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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ____ to ____
______________________
Commission File No. 0-12942
PARLEX CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Massachusetts 04-2464749
------------------------ -----------
(State of incorporation) (I.R.S. ID)
One Parlex Place, Methuen, Massachusetts 01844
(Address of Principal Executive Offices) (Zip Code)
978-685-4341
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of
February 8, 2005 was 6,462,179 shares.
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PARLEX CORPORATION
------------------
FORM 10 - Q
-----------
INDEX
-----
Part I - Financial Information Page
----
Item 1. Unaudited Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets - December 31, 2004 and June 30, 2004 3
Condensed Consolidated Statements of Operations - For the Three and Six
Months Ended December 31, 2004 and December 28, 2003 4
Condensed Consolidated Statements of Cash Flows - For the Six Months Ended
December 31, 2004 and December 28, 2003 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 39
Item 4. Controls and Procedures 40
Part II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders 42
Item 6. Exhibits 42
Signatures 43
Exhibit Index 44
2
PARLEX CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
- ---------------------------------------------------------------------------
ASSETS December 31, 2004 June 30, 2004
CURRENT ASSETS:
Cash and cash equivalents $ 3,419,381 $ 1,626,275
Accounts receivable - net 23,067,200 21,999,646
Inventories - net 23,469,839 20,326,134
Refundable income taxes 13,287 380,615
Deferred income taxes 42,958 42,958
Other current assets 1,830,998 2,381,471
------------ ------------
Total current assets 51,843,663 46,757,099
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - NET 43,354,190 44,979,740
INTANGIBLE ASSETS - NET 31,282 32,746
GOODWILL - NET 1,157,510 1,157,510
DEFERRED INCOME TAXES 40,000 40,000
OTHER ASSETS - NET 2,006,536 2,283,136
------------ ------------
TOTAL $ 98,433,181 $ 95,250,231
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 14,018,356 $ 12,861,077
Accounts payable 19,250,749 16,479,547
Dividends payable 67,582 39,317
Accrued liabilities 5,317,526 4,277,587
------------ ------------
Total current liabilities 38,654,213 33,657,528
------------ ------------
LONG-TERM DEBT 10,638,069 10,534,679
------------ ------------
OTHER NONCURRENT LIABILITIES 876,841 1,025,091
------------ ------------
MINORITY INTEREST IN PARLEX SHANGHAI 651,861 570,963
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock 40,625 40,625
Common stock 644,905 663,281
Accrued interest payable in common stock 98,029 87,924
Additional paid-in capital 65,981,409 66,979,397
Accumulated deficit (20,017,719) (17,771,307)
Accumulated other comprehensive income 864,948 499,675
Less treasury stock, at cost - (1,037,625)
------------ ------------
Total stockholders' equity 47,612,197 49,461,970
------------ ------------
TOTAL $ 98,433,181 $ 95,250,231
============ ============
See notes to unaudited condensed consolidated financial statements.
3
PARLEX CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
- ---------------------------------------------------------------------------
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
----------------- ----------------- ----------------- ------------------
REVENUES: $30,203,361 $23,559,093 $61,690,767 $43,263,524
----------- ----------- ----------- ------------
COSTS AND EXPENSES:
Cost of products sold 26,198,282 20,817,086 53,024,771 38,277,807
Selling, general and administrative expenses 4,610,337 3,959,374 9,218,985 7,699,740
----------- ----------- ----------- ------------
Total costs and expenses 30,808,619 24,776,460 62,243,756 45,977,547
----------- ----------- ----------- ------------
OPERATING LOSS (605,258) (1,217,367) (552,989) (2,714,023)
INTEREST INCOME (EXPENSE)
Interest income 33,507 2,427 39,868 7,021
Interest expense (772,337) (664,855) (1,536,687) (1,197,505)
----------- ----------- ----------- ------------
LOSS BEFORE INCOME TAXES AND MINORITY INTEREST (1,344,088) (1,879,795) (2,049,808) (3,904,507)
PROVISION FOR INCOME TAXES (62,850) - (115,706) -
----------- ----------- ----------- ------------
LOSS BEFORE MINORITY INTEREST (1,406,938) (1,879,795) (2,165,514) (3,904,507)
MINORITY INTEREST (40,747) (47,439) (80,898) (109,758)
----------- ----------- ----------- ------------
NET LOSS (1,447,685) (1,927,234) (2,246,412) (4,014,265)
PREFERRED STOCK DIVIDENDS (67,582) - (135,164) -
----------- ----------- ----------- ------------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $(1,515,267) $(1,927,234) $(2,381,576) $(4,014,265)
=========== =========== =========== ===========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.23) $ (0.30) $ (0.37) $ (0.63)
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 6,449,056 6,331,148 6,442,495 6,321,734
=========== =========== =========== ===========
See notes to unaudited condensed consolidated financial statements.
4
PARLEX CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
- ---------------------------------------------------------------------------
Six Months Ended
December 31, 2004 December 28, 2003
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,246,412) $ (4,014,265)
------------ ------------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Non-cash operating items:
Depreciation of property, plant and equipment 2,625,444 2,724,925
Amortization of deferred loss on sale-leaseback,
deferred financing costs and intangible assets 579,637 479,891
Interest payable in common stock 166,532 174,898
Minority interest 80,898 109,758
Gain on sale of China land use rights - (86,531)
Changes in current assets and liabilities:
Accounts receivable - net (948,405) (4,475,237)
Inventories - net (3,030,508) (2,651,412)
Refundable income taxes 367,328 144,776
Other assets 561,809 (378,917)
Accounts payable and accrued liabilities 2,140,696 112,729
------------ ------------
Net cash provided by (used in) operating activities 297,019 (7,859,385)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of China land use rights - 1,179,145
Additions to property, plant and equipment and other assets (431,278) (208,314)
------------ ------------
Net cash (used in) provided by investing activities (431,278) 970,831
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of warrants - 600,000
Proceeds from bank loans 49,084,779 24,352,824
Payment of bank loans (47,980,145) (23,370,212)
Payment of capital lease (53,036) -
Payment of Methuen sale-leaseback financing obligation (121,939) (151,440)
Cash received for interest on sale-leaseback note receivable 60,750 66,252
Dividend paid to series A preferred stock investors (106,900) -
Receipt of joint venture deposit 1,000,000 -
Proceeds from convertible note, net of costs - 5,480,416
------------ ------------
Net cash provided by financing activities 1,883,509 6,977,840
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 43,856 11,341
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,793,106 100,627
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,626,275 1,513,523
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,419,381 $ 1,614,150
============ ============
SUPPLEMENTARY DISCLOSURE OF NONCASH FINANCING AND
INVESTING ACTIVITIES:
Property, plant, equipment and other asset purchases financed
under capital lease, long-term debt and accounts payable $ 468,795 $ 549,913
============ ============
Issuance of warrants in connection with issuance of convertible debt $ - $ 1,139,252
============ ============
Beneficial conversion feature associated with convertible debt $ - $ 1,035,016
============ ============
Interest paid in common stock $ 156,426 $ 73,195
============ ============
See notes to unaudited condensed consolidated financial statements.
5
PARLEX CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------------------------------------------------------------
1. Basis of Presentation
---------------------
The condensed consolidated financial statements include the accounts
of Parlex Corporation, its wholly owned subsidiaries ("Parlex" or the
"Company") and its 90.1% investment in Parlex (Shanghai) Circuit Co.,
Ltd. ("Parlex Shanghai"). The financial statements as reported in
Form 10-Q reflect all adjustments that are, in the opinion of
management, necessary to present fairly the financial position as of
December 31, 2004 and the results of operations and cash flows for
the three and six months ended December 31, 2004 and December 28,
2003. All adjustments made to the interim financial statements
included all those of a normal and recurring nature. The results for
interim periods are not necessarily indicative of results that may be
expected for any other interim period or for the full year.
This filing should be read in conjunction with the Company's annual
report on Form 10-K for the year ended June 30, 2004.
As shown in the consolidated financial statements, the Company
incurred net losses of $2,246,412 and $4,014,265 and provided
$297,019 of cash from operations and used $7,859,385 in operations
for the six months ended December 31, 2004 and December 28, 2003,
respectively. In addition, the Company had an accumulated deficit of
$20,017,719 at December 31, 2004. As of December 31, 2004, the
Company had a cash balance of $3,419,381.
In response to the worldwide downturn in the electronics industry,
management has taken a series of actions to reduce operating expenses
and to restructure operations, consisting primarily of reductions in
workforce and consolidation of manufacturing operations. During 2004,
the Company transferred its high volume automated surface mount
assembly line from its Cranston, Rhode Island facility to China. In
August 2004, the Company announced a new strategic relationship with
Delphi Corporation to supply all multilayer flex and rigid flex
circuits that were previously manufactured by Delphi Corporation in
its Irvine, California facility. Management continues to implement
plans to control operating expenses, inventory levels, and capital
expenditures as well as manage accounts payable and accounts
receivable to enhance cash flow and return the Company to
profitability. Management's plans include the following actions: 1)
continuing to consolidate manufacturing facilities; 2) continuing to
transfer certain manufacturing processes from the Company's domestic
operations to lower cost international manufacturing locations,
primarily those in the People's Republic of China; 3) expanding the
Company's products in the home appliance, cell phone and handheld
devices, medical, military and aerospace, and electronic
identification markets; 4) continuing to monitor general and
administrative expenses; and 5) continuing to evaluate opportunities
to improve capacity utilization by either acquiring multilayer
flexible circuit businesses or entering into strategic relationships
for their production.
In fiscal years 2003 and 2004, management entered into a series of
alternative financing arrangements to partially replace or supplement
those currently in place in order to provide the Company with
financing to support its current working capital needs. Working
capital requirements, particularly those to support the growth in the
Company's China operations, consumed $10.4 million of a total $11.4
million of cash used in operations during 2004. In September 2004,
the Company secured a new $5 million asset based working capital
agreement with the Bank of China which provides standalone financing
for its China operations. In addition, in May and June of 2004 the
Company received net proceeds of approximately $2.95 million from the
sale of its Series A convertible preferred stock. In December 2004,
the Company entered into a joint venture agreement and related
agreements with Infineon Technologies Asia Pacific Pte Ltd. The
Company received a $1.0 million deposit upon execution of the
agreements, and will receive an additional $2.0 million once certain
People's Republic of China government approvals are received for the
new joint
6
venture company and the transaction closes. Also in December 2004,
the Company executed a loan modification with Silicon Valley Bank
("SVB") extending the term of its loan agreement with SVB to July
2006 and increasing the borrowing limit from $10.0 million to
$12.0 million. During the first six months of fiscal 2005, the
Company generated cash flow from operations of approximately
$297,000. Management continues to evaluate alternative financing
opportunities to further improve its liquidity and to fund working
capital needs. Management believes that the Company's cash on hand
and the cash expected to be generated from operations will be
sufficient to enable the Company to meet its operating obligations at
least through December 2005. If the Company requires additional or
new external financing to repay or refinance its existing financing
obligations or fund its working capital requirements, the Company
believes that it will be able to obtain such financing. Failure to
obtain such financing may have a material adverse impact on the
Company's operations. At December 31, 2004, the Company was in
compliance, and expects to remain in compliance, with all of its
financial covenants associated with its financing arrangements.
2. Inventories
-----------
Inventories of raw materials are stated at the lower of cost (first-
in, first-out) or market. Work in process and finished goods are
valued as a percentage of completed cost, not in excess of net
realizable value. Raw material, work in process and finished goods
inventory associated with programs cancelled by customers are fully
reserved for as obsolete. Reductions in obsolescence reserves are
recognized when the underlying products are disposed of or sold.
Inventories consisted of:
December 31, June 30,
2004 2004
Raw materials $10,763,777 $ 8,729,132
Work in process 10,621,432 9,444,722
Finished goods 4,943,151 5,049,796
----------- -----------
Total cost 26,328,360 23,223,650
Reserve for obsolescence (2,858,521) (2,897,516)
----------- -----------
Inventory, net $23,469,839 $20,326,134
=========== ===========
3. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost and are depreciated
using the straight-line method over their estimated useful lives.
Property, plant and equipment consisted of:
December 31, June 30,
2004 2004
Land and land improvements $ 589,872 $ 589,872
Buildings 18,543,295 18,543,295
Machinery and equipment 63,274,258 64,348,226
Leasehold improvements and other 6,923,327 6,695,173
Construction in progress 4,381,548 2,902,141
------------ ------------
Total cost 93,712,300 93,078,707
Less: accumulated depreciation (50,358,110) (48,098,967)
------------ ------------
Property, plant and equipment, net $ 43,354,190 $ 44,979,740
============ ============
7
4. Intangible Assets
-----------------
Intangible assets consisted of:
December 31, June 30,
2004 2004
Patents $ 58,560 $ 58,560
Accumulated amortization (27,278) (25,814)
-------- --------
Intangible assets, net $ 31,282 $ 32,746
======== ========
The Company has reassessed the remaining useful lives of the
intangible assets at December 31, 2004 and determined the useful
lives are appropriate in determining amortization expense.
Amortization expense for the six months ended December 31, 2004 and
December 28, 2003 was $1,464 and $3,181, respectively.
