocate the fair value determined in step one to the individual assets and liabilities of the reporting unit. Any remaining fair value would be the implied fair value of goodwill on the testing date. Based on its analysis, management determined that the carrying value exceeded the fair value, and therefore, an impairment charge of $198,169 was recognized during the nine months ended March 31, 2009.
The impairment was attributable to (i) lower internal sales forecast and cash flows attributable to the current economic environment which has negatively impacted the ability of our customers to obtain financing for capital purchases and (ii) a decline the our estimated fair value of our stock price since the date of acquisition.
Fair Value Accounting
Effective July 1, 2008, we adopted Statement of Financial Accounting Standard (“SFAS, No. 157”), “Fair Value Measurements”, to account for our financial assets and liabilities. SFAS No. 157 provides a framework for measuring fair value, clarifies the definition of fair value and expands disclosures regarding fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The standard establishes a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
· | Level 1 - Observable quoted prices for identical instruments in active markets; |
· | Level 2 - Observable quoted prices for similar instruments in active markets, observable quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; or |
· | Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. |
We do not have financial assets or liabilities, as defined under SFAS No. 157.
18
Results of Operation for the Three Months Ended March 31, 2009 Compared to the Three Months Ended March 31, 2008
Sales
Sales in the fiscal 2009 period decreased 60% from the comparable period in fiscal 2008. The change is attributable to declines in sales from both the Precision Manufacturing and Machine Sales Groups.
During the 2009 period, the Precision Manufacturing Group’s sales were adversely impacted by lower shipments to our single largest customer, Panasonic which we believe are due to the Boeing strike and the current economic climate which has resulted in delays in scheduled shipment of parts.
During the 2009 period, the Machine Sales Group experienced lower unit sales due to the recent tightening of credit which made it more difficult for our customers to obtain credit to purchase both new and used CNC machines.
Gross Margin
Gross profit decreased by 68% in the fiscal 2009 period from the comparable period in fiscal 2008. The change resulted from lower gross margins from both the Precision Manufacturing and Machine Sales Groups.
19
The decrease within the Precision Manufacturing Group resulted from lower production activity in the 2009 period. The lower production activity impacted gross margins as follow (as a percent of sales):
· | 9% increase resulting in underutilization of direct labor; |
· | 4% increase outside services; and |
· | 5% increase in direct overhead. |
Selling, General & Administrative
Selling, general and administrative costs decreased by $335,015 compared to the comparable period in fiscal 2008. The decrease was attributable to the elimination of management bonuses and other overheads due to lower production activity. During the 2008 period, management bonuses totaled approximately $171,600.
Impairment of Goodwill
During the fiscal 2009 period, we recorded an impairment charge for goodwill of $198,169 compared to $0 for the comparable period in fiscal 2008.
Interest Expense
Interest expense decreased by $6,655 compared to the comparable period in fiscal 2008. The change is attributable to lower average debt balances, and decreases in the variable interest rates on certain debt obligations, primarily our line of credit.
Gain on Sale of Assets
During the fiscal 2009 and 2008 periods, we recognized gains from the sale of assets as we sold certain manufacturing equipment within the Precision Manufacturing Group.
Income Tax Benefit
During the 2009 period, the effective tax benefit rate was 33%. The significant components contributing the decrease from our statutory tax rate included the non-deductibility of the impairment of goodwill; partially offset by timing differences for certain accrued liabilities which impacted the tax benefit rate by a decrease of 20% and an increase of 33%, respectively.
Results of Operation for the Nine Months Ended March 31, 2009 Compared to the Nine Months Ended March 31, 2008
Sales
Sales in the fiscal 2009 period decreased 25% from the comparable period in fiscal 2008. This change in sales results primarily from a decrease in sales in our Machine Tool Group, which declined, likely due to our customers having difficulty in obtaining credit and, therefore, being unable to purchase machines that they may have been able to purchase in better economic times.
During the second quarter of fiscal 2009 sales within both the Precision Manufacturing and Machine Sales Groups were adversely impacted. The decline within the Precision Manufacturing Group resulted from lower shipments to our single largest customer, Panasonic which we believe are due to the Boeing strike and the current economic climate which has resulted in delays in scheduled shipment of products.