5. Other Assets
------------
Other assets consisted of:
December 31, June 30,
2004 2004
Deferred loss on sale-leaseback of Poly-Flex Facility, net $ 950,224 $1,087,606
Deferred financing costs on sale-leaseback of Methuen facility (see Note 7) 361,700 361,700
Deferred financing costs on the Loan and Security Agreement (see Note 7) 325,847 267,722
Deferred financing costs on Convertible Subordinated Note (see Note 7) 673,930 673,930
Other 146,808 160,650
---------- ----------
Total cost 2,458,509 2,551,608
Less: accumulated amortization (451,973) (268,472)
---------- ----------
Total Other Assets, net $2,006,536 $2,283,136
========== ==========
In June 2003, Poly-Flex sold its operating facility in Cranston,
Rhode Island for a total purchase price of $3,000,000 in cash. Under
the terms of the Purchase and Sale Agreement, Poly-Flex entered into
a five-year lease of the Poly-Flex Facility with the buyer. The
Company did not record an immediate loss on the transaction since the
fair value of the Poly-Flex Facility exceeded the net book value of
the facility at the time of sale. However, approximately $1,374,000
of excess net book value over the sales price was recorded as a
deferred loss and included in Other Assets - Net on the condensed
consolidated balance sheets. The deferred loss is being amortized to
lease expense over the five-year lease term. Amortization of the
deferred loss, reported as a component of rent expense, was $137,000
for the six months ended December 31, 2004 and December 28, 2003.
Amortization of deferred financing costs was $184,000 and $127,000
for the six months ended December 31, 2004 and December 28, 2003,
respectively.
8
6. Accrued Liabilities - Facility Exit Costs
-----------------------------------------
The following is a summary of the facility exit costs activity during
the three months ended December 31, 2004:
Facility Facility
Exit Costs FY2005 Activity Exit Costs
Accrued Cash Accrued
June 30, 2004 Payments December 31, 2004
------------- --------------- -----------------
Total facility refurbishment costs $136,952 $(1,500) $135,452
The remaining accrued facility exit costs at December 31, 2004
represent the estimated costs to refurbish the facility. The Company
expects the balance of accrued facility exit costs at December 31,
2004 to be paid by the end of fiscal 2005.
7. Long-term Debt
--------------
Long-term debt consisted of:
December 31, June 30,
2004 2004
Loan and Security Agreement $ 5,942,456 $ 3,618,091
Parlex Shanghai term notes 7,058,449 8,870,792
Parlex Interconnect term note 604,120 -
Finance obligation on sale-leaseback of Methuen Facility 5,848,055 5,909,245
Convertible Subordinated Note 4,663,105 4,404,351
Other 540,240 593,277
----------- -----------
Total long-term debt 24,656,425 23,395,756
Less: current portion of long-term debt 14,018,356 12,861,077
----------- -----------
Long-term debt $10,638,069 $10,534,679
=========== ===========
A summary of the current portion of our long term debt described
above is as follows:
December 31, June 30,
2004 2004
Loan and Security Agreement $ 5,942,456 $ 3,618,091
Parlex Shanghai term notes 7,058,449 8,870,792
Parlex Interconnect term note 604,120 -
Finance obligation on sale-leaseback of Methuen Facility 300,345 263,849
Other 112,986 108,345
----------- -----------
Total current portion of long-term debt $14,018,356 $12,861,077
=========== ===========
Loan and Security Agreement ("the Loan Agreement") - The Company
executed the Loan Agreement with Silicon Valley Bank on June 11,
2003, and since such date has entered into seven amendments to the
Loan Agreement. The Loan Agreement provided Silicon Valley Bank with
a secured interest in
9
substantially all of the Company's assets. The Company may borrow up
to $12.0 million based on a borrowing base of eligible accounts
receivable. Borrowings may be used for working capital purposes only.
The Loan Agreement allows the Company to issue letters of credit,
enter into foreign exchange forward contracts and incur obligations
using the bank's cash management services up to an aggregate limit of
$1.0 million, which reduces the Company's availability for borrowings
under the Loan Agreement. As of December 31, 2004, the Company had a
$1.0 million letter of credit outstanding. The Loan Agreement
contains certain restrictive covenants, including but not limited to,
limitations on debt incurred by its foreign subsidiaries,
acquisitions, sales and transfers of assets, and prohibitions against
cash dividends, mergers and repurchases of stock without prior bank
approval. The Loan Agreement also has financial covenants, which
among other things require the Company to maintain $750,000 in
minimum cash balances or excess availability under the Loan
Agreement.
On September 23, 2003, the Company executed a Modification Agreement
(the "Modification Agreement") with Silicon Valley Bank. The
Modification Agreement increased the interest rate on borrowings to
the bank's prime rate plus 1.5% and amended the financial covenants.
On February 18, 2004, the Company executed a Second Modification
Agreement (the "Second Modification Agreement") with Silicon Valley
Bank. The Second Modification Agreement removed the fixed charge
coverage ratio from the Loan Agreement and required the Company to
report earnings before income taxes, depreciation and amortization
("EBITDA") of at least $50,000 on a three month trailing basis,
beginning January 31, 2004. The minimum EBITDA requirement was
increased to $250,000 at June 30, 2004. The Second Modification
Agreement increased the interest rate on borrowings to the bank's
prime rate plus 2.0% (decreasing to prime plus 1.25% after two
consecutive quarters of positive operating income and to prime plus
0.75% after two consecutive quarters of positive net income,
respectively) and amended the financial covenants. On March 28, 2004,
the Company entered into a Third Loan Modification Agreement with
Silicon Valley Bank, which permitted certain of the Company's
subsidiaries to increase the amount of indebtedness they could incur
from $8 million to $13 million, so long as such indebtedness was
without recourse to Parlex and its principal subsidiaries. On May 10,
2004, the Company executed a Fourth Loan Modification Agreement (the
"Fourth Modification Agreement") with Silicon Valley Bank. The Fourth
Modification Agreement changed the EBITDA requirement to $1.00 as of
April 30, 2004 and May 31, 2004 and $250,000 on a three month
trailing basis beginning June 30, 2004. On June 25, 2004, the Company
executed a Fifth Loan Modification Agreement (the "Fifth Modification
Agreement") with Silicon Valley Bank. The Fifth Modification
Agreement permitted certain of the Company's subsidiaries to borrow
up to $5.0 million in the aggregate from the Bank of China. The Fifth
Modification Agreement increased the interest rate on borrowings to
the bank's prime rate plus 2.25% (decreasing to prime plus 1.25%
after two consecutive quarters of positive operating income and to
prime plus 0.75% after two consecutive quarters of positive net
income, respectively). On September 24, 2004, the Company executed a
Sixth Loan Modification Agreement with Silicon Valley Bank to extend
the maturity date of the Loan Agreement from June 10, 2005 to July
11, 2005. On December 22, 2004, the Company executed a Seventh Loan
Modification Agreement (the "Seventh Modification Agreement") with
Silicon Valley Bank. The Seventh Modification Agreement increased the
Company's maximum borrowings to $12.0 million based upon a borrowing
base of eligible accounts receivable plus the lesser of 20% of
eligible inventory or $1,000,000. The Seventh Modification Agreement
reduced the interest rate on borrowings to the bank's prime rate
(5.25% at December 31, 2004) plus 2.00% (decreasing to prime plus
1.25% after two consecutive quarters of positive operating income and
to prime plus 0.50% after two consecutive quarters of positive net
income, respectively). The Seventh Modification Agreement changed the
EBITDA requirement to $500,000 on a three month trailing basis
beginning December 31, 2004 and to $750,000 on a three month trailing
basis beginning June 30, 2005. The Seventh Modification Agreement
extends the maturity date of the Loan Agreement from July 11, 2005 to
July 11, 2006. As of December 31, 2004, the Company was in compliance
with its financial covenants. At December 31, 2004, the Company had
available borrowing capacity under the Loan Agreement of
approximately $2.8 million. As the available borrowing capacity
exceeded $750,000 at December 31, 2004, none of the Company's cash
balance was subject to restriction at December 31, 2004.
10
The Loan Agreement includes both a subjective acceleration clause and
a lockbox arrangement that requires all lockbox receipts to be used
to pay down the revolving credit borrowings. Accordingly, borrowings
under the Loan Agreement are classified as current liabilities in the
accompanying consolidated balance sheets as of December 31, 2004 and
June 30, 2004 as required by Emerging Issues Task Force Issue No. 95-
22, " Balance Sheet Classification of Borrowings Outstanding Under
Revolving Credit Agreements that include both a Subjective
Acceleration Clause and a Lockbox Arrangement". However, such
borrowings will be excluded from current liabilities in future
periods and considered long-term obligations if: 1) such borrowings
are refinanced on a long-term basis, 2) the subjective acceleration
terms of the Loan Agreement are modified, or 3) such borrowings will
not require the use of working capital within one year.
Parlex Shanghai Term Notes - On December 15, 2003, Parlex Shanghai
entered in to a short-term bank note for $605,000, due December 15,
2004, bearing interest at 5.31% and guaranteed by Parlex
Interconnect. The note was repaid on December 14, 2005. On March 2,
2004, Parlex Shanghai entered into a short-term bank note, due March
1, 2005, bearing interest at 5.31% and guaranteed by Parlex
Interconnect. Amounts outstanding as of December 31, 2004 total $2.5
million. In January 2005, Parlex Shanghai renewed a bank note bearing
interest at LIBOR plus 2.5% and guaranteed by the Company's
subsidiary Parlex Asia Pacific Ltd., ("Parlex Asia"). Amounts
outstanding under this note, due February 28, 2005, as of December
31, 2004 total $1.5 million. On October 11, 2004, Parlex Shanghai
renewed a bank note bearing interest at 5.31%, which is guaranteed by
Parlex Interconnect. Amounts outstanding under this short-term bank
note due April 13, 2005 totaled $725,000 as of December 31, 2004. On
November 11, 2004, Parlex Shanghai renewed a bank note that was due
on November 10, 2004. The short-term note bearing interest at 5.58%,
due June 30, 2005 is guaranteed by Parlex Interconnect. Amounts
outstanding as of December 31, 2004 total $1.0 million. On November
24, 2004, Parlex Shanghai renewed a bank note due January 12, 2005.
The short-term note bearing interest at 5.58%, due June 30, 2005 is
guaranteed by Parlex Interconnect. Amounts outstanding as of December
31, 2004 total $1.3 million. The Company believes that it will be
able to obtain the necessary refinancing of its Parlex Shanghai
short-term debt because of the Company's history of successfully
refinancing its short term Chinese borrowings and its rapidly
improving Chinese operating results.
Parlex Interconnect Term Notes - On October 28, 2004, Parlex
Interconnect entered into a $605,000 short-term bank note, due October
27, 2005, bearing interest at 5.31% and guaranteed by Parlex Shanghai.
Parlex Asia Banking Facility - On September 15, 2004, Parlex Asia
entered into an agreement with the Bank of China for a $5 million
banking facility guaranteed by Parlex. Under the terms of the banking
facility, Parlex Asia may borrow up to $5 million based on a
borrowing base of eligible account receivables. The banking facility
bears interest at LIBOR plus 2.00%. The Company anticipates utilizing
borrowings from this financing for the refinancing of certain Parlex
Shanghai term notes or for working capital needs.
Finance Obligation on Sale Leaseback of Methuen Facility - In June
2003, Parlex entered into a sale-leaseback transaction pursuant to
which it sold its corporate headquarters and manufacturing facility
located in Methuen, Massachusetts (the "Methuen Facility") for a
purchase price of $9.0 million. The purchase price consisted of $5.35
million in cash at the closing, a promissory note in the amount of
$2.65 million (the "Note") and up to $1.0 million in additional cash
under the terms of an Earn Out Clause. In June 2004, Parlex received
$750,000 reducing the principal balance of the promissory note to
$1.9 million. In connection with the transaction, Parlex
simultaneously entered into a lease agreement relating to the Methuen
Facility with a minimum lease term of 15 years.
As the repurchase option contained in the lease and the receipt of
the Note from the buyer provide Parlex with a continuing involvement
in the Methuen Facility, Parlex has accounted for the sale-leaseback
of the Methuen Facility as a financing transaction. Accordingly, the
Company continues to report the Methuen Facility as an asset and
continues to record depreciation expense. The Company records all
cash received
11
under the transaction as a finance obligation. The Note and related
interest thereon, and the $1.0 million in additional cash under the
terms of an Earn Out Clause, will be recorded as an increase to the
finance obligation as cash payments are received. The Company records
the principal portion of the monthly lease payments as a reduction to
the finance obligation and the interest portion of the monthly lease
payments is recorded as interest expense. The closing costs for the
transaction have been capitalized and are being amortized as interest
expense over the initial 15-year lease term. Upon expiration of the
repurchase option (June 30, 2015), the Company will reevaluate its
accounting to determine whether a gain or loss should be recorded on
this sale-leaseback transaction.
Convertible Subordinated Notes - On July 28, 2003, Parlex sold an
aggregate $6.0 million of its 7% convertible subordinated notes (the
"Notes") with attached warrants to several institutional investors.
The Company received net proceeds of approximately $5.5 million from
the transaction, after deducting approximately $500,000 in finders'
fees and other transaction expenses. Net proceeds were used to pay
down amounts borrowed under the Company's Loan Agreement and utilized
for working capital needs. No principal payments are due until
maturity on July 28, 2007. The Notes are unsecured.
The Notes bear interest at a fixed rate of 7%, payable quarterly in
shares of Parlex common stock. The number of shares of common stock
to be issued is calculated by dividing the accrued quarterly interest
by a conversion price, which was initially established at $8.00 per
share. The conversion price is subject to adjustment in the event of
stock splits, dividends and certain combinations.
Interest expense is recorded quarterly based on the fair value of the
common shares issued. Accordingly, interest expense may fluctuate
from quarter to quarter. The Company has concluded that the interest
feature does not constitute an embedded derivative as it does not
currently meet the criteria for classification as a derivative.
The Company recorded accrued interest payable on the Notes of $98,029
within stockholders' equity at December 31, 2004, as the interest is
required to be paid quarterly in the form of common stock. Based on
the conversion price of $8.00 per common share, the Company issued a
total of 61,840 shares of common stock from October 2003 to October
2004 in satisfaction of previously recorded interest and issued
13,123 shares of common stock in January 2005 as payment for the
interest accrued at December 31, 2004.
The Notes contain a beneficial conversion feature reflecting an
effective initial conversion price that was less than the fair market
value of the underlying common stock on July 28, 2003. The fair value
of the beneficial conversion feature was approximately $1.035
million, which has been recorded as an increase to additional paid-in
capital and as an original issue discount on the Notes that is being
amortized to interest expense over the four year life of the Notes.
After two years from the date of issuance, the Company has the right
to redeem all, but not less than all, of the Notes at 100% of the
remaining principal of Notes then outstanding, plus all accrued and
unpaid interest, under certain conditions. After three years from the
date of issuance, the holder of any of the Notes may require the
Company to redeem the Notes in whole, but not in part. Such
redemption shall be at 100% of the remaining principal of such Notes,
plus all accrued and unpaid interest. In the event of a Change in
Control (as defined therein), the holder has the option to require
that the Notes be redeemed in whole (but not in part), at 120% of the
outstanding unpaid principal amount, plus all unpaid accrued
interest.
8. Stockholders' Equity
--------------------
Series A Convertible Preferred Stock - On May 7, 2004 and June 8,
2004, the Company completed a private placement of 40,625 shares of
Series A Convertible Preferred Stock (the "Series A Preferred Stock")
and warrants entitling holders to purchase 203,125 shares of common
stock at $80.00 per unit for proceeds of approximately $2.95 million,
net of issuance costs of approximately $300,000. In connection with
the
12
private placement, investors received rights to purchase additional
shares of the Series A Preferred Stock (the "Over-Allotment Right").
The warrants are exercisable immediately at an exercise price of
$8.00 per share (subject to adjustment for certain dilutive events)
and expire on May 7, 2007 and June 8, 2007. The Over-Allotment Right,
which has now expired, allowed each investor to purchase additional
shares of Series A Preferred Stock in an amount up to 20% of the
original purchase and on the same terms as the original purchase.
The Series A Preferred Stock is redeemable at the option of the
Company on the third anniversary of the closing, upon 30 days notice
to the holders, in whole but not in part, at $80.00 per share
(subject to adjustment for certain dilutive events) together with all
accrued but unpaid dividends to the redemption date. The Series A
Preferred Stockholders have no voting rights, except with respect to
certain limited matters that directly impact the Series A Preferred
Stock.
Each share of Series A Preferred Stock is only convertible into 10
shares of common stock at the option of the holder at any time, until
20 days following the date on which the Company first mails its
notice of redemption, if any. The initial conversion price of $8.00
is adjusted for certain dilutive events. The Series A Preferred Stock
is subject to mandatory conversion if the Company's common stock
price closes above $12.00 per share for twenty (20) consecutive
trading days.
The Series A Preferred Stock is entitled to receive cumulative
dividends at an annual rate of 8.25% ($6.60 per share), payable
quarterly in cash or shares of common stock or a combination of cash
and stock at the election of the Company. In the event the Company
does not exercise its right to redeem the Series A Preferred Stock on
the third anniversary, the dividend rate shall increase to 14%
($11.20 per share) per annum payable quarterly exclusively in cash.
The Preferred Stock also entitles the holders thereof to a
preferential payment in the event of the Company's voluntary or
involuntary liquidation, dissolution or winding up. Specifically, in
any such case, the holders of Preferred Stock shall be entitled to be
paid, out of the Company's assets that are available for distribution
to our shareholders, the sum of $80.00 per share of Preferred Stock
held, or $3.25 million, plus all accrued and unpaid dividends
thereon, prior to any payments being made to holders of our common
stock. The $80.00 per share liquidation preference payment amount is
subject to equitable adjustment for stock splits, stock dividends,
combinations, reorganizations and similar events effecting the shares
of Preferred Stock.
As the original price of $80.00 included a share of Series A
Preferred Stock, a warrant to purchase five shares of common stock
and the Over-Allotment Right, the Company used the relative fair
value method to record the transaction. Accordingly, $2.668 million,
$486,000 and $96,000 of the gross proceeds were attributed to the
40,625 shares of Series A Preferred Stock, the 203,125 common stock
warrants and the Over-Allotment Right, respectively. Since 38,750
shares of Series A Preferred Stock were issued for an effective
purchase price of $6.56 per share, which was lower than the fair
market value of the common stock at the date of closing, the
investors realized a beneficial conversion feature of approximately
$131,750. Accordingly, the beneficial conversion feature and the
relative fair value of the warrants and Over-Allotment Right have
been recorded as an increase to additional paid-in capital. The
beneficial conversion feature was immediately accreted.
Common Stock Warrants - The Company has issued common stock warrants
in connection with certain financings. All warrants are currently
exercisable and the following table summarizes information about
common stock warrants outstanding to lenders and investors at
December 31, 2004:
13
Fiscal Year Number Weighted-Average Expiration
Granted Outstanding Exercise Price Date
----------- ----------- ---------------- ----------
2003 25,000 $6.89 June 10, 2008
2004 225,000 8.00 July 28, 2007
2004 31,500 8.00 July 28, 2008
2004 193,750 8.00 May 7, 2007
2004 9,375 8.00 June 8, 2007
------- -----
Total 484,625 $7.94
======= =====
Upon execution of the Loan Agreement on June 10, 2003, the Company
issued warrants for the purchase of 25,000 shares of its common stock
to Silicon Valley Bank at an initial exercise price of $6.89 per
share. The exercise price is subject to future adjustment under
certain conditions, including but not limited to, stock splits and
stock dividends. The fair value of the warrants on June 10, 2003 was
approximately $100,600, which was recorded as a deferred financing
cost and is being amortized to interest expense over the life of the
Loan Agreement. Amortization expense for the six months ended
December 31, 2004 and December 28, 2003 was $25,000.
In connection with the sale of the Convertible Subordinated Notes,
the investors and the investment adviser received warrants to
purchase 331,500 shares of common stock, at an initial exercise price
of $8.00 per share. The exercise price of the warrants is subject to
adjustment in the event of stock splits, dividends and certain
combinations. The relative fair value of the warrants issued to the
investors and to the investment adviser on July 28, 2003 was
approximately $1,035,000 and $146,000, respectively. The relative
fair value of the warrants was recorded as an increase in additional
paid-in capital and as an original issuance discount recorded against
the carrying value of the Notes. In December 2003, one of the
investors exercised their warrants to purchase 75,000 shares of
Parlex common stock and the Company received proceeds of $600,000.
The original issue discount is being amortized to interest expense
over the four year life of the Note and totaled $144,600 for the six
months ended December 31, 2004.
In connection with the sale of the Series A Convertible Preferred
Stock, the investors received common stock purchase warrants for an
aggregate of 203,125 shares of common stock at an initial exercise
price of $8.00 per share. The conversion price of the Preferred Stock
and the exercise price of the Warrants are subject to adjustment in
the event of stock splits, dividends and certain combinations.
Treasury Stock - Effective July 1, 2004, companies incorporated in
Massachusetts became subject to the Massachusetts Business
Corporation Act, Chapter 156D. The new Act eliminates the concept of
"treasury stock" and instead Section 6.31 of Chapter 156D provides
that shares that are reacquired by a company become authorized but
unissued shares. Accordingly, shares previously reported as treasury
stock by the Company have been redesignated, at an aggregate cost of
$1,037,625, as authorized but unissued shares. This aggregate cost
has been allocated to the common stock's par value and additional
paid-in capital.
9. Revenue Recognition
-------------------
Revenue on product sales is recognized when persuasive evidence of an
agreement exists, the price is fixed or determinable, delivery has
occurred and there is reasonable assurance of collection of the sales
proceeds. The Company generally obtains written purchase
authorizations from its customers for a specified amount of product,
at a specified price and considers delivery to have occurred at the
time title to the product passes to the customer. Title passes to the
customer according to the shipping terms negotiated between the
Company and the customer. License fees and royalty income are
recognized when earned.
14
10. Stock-Based Compensation
------------------------
The Company accounts for stock-based compensation to employees and
nonemployee directors in accordance with Accounting Principles Board
Opinion No. 25 ("APB No. 25"), Accounting for Stock Issued to
Employees, using the intrinsic-value method as permitted by Statement
of Financial Accounting Standards No. 123 ("SFAS No. 123"),
Accounting for Stock-Based Compensation. Under the intrinsic value
method, compensation associated with stock awards to employees and
directors is determined as the difference, if any, between the
current fair value of the underlying common stock on the date
compensation is measured and the price the employee or director must
pay to exercise the award. The measurement date for employee awards
is generally the date of grant.
Had the Company used the fair-value method to measure compensation,
the Company's net loss and basic and diluted net loss per share would
have been as follows:
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
Net loss attributable to common stockholders $(1,515,267) $(1,927,234) $(2,381,576) $(4,014,265)
Add stock-based compensation expense
included in reported net loss - - - -
Deduct stock-based compensation expense
determined under the fair-value method (98,000) (171,000) (180,000) (362,000)
----------- ----------- ----------- -----------
Net loss - attributable to
common stockholders - pro forma $(1,613,267) $(2,098,234) $(2,561,576) $(4,376,265)
=========== =========== =========== ===========
Basic and diluted net loss per share - as reported $ (0.23) $ (0.30) $ (0.37) $ (0.63)
Basic and diluted net loss per share - pro forma $ (0.25) $ (0.33) $ (0.40) $ (0.69)
The fair values of the options at the date of grant were estimated
using the Black-Scholes option pricing model with the following
assumptions:
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
Average risk-free interest rate 2.9% 3.1% 2.9% 3.3%
Expected life of option grants 3.5 years 3.5 years 3.5 years 3.5 years
Expected volatility of underlying stock 70% 72% 70% 74%
Expected dividend rate None None None None
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 123R, Share-
Based Payment ("SFAS No. 123R"). This Statement is a revision of SFAS
No. 123, and supersedes APB No. 25, and its related implementation
guidance. SFAS No. 123R focuses primarily on accounting for
transactions in which an entity obtains employee services in share-
based payment transactions. The Statement requires entities to
recognize stock compensation expense for awards of equity instruments
to employees based on the grant-date fair value of those awards (with
limited exceptions). SFAS No. 123R is effective for the first interim
or annual reporting period that begins after June 15, 2005.
The Company expects to adopt SFAS No. 123R using the Statement's
modified prospective application method.
15
Adoption of SFAS No. 123R is expected to increase stock compensation
expense. The Company is evaluating the effect that SFAS 123R will
have in subsequent years. In addition, SFAS No. 123R requires that
the excess tax benefits related to stock compensation be reported as
a financing cash inflow rather than as a reduction of taxes paid in
cash from operations.
The following is a summary of activity for all of the Company's stock
option plans:
Three Month Ended December 31, 2004 Six Month Ended December 31, 2004
Weighted- Weighted-
Shares Average Shares Average
Under Exercise Under Exercise
Option Price Option Price
Outstanding options at beginning of period 666,775 $11.41 567,775 $12.54
Granted 14,000 5.75 130,500 5.98
Cancelled 3,000 12.31 20,500 12.09
Exercised - - - -
------- ------ ------- ------
Outstanding options at end of period 677,775 $11.29 677,775 $11.29
======= ====== ======= ======
Exercisable options at end of period 398,567 $13.46 398,567 $13.46
======= ====== ======= ======
Weighted average fair value of options
granted during the period $ 2.84 $ 2.98
====== ======
The following table presents weighted-average price and life
information about significant option groups outstanding and
exercisable at December 31, 2004:
Weighted-
Average Weighted- Weighted-
Remaining Average Number Average
Exercise Number Contractual Exercise of Shares Exercise
Prices Outstanding Life (Years) Price Exercisable Price
$ 0.00 - $ 5.67 6,000 9.8 $ 5.40 - $ 0.00
5.67 - 6.67 136,500 8.9 6.01 12,000 6.05
8.39 - 10.48 135,000 8.1 9.04 51,000 9.51
11.37 - 13.25 268,525 6.2 12.17 203,817 12.27
15.50 - 16.25 66,250 4.5 16.18 66,250 16.18
18.75 - 19.13 63,500 2.8 18.78 63,500 18.78
22.00 2,000 5.4 22.00 2,000 22.00
------- --- ------ ------- ------
$ 0.00 - $22.00 677,775 6.7 $11.29 398,567 $13.46
======= === ====== ======= ======
11. Income Taxes
------------
Income taxes are recorded for interim periods based upon an estimated
annual effective tax rate. The Company's effective tax rate is
impacted by the proportion of its estimated annual income being
earned in domestic versus foreign tax jurisdictions, the generation
of tax credits and the recording of a valuation allowance.
The Company performs an ongoing evaluation of the realizability of
its net deferred tax assets. As a result of its operating losses,
uncertain future operating results, and past non-compliance with
certain of its debt covenant requirements, the Company determined
during fiscal 2003 that it is more likely than not that certain
historic and current year income tax benefits will not be realized.
Consequently, the Company
16
established a valuation allowance against all of its U.S. net
deferred tax assets and has not given recognition to these net tax
assets in the accompanying financial statements at December 31, 2004.