20
During second quarter of 2009 period, the Machine Sales Group experienced lower unit sales due to the recent tightening of credit which made it more difficult for customers to obtain credit to purchase both new and used CNC machines.
Gross Margin
Gross profit decreased by 27% in the fiscal 2009 period from the comparable period in fiscal 2008. The decrease in the gross profit margin was attributable to a reduction in sales in both our Machine Tools and Precision Manufacturing Groups.
Selling, General & Administrative
Selling, general and administrative costs decreased by $123,020 compared to the comparable period in fiscal 2008. The decrease was primarily attributable to the elimination of management bonuses. During the 2008 period, management bonuses totaled approximately $171,600.
Impairment of Goodwill
During the fiscal 2009 period, we recorded an impairment charge for goodwill of $198,169 compared to $0 for the comparable period in fiscal 2008.
Interest Expense
Interest expense decreased by $14,169 compared to the comparable period in fiscal 2008. The change is attributable to lower average debt balances, and by decreases in the variable interest rates on certain debt obligations, primarily our line of credit.
Gain on Sale of Assets
During the fiscal 2009 and 2008 periods, we recognized gains from the sale of assets as we sold certain manufacturing equipment within the Precision Manufacturing Group.
Income Tax Benefit
During the 2009 and 2008 periods, the effective tax benefit rates were 31.5% and 41.6%. The significant components contributing the decrease from our statutory tax rate during the 2009 period included the non-deductibility of the impairment of goodwill; partially offset by timing differences for certain accrued liabilities.
Liquidity and Capital Resources
21
Our principal sources of liquidity consist of cash and cash equivalents, cash generated from operations and borrowing from various sources, including Joseph Gledhill, an executive officer of ours, and Pacific Western Bank (“PWB”). In addition, on February 23, 2007, we received net proceeds from the sale of our Precision Manufacturing Group’s facility of $1,926,605, of which $641,667 was used to repay the balance outstanding on a credit facility secured by the building. At March 31, 2009, our cash and cash equivalents decreased by $125,106 and our working capital decreased by $1,359,648 from the June 30, 2008 amounts, respectively.
At March 31, 2009, we had $897,778 in debt outstanding under our credit agreement with Pacific Western Bank, an increase of $31,839 from June 30, 2008. The credit agreement provides for borrowings of up to $1,500,000 consisting of a $1,000,000 line of credit and letter of credit and a $500,000 term loan and a letter of credit. The amount outstanding under the line of credit, term loan and letter of credit are $520,000, $277,778 and $100,000, respectively. The credit agreement is currently secured by substantially all of our assets and personal guarantees by two of our former executive officers, Joseph Gledhill and Timothy Consalvi.
The amount available for borrowings under the line of credit is determined on a monthly basis based on 80% of eligible accounts receivable, less the amount outstanding under the letter of credit, as defined. The term loan provides for borrowings of up to $500,000. The loan bears interest at the lender's referenced prime rate plus 1.5% with principal and interest payments due monthly. As of March 31, 2009, the balance outstanding under the line of credit exceeded the borrowing base amount by $90,508. On April 14, 2009, we repaid $80,000 to reduce the borrowing base amount. As of April 30, 2009, we were in compliance with our obligations under the borrowing base limit.
As of March 31, 2009, we also met the minimum tangible net worth covenant, as set forth in our credit agreement.
However, as of March 31, 2009, we are in breach of a covenant under the Pacific Western Bank loan agreement that relates to incurring losses in two consecutive quarters. We are currently negotiating with the Bank for a letter of forbearance, similar to what we have received for previous covenant breaches.
Cash Flows
The following table sets forth our cash flows for the nine months ended March 31:
Provided by (used in) | 2009 | 2008 | Change | |||||||||
Operating activities | $ | 364,751 | $ | 302,119 | $ | 62,632 | ||||||
Investing activities | $ | (53,373 | ) | $ | (302,933 | ) | $ | 249,560 | ||||
Financing activities | $ | (436,485 | ) | $ | 33,567 | $ | (470,052 | ) | ||||
$ | (125,106 | ) | $ | 32,753 | $ | (157,859 | ) |
Operating Activities
Operating cash flows during the fiscal 2008 and 2009 fiscal periods 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 2009 period, non-cash expenses included in our results of operations and in operating activities totaled $640,806 and $453,025 in the 2008 period. The increase was primarily to the impairment of goodwill charge during the 2009 period totaling $198,169.