Upon a favorable change in the operations and financial condition of
the Company that results in a determination that it is more likely
than not that all or a portion of the net deferred tax assets will be
utilized, all or a portion of the valuation allowance previously
provided for will be eliminated.
12. Net Loss Per Share
------------------
Basic net loss per share is calculated on the weighted-average number
of common shares outstanding during the period. Diluted net loss per
share is calculated on the weighted-average number of common shares
and common share equivalents resulting from outstanding options and
warrants except where such items would be antidilutive.
The net loss attributable to common stockholders for each period is
as follows:
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
----------------- ----------------- ----------------- -----------------
Net loss $(1,447,685) $(1,927,234) $(2,246,412) $(4,014,265)
Dividends accrued on Series A preferred stock (67,582) - (135,164) -
----------- ----------- ----------- -----------
Net loss attributable to common stockholders $(1,515,267) $(1,927,234) $(2,381,576) $(4,014,265)
=========== =========== =========== ===========
Antidilutive shares were not included in the per-share calculations
for the six months ended December 31, 2004 and December 28, 2003 due
to the reported net losses for those periods. Antidilutive shares
totaled approximately 1,162,400 and 837,525 for the six months ended
December 31, 2004 and December 28, 2003, respectively. All
antidilutive shares relate to outstanding stock options except for
484,625 and 272,500 antidilutive shares for the six months ended
December 31, 2004 and December 28, 2003, respectively relating to
warrants issued in connection with certain debt and equity financings
(see Note 8).
13. Comprehensive Loss
------------------
Comprehensive loss for the three months ended December 31, 2004 and
December 28, 2003 is as follows:
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
----------------- ----------------- ----------------- -----------------
Net loss $(1,447,685) $(1,927,234) $(2,246,412) $(4,014,265)
Other comprehensive income (loss):
Foreign currency translation adjustments 288,563 201,486 365,273 143,911
----------- ----------- ----------- -----------
Total comprehensive loss $(1,159,122) $(1,725,748) $(1,881,139) $(3,870,354)
=========== =========== =========== ===========
At December 31, 2004 and June 30, 2004, the Company's accumulated
other comprehensive loss pertains entirely to foreign currency
translation adjustments.
17
14. Joint Venture
-------------
On December 22, 2004, Parlex entered into a Joint Venture Agreement,
Stock Transfer Agreement and License Agreement (collectively, the
"Agreements") with Infineon Technologies Asia Pacific Pte. Ltd
("Infineon"), a wholly-owned subsidiary of Infineon Technologies AG.
Pursuant to the Agreements, Infineon will purchase, for an aggregate
$3,000,000, a 49% interest in a new entity to be formed by Parlex.
Under the terms of the Agreements, Parlex is required to obtain
certain governmental approvals from the People's Republic of China
with respect to establishing the new entity, and be able to
consummate the transaction no later than March 31, 2005 (the "Outside
Closing Date").
Upon execution of the Agreements, Parlex received a deposit of an
aggregate $1,000,000 of the total purchase price. Specifically,
Infineon paid $500,000 to Parlex as consideration for the License
Agreement, pursuant to which Parlex granted Infineon a license
relating to certain proprietary technology used in connection with
the business to be operated by the joint venture. Infineon also paid
$500,000 of the $2.5 million to be payable to Parlex under the Stock
Transfer Agreement, with the remaining $2.0 million to be paid at
closing. In the event the transaction is not consummated on or before
the Outside Closing Date, Parlex is required to repay the $1.0
million, or Infineon shall be entitled to offset such amount against
certain Parlex invoices submitted to Infineon.
15. Other Recent Accounting Pronouncements
--------------------------------------
In November 2004, the FASB issued Statement No. 151, Inventory Costs,
an amendment to ARB No. 43, Chapter 4. Statement 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight,
handling costs and wasted material. Statement 151 is effective for
inventory costs incurred during fiscal years beginning after June 15,
2005. The Company is presently evaluating the effect that adoption
of Statement 151 will have on its consolidated financial position,
results of operations or cash flows.
In December 2004, the FASB issued Statement No. 153, Exchanges of
Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement 153
addresses the measurement of exchanges of nonmonetary assets and
redefines the scope of transactions that should be measured based on
the fair value of the assets exchanged. Statement 153 is effective
for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The Company does not believe that adoption of
Statement 153 will have a material effecton its consolidated
financial position, results of operations or cash flows.
In December 2004, the FASB issued FASB Staff Position No. 109-1,
Application of FASB Statement No. 109 (SFAS 109), Accounting for
Income Taxes, to the Tax Deduction on Qualified Production Activities
Provided by the American Jobs Creation Act of 2004 (FSP 109-1). FSP
109-1 clarifies that the manufacturer's deduction provided for under
the American Jobs Creation Act of 2004 (AJCA) should be accounted for
as a special deduction in accordance with SFAS 109 and not as a tax
rate reduction. The adoption of FSP 109-1 will have no impact on the
Company's results of operations or financial position for fiscal year
2005 because the manufacturer's deduction is not available to the
Company until fiscal year 2006. The Company is presently evaluating
the effect that the manufacturer's deduction will have in subsequent
years.
The FASB also issued FASB Staff Position No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision
within the American Jobs Creation Act of 2004 (FSP 109-2). The AJCA
introduces a special one-time dividends received deduction on the
repatriation of certain foreign earnings to a U.S. taxpayer
(repatriation provision), provided certain criteria are met. FSP 109-2
provides accounting and disclosure guidance for the repatriation
provision. Until the Treasury Department or Congress provides
additional clarifying language on key elements of the repatriation
provision, the amount
18
of foreign earnings to be repatriated by the Company, if any, cannot
be determined and the presumption that such unremitted earnings will
be repatriated cannot be overcome. FSP 109-2 grants an enterprise
additional time beyond the year ended December 31, 2004, in which the
AJCA was enacted, to evaluate the effects of the AJCA on its plan for
reinvestment or repatriation of unremitted earnings. FSP 109-2 calls
for enhanced disclosures of, among other items, the status of a
Company's evaluations, the effects of completed evaluations, and the
potential range of income tax effects of repatriations. Such
disclosures are included in Note 11.
19
Item 2. Management's Discussion and Analysis of Financial Condition and
- -----------------------------------------------------------------------
Results of Operations
- ---------------------
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the financial
information included in this Quarterly Report on Form 10-Q and with
"Factors That May Affect Future Results" set forth on page 31. The
following discussion contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, and is subject to
the safe-harbor created by such Act. Forward-looking statements express our
expectations or predictions of future events or results. They are not
guarantees and are subject to many risks and uncertainties. There are a
number of factors - many beyond our control - that could cause actual
events or results to be significantly different from those described in the
forward-looking statement. Any or all of our forward-looking statements in
this report or in any other public statements we make may turn out to be
wrong. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They use words such
as "anticipate," "estimate," "expect," "project," "intend," "plan,"
"believe" or words of similar meaning. They may also use words such as
"will," "would," "should," "could" or "may". Our actual results could
differ materially from the results contemplated by these forward-looking
statements as a result of many factors, including those discussed below and
elsewhere in this Quarterly Report on Form 10-Q.
Our significant accounting policies are more fully described in Note 2 to
our consolidated financial statements in our Annual Report on Form 10-K for
the year ended June 30, 2004. However, certain of our accounting policies
are particularly important to the portrayal of our financial position and
results of operations and require the application of significant judgment
by our management which subjects them to an inherent degree of uncertainty.
In applying our accounting policies, our management uses its best judgment
to determine the appropriate assumptions to be used in the determination of
certain estimates. Those estimates are based on our historical experience,
terms of existing contracts, our observance of trends in the industry,
information provided by our customers, information available from other
outside sources, and on various other factors that we believe to be
appropriate under the circumstances. We believe that the critical
accounting policies discussed below involve more complex management
judgment due to the sensitivity of the methods, assumptions and estimates
necessary in determining the related asset, liability, revenue and expense
amounts.
Overview
We believe we are a leading supplier of flexible interconnects principally
for sale to the automotive, telecommunications and networking, diversified
electronics, military, home appliance, electronic identification, medical and
computer markets. We believe that our development of innovative materials and
processes provides us with a competitive advantage in the markets in which we
compete. During the past three fiscal years, we have invested approximately
$12.4 million in property and equipment and approximately $17.7 million in
research and development to develop materials and enhance our manufacturing
processes. We believe that these expenditures will help us to meet customer
demand for our products, and enable us to continue to be a technological
leader in the flexible interconnect industry. Our research and development
expenses are included in our cost of products sold.
Over the past three years, we were adversely affected by the economic
downturn and its impact on our key customers and markets. In 2004, we
experienced sales growth in several strategic markets, particularly in the
second half of the fiscal year. Growth in the medical, home appliance and
military markets has helped to reduce domestic losses. Significant investment
over the past three years has positioned us to capitalize on a rapidly
expanding China electronic manufacturing industry. In 2004, our China
operations revenues increased by over 65% with significant improvement in
profitability.
During fiscal years 2002, 2003 and 2004 we incurred operating losses of $35.3
million and used cash to fund operations and working capital of $13.7
million. We have taken certain steps to improve operating margins, including
the closure of facilities, downsizing of our North American employee base,
and transfer of our manufacturing operations to lower cost locations, such as
the People's Republic of China. In addition, we have
20
worked closely with our lenders to manage through this difficult time and
have obtained additional capital in 2003 and 2004 through sale-leasebacks of
selected corporate assets, the issuance of convertible debt and preferred
stock and the execution of new working capital borrowing agreements. As a
result of the difficult economic environment, we have had difficulty
maintaining compliance with the terms and conditions of certain of our
financing facilities in prior years and throughout 2004. At December 31,
2004, however, we were in compliance with all financial covenants. Based upon
our recent improvement in financial performance, we are currently, and expect
to remain, in compliance with all of our financial covenants.
We have $7.7 million in existing short-term debt, associated with our Chinese
operations, that will be refinanced or repaid in 2005. We believe that we
will be able to obtain the necessary refinancing of this debt because of our
history of successfully refinancing our short-term Chinese borrowings and
China's strong operating results. In fiscal 2004, revenues from our Chinese
operations grew 65%. In the six months ended December 31, 2004 revenues from
our Chinese operations grew 60% compared to the six months ended December
28, 2003. We expect continued revenue growth and improved profitability in
China during fiscal 2005. The economy in China continues to expand rapidly,
often outpacing local infrastructure development. During the past year the
Chinese government has taken a series of steps to control economic growth.
These steps include tightening of monetary policies particularly in
industries such as building and commercial real estate development. Controls
over credit have slowed bank loan growth. Additional short term lending may
be more difficult to obtain in the future. Failure to obtain the necessary
refinancing of our short-term Chinese debt may have a material adverse impact
on our operations.
Critical Accounting Policies
The U.S. Securities and Exchange Commission defines critical accounting
policies as those that are, in management's view, most important to the
portrayal of the company's financial condition and results of operations
and most demanding of their judgment. We believe the following policies to
be critical to an understanding of our consolidated financial statements
and the uncertainties associated with the complex judgments made by us that
could impact our results of operations, financial position and cash flows.
Our significant accounting policies are more fully described in our Annual
Report on Form 10-K for the year ended June 30, 2004.
The preparation of consolidated financial statements requires that we make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures. On an ongoing
basis, we evaluate our estimates, including those related to bad debts,
inventories, property, plant and equipment, goodwill and other intangible
assets, valuation of stock options and warrants, income taxes and other
accrued expenses, including self-insured health insurance claims. We base
our estimates on historical experience and on various other assumptions
that are believed 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. In
applying our accounting policies, our management uses its best judgment to
determine the appropriate assumptions to be used in the determination of
certain estimates. Actual results would differ from these estimates.
Revenue recognition and accounts receivable. We recognize revenue on product
sales when persuasive evidence of an agreement exists, the price is fixed and
determinable, delivery has occurred and there is reasonable assurance of
collection of the sales proceeds. We generally obtain written purchase
authorizations from our customers for a specified amount of product, at a
specified price and consider delivery to have occurred at the time title to
the product passes to the customer. Title passes to the customer according to
the shipping terms negotiated between the customer and us. License fees and
royalty income are recognized when earned. We have demonstrated the ability
to make reasonable and reliable estimates of product returns in accordance
with SFAS No. 48 and of allowances for doubtful accounts based on significant
historical experience. We maintain allowances for doubtful accounts for
estimated losses resulting from the inability of
21
our customers to make required payments. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances may be required.
Inventories. We value our raw material inventory at the lower of the actual
cost to purchase and/or manufacture the inventory or the current estimated
market value of the inventory. Work in process and finished goods are valued
as a percentage of completed cost, not in excess of net realizable value. We
regularly review our inventory and record a provision for excess or obsolete
inventory based primarily on our estimate of expected and future product
demand. Our estimates of future product demand will differ from actual demand
and, as such, our estimate of the provision required for excess and obsolete
inventory will change, which we will record in the period such determination
was made. Raw material, work in process and finished goods inventory
associated with programs cancelled by customers are fully reserved for as
obsolete. Reductions in obsolescence reserves are recognized when realized
through disposal of reserved items, either through sale or scrapping.
Goodwill. We recorded goodwill in connection with our acquisition of a 40%
interest in Parlex Shanghai and our 1999 acquisition of Parlex Dynaflex
Corporation ("Dynaflex"). We account for goodwill under the provisions of
SFAS No.142, Goodwill and Other Intangible Assets. Under the provisions
of SFAS No. 142, if an intangible asset is determined to have an indefinite
useful life, it shall not be amortized until its useful life is determined
to be no longer indefinite. An intangible asset that is not subject to
amortization shall be tested for impairment annually or more frequently if
events or changes in circumstances indicate that the asset might be
impaired. Goodwill is not amortized but is tested for impairment, for each
reporting unit, on an annual basis and between annual tests in certain
circumstances. In accordance with the guidelines in SFAS No. 142, we
determined we have one reporting unit. We evaluate goodwill for impairment
by comparing our market capitalization, as adjusted for a control premium,
to our recorded net asset value. If our market capitalization, as adjusted
for a control premium, is less than our recorded net asset value, we will
further evaluate the implied fair value of our goodwill with the carrying
amount of the goodwill, as required by SFAS No. 142, and we will record an
impairment charge against the goodwill, if required, in our results of
operations in the period such determination was made. Since our market
capitalization, as adjusted, exceeded our recorded net asset value upon
adoption of SFAS No. 142 and at the subsequent annual impairment analysis
dates, we have concluded that no impairment adjustments were required at
the time of adoption or at the annual impairment analysis date. The
carrying value of the goodwill was $1,157,510 at December 31, 2004 and June
30, 2004. Based on the current recorded net asset value, we may be required
to record a charge for the impairment of our goodwill in the future should
our stock price consistently remain at a price of less than approximately
$5.00 per share.
Income Taxes. We determine if our deferred tax assets and liabilities are
realizable on an ongoing basis by assessing our valuation allowance and by
adjusting the amount of such allowance, as necessary. In the determination of
the valuation allowance, we have considered future taxable income and the
feasibility of tax planning initiatives. Should we determine that it is more
likely than not that we will realize certain of our net deferred tax assets
for which we previously provided a valuation allowance, an adjustment would
be required to reduce the existing valuation allowance. In addition, we
operate within multiple taxing jurisdictions and are subject to audit in
these jurisdictions. These audits can involve complex issues, which may
require an extended period of time for resolution. Although we believe that
we have adequately considered such issues, there is the possibility that the
ultimate resolution of such issues could have an adverse effect on the
results of our operations.
Off-Balance Sheet Arrangements. We have not created, and are not party to,
any special-purpose or off-balance sheet entities for the purpose of raising
capital, incurring debt or operating parts of our business that are not
consolidated into our financial statements. We do not have any arrangements
or relationships with entities that are not consolidated into our financial
statements that are reasonably likely to materially affect our liquidity or
the availability of capital resources, except as may be set forth below
under "Liquidity and
22
Capital Resources." Our obligations under operating leases are disclosed in
the Notes to our financial statements.
Results of Operations
- ---------------------
The following table sets forth, for the periods indicated, selected items
in our statements of operations as a percentage of total revenue. You
should read the table and the discussion below in conjunction with our
Condensed Consolidated Financial Statements and the Notes thereto.
Three Months Ended Six Months Ended
December 31, 2004 December 28, 2003 December 31, 2004 December 28, 2003
Total revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of products sold 86.7 % 88.4 % 86.0 % 88.5 %
----- ----- ----- -----
Gross profit 13.3 % 11.6 % 14.0 % 11.5 %
Selling, general and administrative expenses 15.3 % 16.8 % 14.9 % 17.8 %
----- ----- ----- -----
Operating loss (2.0)% (5.2)% (0.9)% (6.3)%
Loss from operations before income taxes
and minority interest (4.5)% (8.0)% (3.3)% (9.0)%
===== ===== ===== =====
Net loss (4.8)% (8.2)% (3.6)% (9.3)%
===== ===== ===== =====
Three Months Ended December 31, 2004 Compared to Three Months Ended
- -------------------------------------------------------------------
December 28, 2003
- -----------------
Total Revenues. Total revenues for the three months ended December 31, 2004
were $30.2 million versus $23.6 million for the three months ended December
28, 2003. This represents an increase of $6.6 million or 28%. Solid revenue
growth was recorded in each of our lines of business with the exception of
our laminated cable operations which were essentially flat year over year.
Bookings in the laminated cable business were below plan for a second
consecutive quarter. Increased competition from Asian competitors continues
to have an adverse effect on large volume opportunities. We believe
revenues will improve with additional sales focus coupled with the purchase
of a new high speed laminator ($200,000). The capital acquisition will
provide improved pitch and tolerance capabilities and is anticipated to be
installed in the fourth quarter.
Revenues from our China operations increased to $12.9 million from $9.4
million in the prior year representing a 37% increase for the same period
year over year. Strong growth occurred in the computer and peripheral
market leveraging automated surface mount assembly capabilities. Adding
surface mount assembly to base flex circuit manufacturing significantly
increased the revenue per circuit during the period. Increasing value-add
capabilities such as automated surface mount assembly remains core to our
growth strategy. Growth in China also occurred in several other markets
including automotive, telecommunications (more specifically cell phone
applications) and electronic identification. Revenues from our smart card
business were $400,000 below expectations caused by delayed orders from
Infineon during the month of December. Product qualification problems with
their end customer triggered the delay. We expect this to have an adverse
effect on third quarter revenues as well.
Polymer thick film revenues totaled $8.9 million increasing 21% versus the
same period of the prior year. Revenue increases continue to be driven by
accelerated growth in the medical market, particularly in disposable
medical devices. Strong performance occurred in both our United Kingdom and
United States manufacturing operations.
23
Revenues in our Methuen, Massachusetts multilayer manufacturing operations
increased 64% versus the same period of the prior year. Steady growth in
military /aerospace programs has contributed to an improved backlog of base
business. In July 2004, we began transitioning multilayer flex
manufacturing from Delphi Corporation's Irvine, California facility to our
Methuen operation under a strategic sourcing relationship. We expect to
complete this transition by the fourth quarter of the current fiscal year.
Cost of Products Sold. Cost of products sold was $26.2 million, or 87% of
total revenues, for the three months ended December 31, 2004, versus $20.8
million, or 88% of total revenues, for the three months ended December 28,
2003. Reduction in the cost of products sold as a percentage of total
revenues, or correspondingly an improvement in our gross margin, was in
large part driven by manufacturing volume increases. Revenues increased
28%, for the same period year over year, resulting in improved factory
utilization and better absorption of fixed overhead costs. Fixed and
variable manufacturing overhead decreased from 40% of revenues in the
second quarter of fiscal 2004 to 35% of revenues for the current quarter.
In addition to improved utilization, overhead as a percentage of revenue
was favorably impacted by a continued shift of manufacturing to our low
cost China operations.
Reductions in manufacturing overhead were in part offset by increases in
material cost. Raw material costs and in particular copper prices escalated
more than 25% during the past year. Similarly, base flexible materials such
as polyimide rose substantially during the year with worldwide supply
constraints. In many cases this has forced increased pricing to our
customers. Long term supply commitments however, do not always permit price
increases, at least in the short term. Rising material costs continues to
place adverse pressure on gross margins.
The Methuen multilayer operation continues to experience low capacity
utilization and, correspondingly, significant unfavorable manufacturing
variances. We currently estimate our multilayer utilization to be
approximately 45%. Revenue in the multilayer operation was severely
impacted by the rapid decline of the telecommunications network
infrastructure market. In fiscal 2001 this market represented over 75% of
multilayer revenues. In the first quarter of fiscal 2005, revenues in this
market were immaterial. Over the past two years we have sought to replace
this revenue by targeting markets demanding complex North American design
and manufacturing solutions. We believe the military aerospace and medical
markets represent two growing markets demanding such services. In addition
to a focused corporate sales effort targeting new business development, we
have continued to evaluate opportunities to acquire business, particularly
in the highly fragmented military aerospace market. In June 2004, we
entered into a strategic sourcing agreement with Delphi Corporation. Under
the arrangement Delphi Corporation will transfer production of its
multilayer flexible circuit manufacturing to our Methuen operation. In the
second quarter of fiscal 2005 shipments totaled approximately $395,000. We
expect manufacturing to increase significantly over the remainder of the
2005 fiscal year improving facility utilization and further reducing
multilayer operating losses.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $4.6 million for the three months ended
December 31, 2004 versus $4.0 million for the comparable period in the
prior year. Increases can be primarily attributed to higher commissions
($200,000) on increases in revenues, higher public company costs ($100,000)
including legal, audit and insurance, continued escalation of fringe costs
($100,000) in particular medical expenses, and infrastructure investment in
China ($190,000).
Interest Income. Interest income was $34,000 for the three months ended
December 31, 2004 compared to $2,000 for the three months ended December
28, 2003. Interest income for the three months ended December 31, 2004
included $26,000 of interest income on our tax refunds. The balance
represents interest income on our cash balances.
Interest Expense. Interest expense was $772,000 for the three months ended
December 31, 2004 compared
24
to $665,000 for the three months ended December 28, 2003. Interest expense
for the period ended December 31, 2004 included $420,000 for amortized
deferred financing costs and $98,000 for interest payable in common stock
related to issuance of convertible notes in July 2003. The deferred
financing costs are associated with the sale-leaseback of our Methuen,
Massachusetts facility, the Loan and Security Agreement with Silicon Valley
Bank and sale of our convertible subordinated notes. The balance of the
interest expense represents interest incurred on our short and long term
bank borrowings and deferred compensation.
Our loss before income taxes and the minority interest in our Chinese joint
venture, Parlex Shanghai, was $1.3 million in the three months ended
December 31, 2004 compared to $1.9 million in the three months ended
December 28, 2003. We own 90.1% of the equity interest in Parlex Shanghai
and, accordingly, include Parlex Shanghai's results of operations, cash
flows and financial position in our consolidated financial statements.
Income Taxes. Our effective tax rate was approximately 5% for the three
months ended December 31, 2004 versus 0% for the three months ended
December 28, 2003. Our effective tax rate is impacted by the proportion of
our estimated annual income being earned domestically versus in foreign tax
jurisdictions, the generation of tax credits and the recording of any
valuation allowance. As a result of our history of operating losses,
uncertain future operating results, and the past non-compliance with
certain of our debt covenants requirements, which have subsequently been
waived, we determined that it is more likely than not that certain historic
and current year income tax benefits will not be realized. Consequently, we
recorded no income tax benefits on our U.S. operating losses during the
three months ended December 31, 2004. In fiscal 2003, we established a
valuation allowance against all of our remaining net U.S. deferred tax
assets.
Six Months Ended December 31, 2004 Compared to Six Months Ended
- ---------------------------------------------------------------
December 28, 2003
- -----------------
Total Revenues. Total revenues for the six months ended December 31, 2004
were $61.7 million versus $43.3 million for the six months ended December
28, 2003. This represents an increase of $18.4 million or 43%. Increases
were recorded in each of our business units with particularly strong growth
in our China (60%), Multilayer (51%) and Polymer Thick Film (28%)
operations.
Strong revenues were recorded in our China operations for the first six
months of fiscal 2005. China sales increased to 45% of the Company's total
revenues versus 40% for the first six months of fiscal 2003. Foreign
sourced revenues increased to 58% of total revenues for the first six
months of fiscal 2005. China revenue increases ($10.4 million), were driven
by strong sales in the computer peripherals, wireless telecom, automotive,
and electronic identification markets. Hewlett Packard remained our largest
China customer and only customer representing greater than 10% of total
Company revenues. Total revenues from Hewlett Packard for the first six
months were $15.2 million. Polymer thick film revenues increased $4.0
million over the same period of the prior year with growth occurring
primarily in the disposable medical market. Multilayer revenues increased
$2.9 million versus the same period of the prior year. Focused efforts to
re-develop our military aerospace business have begun to show improved
results. Raytheon Company remained our single largest multilayer customer
in the second quarter with solid growth from Delphi Corporation and BAE
Systems.
Cost of Products Sold. Cost of products sold was $53.0 million, or 86% of
total revenues, for the six months ended December 30, 2004, versus $38.3
million, or 89% of total revenues, for the six months ended December 28,
2003. Increased capacity utilization in China resulted in a margin
improvement. Gross margins in China were 21% for the first six months of
fiscal 2005 versus 20% for the comparable period of the prior year. Polymer
thick film gross margins decreased from 17% to 14% for the first six months
of the fiscal year. Decreases can be primarily attributed to an increase in
lower margin assembly business during fiscal 2005. Margins on assembly
activities are typically 8% to 10% versus polymer thick film circuit
25
fabrication which typically yields margins greater than 20%. Our Methuen
facility continued to experience low capacity utilization and
correspondingly, significant unfavorable manufacturing variances. Continued
growth in our Multi-Layer business, primarily in the military and medical
markets, and the relocation of our Laminated Cable operations from Salem,
New Hampshire to Methuen Massachusetts, which was completed in January
2003, have improved factory utilization substantially. We continue to drive
operational improvements which we believe will reduce breakeven revenue
levels. These include yield and process improvement programs as well as raw
material cost reduction initiatives. In addition, we have significantly
strengthened the multilayer management team over the past year with new
hires in senior leadership, quality and production control.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $9.2 million for the six months ended December
31, 2004 versus $7.7 million for the comparable period in the prior year.
Increases can be primarily attributed to higher commissions ($500,000) on a
43% increase in revenues, higher public company costs ($200,000) including
legal, audit and insurance, continued escalation of fringe costs ($300,000)
in particular medical expenses, and infrastructure investment in China
($300,000). In addition, during fiscal 2005 we increased our China bad debt
reserves $100,000 in part based upon the increased business levels.
Interest Income. Interest income was $40,000 for the six months ended
December 31, 2004 compared to $7,000 for the six months ended December 28,
2003. Interest income for the six months ended December 31, 2004 included
$26,000 of interest income on our tax refunds. The balance represents
interest income on our cash balances.