22
The change in operating assets and liabilities for the 2009 and 2008 periods were $1,182,079 and $139,134, respectively. During the 2009 period, the increase in operating assets resulted from higher collections of accounts receivable, and lower inventory balances. The change in accounts receivable is lower sequential sales within both the Machine Sales and Precision Manufacturing segments while the change in inventory and accounts payable are due to the reduction of CNC machine inventory.
The changes in operating assets for the 2008 period were primarily attributable a reduction in accounts receivable, offset increases in inventory and customer deposits. The changes in inventory resulting purchases of CNC machines for customer deposits received and for forecasted demand.
Investing Activities
We made capital expenditures of $128,162 and $302,933 during the first nine months of the fiscal 2009 and 2008 periods, respectively. During the 2008 period, our expenditures primarily consisted of equipment employed by our Precision Manufacturing Group.
Financing Activities
During the first nine months of the fiscal 2009 and 2008 periods, we repaid (net of borrowings) $626,485 and $216,301, respectively of outstanding debt and capital lease obligations. During the 2009 period, we borrowed a total of $190,000 on our line of credit, as compared to $249,868 of net repayments during the 2008 period.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.
As a smaller reporting company we are not required to provide the information required by this Item. However, we opted to include the following information.
The only financial instruments we hold are cash and cash equivalents. We also have a floating interest rate credit agreement with Pacific Western Bank. Changes in market interest rates will impact our interest costs.
We are currently billed by the majority of our vendors in U.S. dollars and we currently bill the majority of our customers in U.S. dollars. However, our financial results could be affected by factors such as changes in foreign currency rates or changes in economic conditions.
ITEM 4T. Controls and Procedures.
Disclosure Controls and Procedures
23
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2009 in alerting them in a timely manner to material information required to be disclosed by us in the reports we file with or submit to the Securities and Exchange Commission under the Securities Exchange Act of 1934.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the third quarter of fiscal 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
24
PART II – OTHER INFORMATION
ITEM 1. Legal Proceedings.
1. Onofrio Saputo and Christopher Frisco v. Gateway International Holdings, Inc., Lawrence Consalvi, Timothy Consalvi and Joe Gledhill, Court of the State of California, County of Orange, Case No. 30-2008-00110905. Plaintiffs filed this action on August 21, 2008.
The Complaint, which had causes of action for securities fraud, breach of fiduciary duties, fraud and deceit, and rescission, alleged that the defendants intentionally misrepresented, or failed to disclose, certain facts regarding the company prior to the plaintiffs purchasing Gateway International Holdings, Inc. (now M Line Holdings, Inc.) common stock. The Complaint sought total monetary damages of approximately $188,415, plus interest, and punitive damages. The Company filed an Answer to the Complaint on October 17, 2008, denying the allegations of the Complaint, denying that plaintiffs are entitled to any relief whatsoever and asserting various affirmative defenses. A trial date has not yet been scheduled. No amounts have been accrued for this matter in the accompanying consolidated financial statements.
2. Voicu Belteu v. Mori Seiki Co., Ltd.; Mori Seiki U.S.A., Inc.; All American CNC Sales, Inc. dba Elite Machine Tool Company; Ellison Manufacturing Tech., Superior Court for the State of California, County of Orange, Case No. 30-2008-00103710. Plaintiff filed this action on March 7, 2008.
The Complaint, which has causes of action for strict products liability and negligence, alleges that a CNC machine manufactured by Mori Seiki and sold through our subsidiary, All American CNC Sales, Inc. dba Elite Machine Tool Company, was defective and injured the plaintiff. The Complaint seeks damages in excess of $6,300,000 for medical expenses, future medical expenses, lost wages, future lost wages and general damages. We have filed cross-complaints against several individuals and entities involved in the machine purchase and sales transaction, seeking indemnity, contribution, and damages based on other legal theories. We filed an Answer to the Complaint along with the various aforementioned cross-complaints.