Interest Expense. Interest expense was $1.5 million for the six months
ended December 31, 2004 and $1.2 million for the six months ended December
28, 2003. Interest expense for the six months ended December 31, 2004
included $845,000 for amortized deferred financing costs and $167,000 for
interest payable in common stock related to issuance of convertible notes
in July 2003. The deferred financing costs are associated with the sale-
leaseback of our Methuen, Massachusetts facility, the Loan and Security
Agreement with Silicon Valley Bank and sale of our convertible subordinated
notes. The balance of the interest expense represents interest incurred on
our short and long term bank borrowings and deferred compensation.
Our loss before income taxes and the minority interest in our Chinese
venture, Parlex Shanghai, was $2.0 million in the six months ended December
31, 2004 compared to $3.9 million in the six months ended December 28,
2003. We own 90.1% of the equity interest in Parlex Shanghai and,
accordingly, include Parlex Shanghai's results of operations, cash flows
and financial position in our consolidated financial statements.
Income Taxes. Our effective tax rate was approximately 5.6% for the six
months ended December 31, 2004 versus an effective tax rate of 0% for the
six months ended December 28, 2003. Our effective tax rate is impacted by
the proportion of our estimated annual income being earned domestically
versus in foreign tax jurisdictions, the generation of tax credits and the
recording of any valuation allowance. As a result of our recent history of
operating losses, uncertain future operating results, and the past non-
compliance with certain of our debt covenants requirements, we determined
that it is more likely than not that certain historic and current year
income tax benefits will not be realized. Consequently, we recorded no
income tax benefits on our U.S operating losses during the six months ended
December 31, 2004 and December 28, 2003. In the prior year, we established
a valuation allowance against all of our remaining net U.S. deferred tax
assets.
Liquidity and Capital Resources
- -------------------------------
As of December 31, 2004, we had approximately $3.4 million in cash and cash
equivalents.
26
Net cash generated by operations during the six months ended December 31,
2004 was $297,000. This compares to net cash used in operations of $7.9
million for the same period of the prior year. Net operating losses of $2.2
million after adjustment for minority interest, interest payable in common
stock, depreciation and amortization, provided $1.2 million of operating
cash. Operations consumed $900,000 of working capital. Cash used for
working capital included $900,000 for accounts receivable, $3.0 million for
inventory partially offset by $2.0 million from increases in accounts
payable, and $900,000 from other working capital sources. Increases in
accounts receivable were primarily driven by revenue growth. Inventory
increases occurred in raw material, which includes connectors and assembly
components ($2.0 million) and work in process ($1.2 million). The growth in
inventory is in part a function of our expanded value-add strategy.
Increasingly, customers are demanding more complex sub-assemblies from
their interconnect providers. Assembly on flex materials can be challenging
and when executed well, a differentiation opportunity exists versus our
competition. A cost to this business opportunity is a significant increase
in inventory levels and the associated working capital requirement. From an
industry perspective, we see this trend toward increased sub-assembly
requirements continuing to grow.
Net cash consumed by investing activities was $431,000 for the six months
ended December 31, 2004, and was used to purchase capital equipment. As of
December 31, 2004, we had an additional $468,000 of capital equipment
financed under our accounts payable. We have implemented plans to control
our capital expenditures in order to enhance cash flows. Cash provided by
financing activities was $1.9 million for the six months ended December 31,
2004 including $1.1 million that represents the net repayments and
borrowings on our bank debt. In addition, we received $1.0 million from
Infineon Technologies as a deposit for our a joint venture agreement. Upon
closing of the joint venture, currently anticipated to be in late March
2005, Infineon would contribute additional proceeds of $2.0 million.
Closing is predicated on obtaining a business license for the joint venture
company in the People's Republic of China. Should the Company be unable to
close the transaction, the $1.0 million deposit would be re-paid.
Improved financial performance in the first quarter of 2005 significantly
reduced operating losses and cash used in operations. Increased sales in
the first six months of 2005, however, have placed additional cash demands
on working capital with growth in accounts receivables and inventory. The
strong credit ratings of our large OEM and EMS customer base have allowed
us to successfully finance this growth through our asset based working
capital lines of credit. We recently completed stand alone financing for
our China operations through a new line of credit with Bank of China which
will allow us to continue financing our growth plans. See "Factors That May
Affect Future Results".
Series A Convertible Preferred Stock - On June 8, 2004, we completed a
private placement of 40,625 shares of Series A Convertible Preferred Stock
and warrants entitling holders to purchase an aggregate of 203,125 shares
of common stock at $80.00 per unit for proceeds of approximately $2.95
million, net of issuance costs of approximately $300,000. For additional
information relating to the Series A Convertible Preferred Stock, please
see Note 8 to the Notes to Unaudited Condensed Consolidated Financial
Statements.
Loan and Security Agreement (the "Loan Agreement") - We executed the Loan
Agreement with Silicon Valley Bank on June 11, 2003. The Loan Agreement
provided Silicon Valley Bank with a secured interest in substantially all
of our assets. As subsequently amended under the Loan Agreement we may
borrow up to $12.0 million, based on a borrowing base of eligible accounts
receivable. Borrowings may be used for working capital purposes only. The
Loan Agreement allows us to issue letters of credit, enter into foreign
exchange forward contracts and incur obligations using the bank's cash
management services up to an aggregate limit of $1.0 million, which reduces
our availability for borrowings under the Loan Agreement. The Loan
Agreement contains certain restrictive covenants, including but not limited
to, limitations on debt incurred by our foreign subsidiaries, acquisitions,
sales and transfers of assets, and prohibitions against cash dividends,
mergers and repurchases of stock without prior bank approval. The Loan
Agreement also has
27
financial covenants, which among other things require us to maintain
$750,000 in minimum cash balances or excess availability under the Loan
Agreement.
On September 23, 2003, we executed a Modification Agreement (the
"Modification Agreement") with Silicon Valley Bank. The Modification
Agreement increased the interest rate on borrowings to the bank's prime
rate plus 1.5% and amended the financial covenants. On February 18, 2004,
we executed a Second Modification Agreement (the "Second Modification
Agreement") with Silicon Valley Bank. The Second Modification Agreement
removed the fixed charge coverage ratio from the Loan Agreement and
required us to report EBITDA of at least $50,000 on a three month trailing
basis, beginning January 31, 2004. The minimum EBITDA requirement was
increased to $250,000 at June 30, 2004. The Second Modification Agreement
increased the interest rate on borrowings to the bank's prime rate plus
2.0% (decreasing to prime plus 1.25% after two consecutive quarters of
positive operating income and to prime plus 0.75% after two consecutive
quarters of positive net income, respectively) and amended the financial
covenants. On March 28, 2004, we entered into a Third Loan Modification
Agreement with Silicon Valley Bank, which permitted certain of our
subsidiaries to increase the amount of indebtedness they could incur from
$8 million to $13 million, so long as such indebtedness was without
recourse to Parlex and our principal subsidiaries. On May 10, 2004, we
executed a Fourth Loan Modification Agreement (the "Fourth Modification
Agreement") with Silicon Valley Bank. The Fourth Modification Agreement
changed the EBITDA requirement to $1.00 as of April 30, 2004 and May 31,
2004 and $250,000 on a three month trailing basis beginning June 30, 2004.
On June 25, 2004, we executed a Fifth Loan Modification Agreement (the
"Fifth Modification Agreement") with Silicon Valley Bank. The Fifth
Modification Agreement permitted certain of our subsidiaries to borrow up
to $5,000,000 in the aggregate from the Bank of China. The Fifth
Modification Agreement increased the interest rate on borrowings to the
bank's prime rate plus 2.25% (decreasing to prime plus 1.25% after two
consecutive quarters of positive operating income and to prime plus 0.75%
after two consecutive quarters of positive net income, respectively). On
September 24, 2004, we executed a Sixth Loan Modification Agreement with
Silicon Valley Bank to extend the maturity date of the Loan Agreement from
June 10, 2005 to July 11, 2005. On December 22, 2004, we executed a Seventh
Loan Modification Agreement (the "Seventh Modification Agreement") with
Silicon Valley Bank. The Seventh Modification Agreement increased our
maximum borrowings to $12.0 million based upon a borrowing base of eligible
account receivables plus the lesser of 20% of eligible inventory or $1.0
million. The Seventh Modification Agreement reduced the interest rate on
borrowings to the bank's prime rate (5.25% at December 31, 2004) plus 2.00%
(decreasing to prime plus 1.25% after two consecutive quarters of positive
operating income and to prime plus 0.50% after two consecutive quarters of
positive net income, respectively). The Seventh Modification Agreement
changed the EBITDA requirement to $500,000 on a three month trailing basis
beginning December 31, 2004 and to $750,000 on a three month trailing basis
beginning June 30, 2005. The Seventh Modification Agreement extends the
maturity date of the Loan Agreement from July 11, 2005 to July 11, 2006. At
December 31, 2004, we had available borrowing capacity under the Loan
Agreement of approximately $1.6 million. Since the available borrowing
capacity exceeded $750,000 at December 31, 2004, none of our cash balance
was subject to restriction at December 31, 2004.
The Loan Agreement includes both a subjective acceleration clause and a
lockbox arrangement that requires all lockbox receipts to be used to pay
down the revolving credit borrowings. Accordingly, borrowings under the
Loan Agreement have been classified as current liabilities in the
accompanying consolidated balance sheets as of December 31, 2004 and June
30, 2004 as required by Emerging Issues Task Force Issue No. 95-22, "
Balance Sheet Classification of Borrowings Outstanding Under Revolving
Credit Agreements that include both a Subjective Acceleration Clause and a
Lockbox Arrangement". However, such borrowings will be excluded from
current liabilities in future periods and considered long-term obligations
if: 1) such borrowings are refinanced on a long-term basis, 2) the
subjective acceleration terms of the Loan Agreement are modified, or 3)
such borrowings will not require the use of working capital within one
year.
28
Parlex Shanghai Term Notes - On December 15, 2003, Parlex Shanghai entered
in to a short-term bank note for $605,000, due December 15, 2004, bearing
interest at 5.31% and guaranteed by Parlex Interconnect. The note was
repaid on December 14, 2005. On March 2, 2004, Parlex Shanghai entered into
a short-term bank note, due March 1, 2005, bearing interest at 5.31% and
guaranteed by Parlex Interconnect. Amounts outstanding as of December 31,
2004 total $2.5 million. In January 2005, Parlex Shanghai renewed a bank
note bearing interest at LIBOR plus 2.5%, and guaranteed by our subsidiary
Parlex Asia Pacific Ltd. ("Parlex Asia"). Amounts outstanding under this
note, due February 28, 2005, as of December 31, 2004 total $1.5 million. On
October 11, 2004, Parlex Shanghai renewed a bank note bearing interest at
5.31%, which is guaranteed by Parlex Interconnect. Amounts outstanding
under this short-term bank note due April 13, 2005 totaled $725,000 as of
December 31, 2004. On November 11, 2004, Parlex Shanghai renewed a bank
note that was due on November 10, 2004. The short-term note bearing
interest at 5.58%, due June 30, 2005 is guaranteed by Parlex Interconnect.
Amounts outstanding as of December 31, 2004 total $1.0 million. On November
24, 2004, Parlex Shanghai renewed a bank note due January 12, 2005. The
short-term note bearing interest at 5.58%, due June 30, 2005 is guaranteed
by Parlex Interconnect. Amounts outstanding as of December 31, 2004 total
$1.3 million. We believe that we will be able to obtain the necessary
refinancing of our Parlex Shanghai short-term debt because of our history
of successfully refinancing our Chinese debt and our improving operating
results.
Parlex Interconnect Term Notes - On October 28, 2004, Parlex Interconnect
entered into a $605,000 short-term bank note, due October 27, 2005, bearing
interest at 5.31% and guaranteed by Parlex Shanghai.
Parlex Asia Banking Facility - On September 15, 2004, Parlex Asia entered
into an agreement with the Bank of China for a $5 million banking facility
guaranteed by Parlex. Under the terms of the banking facility, Parlex Asia
may borrow up to $5.0 million based on a borrowing base of eligible account
receivables. The banking facility bears interest at LIBOR plus 2.00%. We
anticipate utilizing borrowings from this financing for the refinancing of
certain Parlex Shanghai term notes or for working capital needs.
Finance Obligation on Sale Leaseback of Methuen Facility - In June 2003, we
entered into a sale-leaseback transaction pursuant to which we sold our
corporate headquarters and manufacturing facility located in Methuen,
Massachusetts (the "Methuen Facility") for a purchase price of $9.0
million. The purchase price consisted of $5.35 million in cash at the
closing, a promissory note in the amount of $2.65 million (the "Note") and
up to $1.0 million in additional cash under the terms of an Earn Out
Clause. In June 2004, we received $750,000 reducing the principal balance
of the promissory note to $1.9 million. Under the terms of the Purchase and
Sale Agreement, we simultaneously entered into a lease agreement relating
to the Methuen Facility with a minimum lease term of 15 years.
As the repurchase option contained in the lease and the receipt of the Note
from the buyer provide us with a continuing involvement in the Methuen
Facility, we have accounted for the sale-leaseback of the Methuen Facility
as a financing transaction. Accordingly, we continue to report the Methuen
Facility as an asset and continue to record depreciation expense. We record
all cash received under the transaction as a finance obligation. The Note
and related interest thereon, and the $1.0 million in additional cash under
the terms of an Earn Out Clause, will be recorded as an increase to the
finance obligation as cash payments are received. We record the principal
portion of the monthly lease payments as a reduction to the finance
obligation and the interest portion of the monthly lease payments is
recorded as interest expense. The closing costs for the transaction have
been capitalized and are being amortized as interest expense over the
initial 15-year lease term. Upon expiration of the repurchase option (June
30, 2015), we will reevaluate our accounting to determine whether a gain or
loss should be recorded on this sale-leaseback transaction.