Discovery has commenced in this action both by us and by some of the other parties but substantial discovery work remains, including depositions of various witnesses. Currently the parties are involved in the meet and confer process to resolve outstanding discovery issues. The Court has set a Case Management Conference for May 7, 2009. No trial date has been set. Management believes we have meritorious defenses to plaintiff’s claims and plan to vigorously defend against the lawsuit and pursue Mori Seiki, and possibly other entities or individuals, for any damages we incur. However, there can be no assurance as to the outcome of the lawsuit.
3. James M. Cassidy v. Gateway International Holdings, Inc., American Arbitration Association, Case No. 73-194-32755-08. We were served with a Demand for Arbitration and Statement of Claim, which was filed on September 16, 2008.
The Statement of Claim alleges that claimant is an attorney who performed services for us pursuant to an agreement dated April 2, 2007 between us and the claimant. The Statement of Claim alleges that we breached the agreement and seeks compensatory damages in the amount of $195,000 plus interest, attorneys’ fees and costs. We deny the allegations of the Statement of Claim and will vigorously defend against these allegations. An arbitrator has not yet been selected, and a trial date has not yet been scheduled. The parties have informally agreed to attend mediation in order to discuss a potential resolution of the matter, which should occur in the next 60 days. The parties have agreed to stay arbitration pending completion of mediation.
25
4. Elite Machine Tool Company v. ARAM Precision Tool and Die, Avi Amichai, Superior Court for the State of California, County of Orange, Case No. 30-2008-00090891. Elite Machine filed this action on August 8, 2008.
The Complaint alleges breach of contract for the defendants failing to pay Elite Machine for a machine the defendants purchased from Elite Machine, and seeks damages totaling $16,238. ARAM Precision Tool and Die filed its Answer and Cross-Complaint on October 1, 2008. The Cross-Complaint alleges that Elite Machine failed to deliver certain parts of the machine per the sales contract and seeks damages totaling $25,000. Plaintiff and Defendant have both served and responded to discovery, and are now preparing for trial, currently set for June 8, 2009.
5. RACL, Inc. v. All American CNC Sales, Inc., Elite Machine Tool Company/Sales & Services, CNC Repos, Superior Court for the State of California, County of Riverside, Case No. RIC 509650. Plaintiff filed this Complaint on October 2, 2008.
The Complaint alleges causes of action for breach of contract and rescission and claims All American breached the agreement with RACL by failing to deliver a machine that conforms to the specifications requested by RACL, and requests damages totaling $138,750. Elite Machine filed an Answer timely, on January 15, 2009. Discovery has commenced in this matter but is not expected to be concluded for several months. The Court has set a Case Management Conference for September 29, 2009. Management intends to aggressively defend itself against this claim. No trial date has been set.
6. All American CNC v. Sunbelt Machine, Orange County Superior Court, Case No. 0-2008-00112502. All American filed the Complaint on September 25, 2008. No trial date has been set.
This case involves a dispute between All American and Sunbelt regarding the sale of a Makino MC 98 HMC machine by All American to Sunbelt. Sunbelt has claimed that it received a machine that does not conform to the specifications it ordered. The amount at issue is approximately $140,000 at this stage. Subsequent to filing of the above-referenced suit, Sunbelt has filed a similar action in Federal District Court in Houston, Texas. All American plans to seek to transfer and consolidate the federal case into the State of California case in Orange County, California. Discovery has not commenced. All American anticipates substantial law and motion activity in this case prior to commencement of discovery. Management believes that the machine delivered to Sunbelt was conforming and Sunbelt’s claims are without merit. Management intends to vigorously defend this claim. The Court has scheduled a Case Management Conference for May 29, 2009.
Litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur in any of the above matters, there could be a material adverse effect on our financial condition, results of operations or liquidity.
ITEM 1A. Risk Factors.
As a smaller reporting company we are not required to provide the information required by this Item. However, we did include risk factors in our Annual Report on Form 10-K for the year ended June 30, 2008, as filed with the Commission on October 1, 2008.