Convertible Subordinated Notes - On July 28, 2003, we sold an aggregate
$6.0 million of our 7% convertible subordinated notes (the "Notes") with
attached warrants to several institutional investors. We received net
proceeds of approximately $5.5 million from the transaction, after
deducting approximately $500,000 in finders' fees and other transaction
expenses. Net proceeds were used to pay down amounts
29
borrowed under our Loan Agreement and utilized for working capital needs.
No principal payments are due until maturity on July 28, 2007. The Notes
are unsecured.
The Notes bear interest at a fixed rate of 7%, payable quarterly in shares
of our common stock. The number of shares of common stock to be issued is
calculated by dividing the accrued quarterly interest by a conversion
price, which was initially established at $8.00 per share. The conversion
price is subject to adjustment in the event of stock splits, dividends and
certain combinations.
Interest expense is recorded quarterly based on the fair value of the
common shares issued. Accordingly, interest expense may fluctuate from
quarter to quarter. We have concluded that the interest feature does not
constitute an embedded derivative as it does not currently meet the
criteria for classification as a derivative. We recorded accrued interest
payable on the Notes of $98,029 within stockholders' equity at December 31,
2004, as the interest is required to be paid quarterly in the form of
common stock. Based on the conversion price of $8.00 per common share, we
issued a total of 61,840 shares of common stock from October 2003 to
October 2004 in satisfaction of the previously recorded interest. We also
issued 13,123 shares of common stock in January 2005 as payment for the
interest accrued as of December 31, 2004.
The Notes contained a beneficial conversion feature reflecting an effective
initial conversion price that was less than the fair market value of the
underlying common stock on July 28, 2003. The fair value of the beneficial
conversion feature was approximately $1.035 million, which has been
recorded as an increase to additional paid-in capital and as an original
issue discount on the Notes which is being amortized to interest expense
over the four year life of the Notes.
After two years from the date of issuance, we have the right to redeem all,
but not less than all, of the Notes at 100% of the remaining principal of
Notes then outstanding, plus all accrued and unpaid interest, under certain
conditions. After three years from the date of issuance, the holder of any
of the Notes may require us to redeem the Notes in whole, but not in part.
Such redemption shall be at 100% of the remaining principal of such Notes,
plus all accrued and unpaid interest. In the event of a Change in Control
(as defined therein), the holder has the option to require that the Notes
be redeemed in whole (but not in part), at 120% of the outstanding unpaid
principal amount, plus all unpaid accrued interest.
In response to the worldwide downturn in the electronics industry, we have
taken a series of actions to reduce operating expenses and to restructure
operations, consisting primarily of reductions in workforce and
consolidation of manufacturing operations. During 2004, we transferred our
high volume automated surface mount assembly line from our Cranston, Rhode
Island facility to China. In August 2004, we announced a new strategic
relationship with Delphi Corporation to supply all multilayer flex and
rigid flex circuits which were previously manufactured by Delphi
Corporation in its Irvine, California facility. We continue to implement
plans to control operating expenses, inventory levels, and capital
expenditures as well as manage accounts payable and accounts receivable to
enhance cash flow and return us to profitability. Our plans include the
following actions: 1) continuing to consolidate manufacturing facilities;
2) continuing to transfer certain manufacturing processes from our domestic
operations to lower cost international manufacturing locations, primarily
those in the People's Republic of China; 3) expanding our products in the
home appliance, cell phone and handheld devices, medical, military and
aerospace, and electronic identification markets; 4) continuing to monitor
general and administrative expenses; and 5) continuing to evaluate
opportunities to improve capacity utilization by either acquiring
multilayer flexible circuit businesses or entering into strategic
relationships for their production.
In fiscal years 2003 and 2004, we entered into a series of alternative
financing arrangements to partially replace or supplement those currently
in place in order to provide us with financing to support our current
working capital needs. Working capital requirements, particularly those to
support the growth in our China operations, consumed $10.4 million of a
total of $11.4 million of cash used in operations during 2004. In September
2004, we secured a new $5.0 million asset based working capital agreement
with the Bank of
30
China which provides stand alone financing for our China operations. In
addition, in May 2004 we received net proceeds of approximately $2.95
million from the sale of our Series A convertible preferred stock. In
December 2004, we entered into a joint venture agreement with Infineon
Technologies Asia Pacific Pte Ltd. Upon execution of the joint venture
agreement, we received a $1.0 million deposit and will receive an
additional $2.0 million once certain People's Republic of China government
approvals are received for the new joint venture company and the
transaction closes. Also in December 2004, we executed a loan modification
with Silicon Valley Bank extending the term to July 2006 and increasing the
borrowing limit to $12.0 million. During the first six months of fiscal
2005, we generated cash flow from operations of approximately $297,000 We
continue to evaluate alternative financing opportunities to further improve
our liquidity and to fund working capital needs.
We believe that our cash on hand and the cash expected to be generated from
operations will be sufficient to enable us to meet our operating
obligations through December 2005. If we require additional or new external
financing to repay or refinance our existing financing obligations or fund
our working capital requirements, we believe that we will be able to obtain
such financing. Failure to obtain such financing may have a material
adverse impact on our operations. At December 31, 2004, we were in
compliance, and we expect to remain in compliance, with all of our financial
covenants associated with our financing arrangements.
Factors That May Affect Future Results
- --------------------------------------
Our prospects are subject to certain uncertainties and risks. Our future
results may differ materially from the current results and actual results
could differ materially from those projected in the forward-looking
statements as a result of certain risk factors, other one-time events and
other important factors disclosed previously and from time to time in our
other filings with the Securities and Exchange Commission.
If we cannot obtain additional financing when needed, we may experience a
material adverse impact on our operations.
We may need to raise additional funds either through borrowings or further
equity financing. We may not be able to raise additional capital on
reasonable terms, or at all. The cash expected to be generated will not be
sufficient to enable us to meet our financing and operating obligations
over the next twelve months based on current growth plans. If we cannot
raise the required funds when needed, we may experience a material adverse
impact on our operations.
Our business has been, and could continue to be, materially adversely
affected as a result of general economic and market conditions.
We are subject to the effects of general global economic and market
conditions. Our operating results have been materially adversely affected
as a result of recent unfavorable economic conditions and reduced
electronics industry spending on both a domestic and worldwide basis.
Though we have experienced some general market spending improvement during
the past quarter, should market conditions not continue to improve, our
business, results of operations or financial condition could continue to be
materially adversely affected.
We have at times relied upon waivers from our lenders and amendments or
modifications to our financing agreements to avoid any acceleration of our
debt payments. In the event that we are not in compliance with our
financial covenants in the future, we cannot be certain our lenders will
grant us waivers or execute amendments on terms, which are satisfactory to
us. If such waivers are not received, our debt is immediately callable.
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Since entering into our current loan arrangement with our primary lender,
Silicon Valley Bank, in June of 2003, we have requested and received
several waivers relating to our failure to comply with certain financial
covenants under our loan arrangement. In conjunction with the waivers, we
have also executed several modifications of our loan arrangement, which
have primarily resulted in easing our covenant compliance requirements, but
have also increased our costs of borrowing. Although we do not believe
Silicon Valley Bank will exercise any right it may have to immediately call
our debt if we fail to comply with our financial covenants, we cannot
guarantee that they will not do so. We are currently in compliance with all
of our financial covenants, as amended.
The issuance of our shares upon conversion of outstanding convertible
notes, conversion of preferred stock and upon exercise of outstanding
warrants may cause significant dilution to our stockholders and may have an
adverse impact on the market price of our common stock.
On July 28, 2003, we completed a private placement of our 7% convertible
subordinated notes (and accompanying warrants) in an aggregate subscription
amount of $6 million. The conversion price of the convertible notes and the
exercise price of the warrants is $8.00 per share. In addition, on June 8,
2004, we completed a private placement of 40,625 shares of our Series A
Convertible Preferred Stock (the "Preferred Stock") (and accompanying
warrants), for $80.00 per share, or $3.25 million in the aggregate. Each
share of Preferred Stock may be converted at any time at the option of the
holder of the Preferred Stock for 10 shares of common stock, and the
exercise price of the warrants is $8.00 per share. For additional
information relating to the sale of the convertible subordinated notes and
related warrants, please see "Market for Registrant's Common Equity and
Related Stockholder Matters - Recent Sales of Unregistered Securities - 7%
Convertible Subordinated Notes and Warrants" in our Form 10-K filing for
the period ended June 30, 2004. For additional information relating to the
sale of Preferred Stock and related warrants, please see "Market for
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities - Series A Preferred Stock and Warrants" in our
Form 10-K filing for the period ended June 30, 2004.
The issuance of our shares upon conversion of the convertible subordinated
notes and/or Preferred Stock, and exercise of the warrants, and their
resale by the holders thereof will increase our publicly traded shares.
These re-sales could also depress the market price of our common stock. We
will not control whether or when the holders of these securities elect to
convert or exercise their securities for common stock. In addition, the
perceived risk of dilution may cause our stockholders to sell their shares,
which would contribute to a downward movement in the stock price of our
common stock. Moreover, the perceived risk of dilution and the resulting
downward pressure on our stock price could encourage investors to engage in
short sales of our common stock. By increasing the number of shares offered
for sale, material amounts of short selling could further contribute to
progressive price declines in our common stock.
Substantial leverage and debt service obligations may adversely affect us.
We have a substantial amount of indebtedness. As of December 31, 2004, we
had approximately $25.0 million of consolidated debt of which $14.0 million
is due within one year. Our substantial level of indebtedness increases the
possibility that we may be unable to generate sufficient cash to pay when
due the principal of, interest on, or other amounts due with respect to our
indebtedness. Approximately 30% of our outstanding indebtedness bears
interest at floating rates. As a result, our interest payment obligations
on such indebtedness will increase if interest rates increase.
Our substantial leverage could have significant negative consequences on
our financial condition, results of operations, and cash flows, including:
* Impairing our ability to meet one or more of the financial ratios
contained in our debt agreements or to generate cash sufficient to pay
interest or principal, including periodic principal amortization
payments,
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which events could result in an acceleration of some or all of our
outstanding debt as a result of cross-default provisions;
* Increasing our vulnerability to general adverse economic and industry
conditions;
* Limiting our ability to obtain additional debt or equity financing;
* Requiring the dedication of a substantial portion of our cash flow from
operations to service our debt, thereby reducing the amount of our cash
flow available for other purposes, including capital expenditures;
* Requiring us to sell debt or equity securities or to sell some of our
core assets, possibly on unfavorable terms, to meet payment obligations;
* Limiting our flexibility in planning for, or reacting to, changes in our
business and the industries in which we compete; and
* Placing us at a possible competitive disadvantage with less leveraged
competitors and competitors that may have better access to capital
resources.
Our credit agreement contains restrictive covenants that could adversely
affect our business by limiting our flexibility.
Our credit agreement imposes restrictions that affect, among other things,
our ability to incur additional debt, pay dividends, sell assets, create
liens, make capital expenditures and investments, merge or consolidate,
enter into transactions with affiliates, and otherwise enter into certain
transactions outside the ordinary course of business. Our credit agreement
also requires us to maintain specified financial ratios and meet certain
financial tests. Our ability to continue to comply with these covenants and
restrictions may be affected by events beyond our control. A breach of any
of these covenants or restrictions would result in an event of default
under our credit agreement. Upon the occurrence of a breach, the lender
under our credit agreement could elect to declare all amounts borrowed
thereunder, together with accrued interest, to be due and payable,
foreclose on the assets securing our credit agreement and/or cease to
provide additional revolving loans or letters of credit, which would have a
material adverse effect on us.
We have incurred losses in each of the last three years, and we may
continue to incur losses.
We incurred net losses in each of the last three fiscal years. We had net
losses of $8.2 million in fiscal year 2004, $19.5 million in fiscal year
2003 and $10.4 million in fiscal year 2002. Our operations may not be
profitable in the future.
If we cannot obtain additional financing when needed, we may not be able to
expand our operations and invest adequately in research and development,
which could cause us to lose customers and market share.
The development and manufacturing of flexible interconnects is capital
intensive. To remain competitive, we must continue to make significant
expenditures for capital equipment, expansion of operations and research
and development. We expect that substantial capital will be required to
expand our manufacturing capacity and fund working capital for anticipated
growth. We may need to raise additional funds either through borrowings or
further equity financing. We may not be able to raise additional capital on
reasonable terms, or at all. If we cannot raise the required funds when
needed, we may not be able to satisfy the demands of existing and
prospective customers and may lose revenue and market share.
33
Our operating results fluctuate and may fail to satisfy the expectations of
public market analysts and investors, causing our stock price to decline.
Our operating results have fluctuated significantly in the past and we
expect our results to continue to fluctuate in the future. Our results may
fluctuate due to a variety of factors, including the timing and volume of
orders from customers, the timing of introductions of and market acceptance
of new products, changes in prices of raw materials, variations in
production yields and general economic trends. It is possible that in some
future periods our results of operations may not meet or exceed the
expectations of public market analysts and investors. If this occurs, the
price of our common stock is likely to decline.
Our quarterly results depend upon a small number of large orders received
in each quarter, so the loss of any single large order could adversely
impact quarterly results and cause our stock price to drop.