26
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On March 25, 2009, we entered into an Assignment of Promissory Note and Consent Thereto (the “Assignment”) with Money Line Capital, Inc., a California corporation (“MLCI”), and our largest shareholder, under which MLCI agreed to assume our repayment obligations to Joseph Gledhill and Joyce Gledhill under that certain $650,000 principal amount Promissory Note dated December 8, 2008 (the “M Line Note”) in exchange for the issuance of 3,250,000 shares of our common stock, restricted in accordance with Rule 144 (the “Shares”). We expect to issue these shares in the near future. This issuance is exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, and MLCI is a sophisticated investor and familiar with our operations.
ITEM 3. Defaults upon Senior Securities.
On August 21, 2006, we entered into credit agreement with Pacific Western Bank (“PWB”). The credit agreement provides for borrowings of up to $1,500,000 through a line of credit. On November 15, 2007, the credit agreement was amended to reduce the amount available under the line of credit to $1,000,000 and to convert $500,000 of outstanding principal into a term loan. On September 29, 2008, we renewed the credit agreement through September 21, 2009. Two of our former officers and directors, Joseph Gledhill and Timothy Consalvi, are guarantors under the credit agreement.
The line of credit has a stated interest rate equal to the lender's referenced prime rate plus 1.5%. Interest is payable monthly with the outstanding principal balance due on September 21, 2009. The amount available for borrowings is determined based on a monthly basis based on 80% of eligible accounts receivable, as defined. As of March 31, 2009, we also have an irrevocable letter of credit outstanding of $100,000. The proceeds from the line of credit have been used for working capital needs.
The term loan provides for borrowings of up to $500,000. The loan has a stated interest rate equal to the lender's referenced prime rate plus 1.5%. Principal and interest payments are payable monthly.
The amount available for borrowings under the line of credit is determined on a monthly basis based on 80% of eligible accounts receivable, less the amount outstanding under the letter of credit, as defined. The term loan provides for borrowings of up to $500,000. The loan bears interest at the lender's referenced prime rate plus 1.5% with principal and interest payments due monthly. As of March 31, 2009, the balance outstanding under the line of credit exceeded the borrowing base amount by $90,508. On April 14, 2009, the Company repaid $80,000 to reduce the borrowing base amount. As of April 30, 2009, we were in compliance with our obligations under the borrowing base limit.
As of March 31, 2009, we met our minimum tangible net worth covenant, as set forth in the credit agreement.
However, as of March 31, 2009, we are in breach of a covenant under the Pacific Western Bank loan agreement that relates to losses in two consecutive quarters. We are currently negotiating with the Bank for a letter of forbearance, similar to what we have received for previous covenant breaches.
ITEM 4. Submission of Matters to a Vote of Security Holders.
There have been no events required to be reported under this Item.
ITEM 5. Other Information.
27
Departure of Directors and Officers
On December 8, 2008, three of our affiliate-shareholders, namely, Timothy D. Consalvi, our Chief Executive Officer and Director, Joseph Gledhill, an Executive Vice President, Director and 10% shareholder, and Lawrence A. Consalvi, a former officer and Director, and a 10% shareholder, entered into a Stock Purchase Agreement (the “Agreement”) with MLCI, under which MLCI agreed to purchase an aggregate of 11,850,000 shares of our common stock from these shareholders. The transaction closed December 9, 2008.
Pursuant to the Agreement, Mr. Timothy D. Consalvi and Mr. Joseph Gledhill submitted their resignations from our Board of Directors, effective when accepted by our Board of Directors. On March 25, 2009, our Board of Directors accepted Mr. Consalvi’s and Mr. Gledhill’s resignations. We are not aware of any disagreements with Mr. Consalvi or Mr. Gledhill of the type required to be disclosed per Item 5.02(a) of this Form 8-K.
On March 31, 2009, Stephen Kasprisin, one of our directors, submitted his resignation from our Board of Directors and from his position as our interim Chief Financial Officer. We are not aware of any disagreements with Mr. Kasprisin of the type required to be disclosed per Item 5.02(a) of this Form 8-K.
Appointment of Directors and Officers
On March 31, 2009, in response to Mr. Kasprisin’s resignation, we hired Jitu Banker as our Chief Financial Officer, and appointed Robert Sabahat to fill a vacancy on our Board of Directors. Mr. Sabahat was appointed to serve until our next Annual Meeting of Shareholders and thereafter and until his successor is elected and qualified.
Jitu Banker has been one of our Directors since January 2009, and is currently the President and Chief Financial Officer of Money Line Capital, Inc., our largest shareholder. Since 1990, Mr. Banker has also been the owner of Banker & Co., a company specializing in tax, accounting, Internal Revenue Service audits, and other related services. From 2004 to 2006, Mr. Banker was one of our Directors and our Chief Financial Officer. Mr. Banker has a Bachelor of Arts in Accounting with Economics and is a member of the Institute of Chartered Accountants in England and Wales, the Institute of Management Accountants in London, England, and the American Institute of Certified Public Accountants.
Mr. Sabahat is an owner and partner of Madison Harbor, a law firm located in Orange County, California. Mr. Sabahat has held this position since September 1999. In this position Mr. Sabahat has a practice focusing on real estate and commercial litigation involving contract and tort based claims, business transactions, commercial lease agreements, and unfair competition. From June 1995 to September 1999, Mr. Sabahat was Corporate Counsel for Unicorp Paper Industries, Inc., where he was responsible for all legal matters for the multinational manufacturer of commercial printing papers. Mr. Sabahat received his Juris Doctorate with honors from Western State University, College of Law in 1994.
Assignment of Gledhill Note
On March 25, 2009, we entered into an Assignment of Promissory Note and Consent Thereto (the “Assignment”) with Money Line Capital, Inc., a California corporation (“MLCI”), and our largest shareholder, under which MLCI agreed to assume our repayment obligations to Joseph Gledhill and Joyce Gledhill under that certain $650,000 principal amount Promissory Note dated December 8, 2008 (the “M Line Note”) in exchange for the issuance of 3,250,000 shares of our common stock (the “Shares”). Mr. Gledhill, one of our former directors, and Joyce Gledhill consented to the Assignment. Pursuant to the Assignment, MLCI and the Gledhill’s entered into a new $650,000 principal amount secured promissory note, a security agreement and a pledge agreement.
28
Money Line Demand Note
In a separate transaction, we entered into a Demand Promissory Note dated March 25, 2009 (the “Note”), evidencing the terms under which MLCI will loan us up to $500,000 on an “as needed” basis for working capital purposes. The Note accrues interest at a rate of 10% per annum. Under the terms of the Note, MLCI is not obligated to loan us any money, but the Note sets forth the terms in the event MLCI elects to loan us money for working capital purposes.
Annual Shareholders Meeting
We held our 2009 Annual Meeting of Shareholders on March 25, 2009, in Tustin, California. There were shareholders representing 14,941,334 votes present at the meeting, either in person or by proxy, which represented over 50% of the 27,611,956 total outstanding votes of the Company, so a quorum was present. The following agenda items set forth in the Company’s 14C Information Statement on file with the SEC, which had been pre-approved by the holders of a majority of our common stock, went effective on March 25, 2009:
1. The election of three (3) directors, namely George Colin, Stephen Kasprisin and Jitu Banker, to serve until the next Annual Meeting of Shareholders and thereafter until a successor is elected and qualified. All three nominees were directors prior to the meeting. This agenda item was pre-approved by a majority of our shareholders prior the meeting. The shares voting in favor of this agenda item were as follows:
Director | Votes For | Votes Against | Votes Withheld | Abstentions | Broker Non-Votes |
George Colin | 14,371,334 | -0- | -0- | -0- | -0- |
Stephen Kasprisin | 14,371,334 | -0- | -0- | -0- | -0- |
Jitu Banker | 14,371,334 | -0- | -0- | -0- | -0- |
2. An amendment to our Articles of Incorporation to change the name of the Company to M Line Holdings, Inc. This agenda item was pre-approved by a majority of our shareholders prior the meeting. The shares voting in favor of this agenda item were as follows:
Votes For | Votes Against | Votes Withheld | Abstentions | Broker Non-Votes |
14,371,334 | -0- | -0- | -0- | -0- |
3. The ratification of the appointment of Kabani & Company as independent auditors of the Company for the fiscal year ending June 30, 2009. Kabani & Company were approved as our independent auditors in place of McKennon Wilson & Morgan LLP, who were removed by our Board of Directors on March 16, 2009, prior to the meeting. The results of the voting were as follows:
Votes For | Votes Against | Votes Withheld | Abstentions | Broker Non-Votes |
14,371,334 | -0- | -0- | -0- | -0- |
29
A more detailed description of each agenda item at the 2009 Annual Shareholders Meeting can be found in our Schedule 14C Information Statement dated and filed with the Securities and Exchange Commission on February 25, 2009.
ITEM 6. Exhibits.
(a) Exhibits
Item No. | Description | |
3.1 (1) | Articles of Incorporation of M Line Holdings, Inc., a Nevada corporation, as amended | |
3.2 (5) | Certificate of Amendment of Articles of Incorporation | |
3.3 (1) | Bylaws of M Line Holdings, Inc., a Nevada corporation | |
10.1 (1) | Asset Purchase Agreement with CNC Repos, Inc. and certain of its shareholders dated October 1, 2007 | |
10.2 (1) | Commercial Real Estate Lease dated February 15, 2007 for the office space located in Tustin, CA | |
10.3 (1) | Commercial Real Estate Lease dated November 15, 2007 for the office space located in Anaheim, CA | |
10.4 (1) | Employment Agreement with Timothy D. Consalvi dated February 1, 2007 | |
10.5 (1) | Employment Agreement with Joseph T.W. Gledhill dated February 5, 2007 | |
10.6 (2) | Employment Agreement with Lawrence A. Consalvi dated February 5, 2007 | |
10.7 (1) | Share Exchange Agreement with Gledhill/Lyons, Inc. dated March 26, 2007 | |
10.8 (1) | Share Exchange Agreement with Nu-Tech Industrial Sales, Inc. dated March 19, 2007 | |
10.9 (1) | Fee Agreement with Steve Kasprisin dated April 30, 2008 | |
10.10 (3) | Separation Agreement by and between Gateway International Holdings, Inc., and Mr. Lawrence A. Consalvi dated September 26, 2008 | |
10.11 (4) | Sales Agent Agreement by and between Gateway International Holdings, Inc., and Mr. Lawrence A. Consalvi dated September 30, 2008 | |
10.12 (4) | Loan Agreements with Pacific Western Bank dated September 20, 2008 | |
10.13 (5) | Assignment of Promissory Note and Consent Thereto by and between M Line Holdings, Inc. and Money Line Capital, Inc. dated March 24, 2009 | |
10.14 (5) | M Line Holdings, Inc. Demand Note for up to $500,000 dated March 25, 2009 | |
21 (1) | List of Subsidiaries |
30
31.1 | Rule 13a-14(a)/15d-14(a) Certification of Timothy D. Consalvi (filed herewith). | |
31.2 | Rule 13a-14(a)/15d-14(a) Certification of Steve Kasprisin (filed herewith). | |
32.1 | Section 1350 Certification of Timothy D. Consalvi (filed herewith). | |
32.2 | Section 1350 Certification of Steve Kasprisin (filed herewith). |
(1) Incorporated by reference from our Registration Statement on Form 10-12G filed with the Commission on May 16, 2008.
(2) Incorporated by reference from our Registration Statement on First Amended Form 10-12G/A filed with the Commission on July 16, 2008.
(3) Incorporated by reference from our First Amended Current Report on Form 8-K/A filed with the Commission on October 10, 2008.
(4) Incorporated by reference from our Quarterly Report on Form 10-Q for the period ended September 30, 2008, as filed with the Commission on November 13, 2008.
(5) Incorporated by reference from our Current Report on Form 8-K filed with the Commission on April 24, 2009.
31
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MM Line Holdings, Inc. | ||
Dated: May 18, 2009 | /s/ George Colin | |
By: | George Colin | |
President, Chief Executive | ||
Officer and a Director | ||
Dated: May 18, 2009 | /s/ Jitu Banker | |
By: | Jitu Banker | |
Chief Financial Officer, | ||
Secretary and a Director | ||
32