A substantial portion of our sales in any given quarter depends on
obtaining a small number of large orders for products to be manufactured
and shipped in the same quarter in which the orders are received. Although
we attempt to monitor our customers' needs, we often have limited knowledge
of the magnitude or timing of future orders. It is difficult for us to
reduce spending on short notice on operating expenses such as fixed
manufacturing costs, development costs and ongoing customer service. As a
result, a reduction in orders, or even the loss of a single large order,
for products to be shipped in any given quarter could have a material
adverse effect on our quarterly operating results. This, in turn, could
cause our stock price to decline.
Because we sell a substantial portion of our products to a limited number
of customers, the loss of a significant customer or a substantial reduction
in orders by any significant customer would adversely impact our operating
results.
Historically we have sold a substantial portion of our products to a
limited number of customers. Our 20 largest customers based on sales
accounted for approximately 52% of total revenues in fiscal year 2004, 50%
of total revenues in fiscal year 2003, and 44% in fiscal year 2002.
We expect that a limited number of customers will continue to account for a
high percentage of our total revenues in the foreseeable future. As a
result, the loss of a significant customer or a substantial reduction in
orders by any significant customer would cause our revenues to decline and
have an adverse effect on our operating results.
If we are unable to respond effectively to the evolving technological
requirements of customers, our products may not be able to satisfy the
demands of existing and prospective customers and we may lose revenues and
market share.
The market for our products is characterized by rapidly changing technology
and continuing process development. The future success of our business will
depend in large part upon our ability to maintain and enhance our
technological capabilities. We will need to develop and market products
that meet changing customer needs, and successfully anticipate or respond
to technological changes on a cost-effective and timely basis. There can be
no assurance that the materials and processes that we are currently
developing will result in commercially viable technological processes, or
that there will be commercial applications for these technologies. In
addition, we may not be able to make the capital investments required to
develop, acquire or implement new technologies and equipment that are
necessary to remain competitive. If we fail to keep pace with technological
change, our products may become less competitive or obsolete and we may
lose customers and revenues.
Competing technologies may reduce demand for our products.
34
Flexible circuit and laminated cable interconnects provide electrical
connections between components in electrical systems and are used as a
platform to support the attachment of electronic devices. While flexible
circuits and laminated cables offer several advantages over competing
printed circuit board and ceramic hybrid circuit technologies, our
customers may consider changing their designs to use these alternative
technologies in future applications. If our customers switch to alternative
technologies, our business, financial condition and results of operations
could be materially adversely affected. It is also possible that the
flexible interconnect industry could encounter competition from new
technologies in the future that render existing flexible interconnect
technology less competitive or obsolete.
We are heavily dependent upon certain target markets for domestic
manufacturing. A slowdown in these markets could have a material impact on
domestic capacity utilization resulting in lower sales and gross margins.
We manufacture our products in seven facilities worldwide, including lower
cost offshore locations in China. However, a significant portion of our
manufacturing is still performed domestically. Domestic manufacturing may
be at a competitive disadvantage with respect to price when compared to
lower cost facilities in Asia and other locations. While historically our
competitors in these locations have produced less technologically advanced
products, they continue to expand their capabilities. Further, we have
targeted markets that have historically sought domestic manufacturing,
including the military and aerospace markets. Should we be unsuccessful in
maintaining our competitive advantage or should certain target markets also
move production to lower cost offshore locations, our domestic sales will
decline resulting in significant excess capacity and reduced gross margins.
A significant downturn in any of the sectors in which we sell products
could result in a revenue shortfall.
We sell our flexible interconnect products principally to the automotive,
telecommunications and networking, diversified electronics, military, home
appliance, electronic identification and computer markets. The worldwide
electronics industry has seen a substantial downturn since 2001 impacting a
number of our target markets. Although we serve a variety of markets to
avoid a dependency on any one sector, a significant further downturn in any
of these market sectors could cause a material reduction in our revenues,
which could be difficult to replace.
We rely on a limited number of suppliers, and any interruption in our
primary sources of supply, or any significant increase in the prices of
materials, chemicals or components, would have an adverse effect on our
short-term operating results.
We purchase the bulk of our raw materials, process chemicals and components
from a limited number of outside sources. In fiscal year 2004, we purchased
approximately 21% of our materials from Tongxing, a Chinese gold plater,
and Northfield Acquisition Co., doing business as Sheldahl, our two largest
suppliers. We operate under tight manufacturing cycles with a limited
inventory of raw materials. As a result, although there are alternative
sources of the materials that we purchase from our existing suppliers, any
unanticipated interruption in supply from Tongxing or Sheldahl, or any
significant increase in the prices of materials, chemicals or components,
would have an adverse effect on our short-term operating results.
The additional expenses and risks related to our existing international
operations, as well as any expansion of our global operations, could
adversely affect our business.
We own a 90.1% equity interest in our investment in China, Parlex Shanghai,
which manufactures and sells flexible circuits. We also operate a facility
in Mexico for use in the finishing, assembly and testing of flexible
circuit and laminated cable products. We have a facility in the United
Kingdom where we manufacture polymer thick film flexible circuits and
polymer thick film flexible circuits with surface
35
mounted components and intend to introduce production of laminated cable
within the next year. We will continue to explore appropriate expansion
opportunities as demand for our products increases.
Manufacturing and sales operations outside the United States carry a number
of risks inherent in international operations, including: imposition of
governmental controls, regulatory standards and compulsory licensure
requirements; compliance with a wide variety of foreign and U.S. import and
export laws; currency fluctuations; unexpected changes in trade
restrictions, tariffs and barriers; political and economic instability;
longer payment cycles typically associated with foreign sales; difficulties
in administering business overseas; foreign labor issues; wars and acts of
terrorism; and potentially adverse tax consequences. Although these issues
have not materially impacted our revenues or operations to date, we cannot
guarantee that they will not impact our revenues or operations in the
future.
International expansion may require significant management attention, which
could negatively affect our business. We may also incur significant costs
to expand our existing international operations or enter new international
markets, which could increase operating costs and reduce our profitability.
We face significant competition, which could make it difficult for us to
acquire and retain customers.
We face competition worldwide in the flexible interconnect market from a
number of foreign and domestic providers, as well as from alternative
technologies such as rigid printed circuits. Many of our competitors are
larger than we are and have greater financial resources. New competitors
could also enter our markets. Our competitors may be able to duplicate our
strategies, or they may develop enhancements to, or future generations of,
products that could offer price or performance features that are superior
to our products. Competitive pressures could also necessitate price
reductions, which could adversely affect our operating results. In
addition, some of our competitors are based in foreign countries and have
cost structures and prices based on foreign currencies. Accordingly,
currency fluctuations could cause our dollar-priced products to be less
competitive than our competitors' products priced in other currencies.
We will need to make a continued high level of investment in product
research and development, sales and marketing and ongoing customer service
and support in order to remain competitive. We may not have sufficient
resources to be able to make these investments. Moreover, we may not be
able to make the technological advances necessary to maintain our
competitive position in the flexible interconnect market.
We face risks from fluctuations in the value of foreign currency versus the
U.S. dollar and the cost of currency exchange.
While we transact business predominantly in U.S. dollars, a large portion
of our sales and expenses are denominated in foreign currencies, primarily
the Chinese Renminbi ("RMB"), the basic unit of currency issued by the
People's Bank of China. Currently, our exposure to risk from foreign
exchange is limited due to the fact that the People's Republic of China has
fixed the exchange rate of the Renminbi to the U.S. dollar. The value of
the Renminbi is subject to changes in the PRC government's policies and
depends to an extent on its domestic and international economic and
political developments, as well as supply and demand in the local market.
We cannot give any assurance that the Renminbi will continue to remain
stable against the U.S. dollar and other foreign currencies. Any
devaluation of the Renminbi may adversely affect our results of operations.
In addition, a small portion of our sales and expenses are denominated in
Euros and the British Pound. Changes in the relation of foreign currencies
to the U.S. dollar will affect our cost of sales and operating margins and
could result in exchange losses. We do not enter into foreign exchange
contracts to reduce our exposure to these risks.
If we are unable to attract, retain and motivate key personnel, we may not
be able to develop, sell and support our products and our business may lack
strategic direction.
36
We are dependent upon key members of our management team. In addition, our
future success will depend in large part upon our continuing ability to
attract, retain and motivate highly qualified managerial, technical and
sales personnel. Competition for such personnel is intense, and there can
be no assurance that we will be successful in hiring or retaining such
personnel. We currently maintain a key person life insurance policy in the
amount of $1.0 million on Peter J. Murphy. If we lose the services of Mr.
Murphy or one or more other key individuals, or are unable to attract
additional qualified members of the management team, our ability to
implement our business strategy may be impaired. If we are unable to
attract, retain and motivate qualified technical and sales personnel, we
may not be able to develop, sell and support our products.
If we are unable to protect our intellectual property, our competitive
position could be harmed and our revenues could be adversely affected.
We rely on a combination of patent and trade secret laws and non-disclosure
and other contractual agreements to protect our proprietary rights. We own
20 patents issued and have 8 patent applications pending in the United
States and have several corresponding foreign patent applications pending.
Our existing patents may not effectively protect our intellectual property
and could be challenged by third parties, and our future patent
applications, if any, may not be approved. In addition, other parties may
independently develop similar or competing technologies. Competitors may
attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. If we fail to adequately protect our
proprietary rights, our competitors could offer similar products using
materials, processes or technologies developed by us, potentially harming
our competitive position and our revenues.
If we become involved in a protracted intellectual property dispute, or one
with a significant damages award or which requires us to cease selling some
of our products, we could be subject to significant liability and the time
and attention of our management could be diverted.
Although no claims have been asserted against us for infringement of the
proprietary rights of others, we may be subject to a claim of infringement
in the future. An intellectual property lawsuit against us, if successful,
could subject us to significant liability for damages and could invalidate
our proprietary rights. A successful lawsuit against us could also force us
to cease selling, or redesign, products that incorporate the infringed
intellectual property. We could also be required to obtain a license from
the holder of the intellectual property to use the infringed technology. We
might not be able to obtain a license on reasonable terms, or at all. If we
fail to develop a non-infringing technology on a timely basis or to license
the infringed technology on acceptable terms, our revenues could decline
and our expenses could increase.
We may, in the future, be required to initiate claims or litigation against
third parties for infringement of our proprietary rights or to determine
the scope and validity of our proprietary rights or the proprietary rights
of competitors. Litigation with respect to patents and other intellectual
property matters could result in substantial costs and divert our
management's attention from other aspects of our business.
Market prices of technology companies have been highly volatile, and our
stock price may be volatile as well.
From time to time the U.S. stock market has experienced significant price
and trading volume fluctuations, and the market prices for the common stock
of technology companies in particular have been extremely volatile. In the
past, broad market fluctuations that have affected the stock price of
technology companies have at times been unrelated or disproportionate to
the operating performance of these companies. Any significant fluctuations
in the future might result in a material decline in the market price of our
common stock.
37
Following periods of volatility in the market price of a particular
company's securities, securities class action litigation has often been
brought against that company. If we were to become involved in this type of
litigation, we could incur substantial costs and diversion of management's
attention, which could harm our business, financial condition and operating
results.
The costs of complying with existing or future environmental regulations,
and of curing any violations of these regulations, could increase our
operating expenses and reduce our profitability.
We are subject to a variety of environmental laws relating to the storage,
discharge, handling, emission, generation, manufacture, use and disposal of
chemicals, solid and hazardous waste and other toxic and hazardous
materials used to manufacture, or resulting from the process of
manufacturing, our products. We cannot predict the nature, scope or effect
of future regulatory requirements to which our operations might be subject
or the manner in which existing or future laws will be administered or
interpreted. Future regulations could be applied to materials, products or
activities that have not been subject to regulation previously. The costs
of complying with new or more stringent regulations, or with more vigorous
enforcement of these regulations, could be significant.
Environmental laws require us to maintain and comply with a number of
permits, authorizations and approvals and to maintain and update training
programs and safety data regarding materials used in our processes.
Violations of these requirements could result in financial penalties and
other enforcement actions. We could also be required to halt one or more
portions of our operations until a violation is cured. Although we attempt
to operate in compliance with these environmental laws, we may not succeed
in this effort at all times. The costs of curing violations or resolving
enforcement actions that might be initiated by government authorities could
be substantial.
Undetected problems in our products could directly impair our financial
results.
If flaws in design, production, assembly or testing of our products were to
occur by us or our suppliers, we could experience a rate of failure in our
products that would result in substantial repair or replacement costs and
potential damage to our reputation. Continued improvement in manufacturing
capabilities, control of material and manufacturing quality, and costs and
product testing, are critical factors in our future growth. There can be no
assurance that our efforts to monitor, develop, modify and implement
appropriate test and manufacturing processes for our products will be
sufficient to permit us to avoid a rate of failure in our products that
results in substantial delays in shipment, significant repair or
replacement costs, or potential damage to our reputation, any of which
could have a material adverse effect on our business, results of operations
or financial condition.
Our stock is thinly traded.
Our stock is thinly traded and you may have difficulty in reselling your
shares quickly. The low trading volume of our common stock is outside of
our control, and we cannot guarantee that trading volume will increase in
the near future.
We do not expect to pay dividends in the foreseeable future.
We have never paid cash dividends on our common stock and we do not expect
to pay cash dividends on our common stock any time in the foreseeable
future. In addition, our current financing agreements prohibit the payment
of dividends. The future payment of dividends directly depends upon our
future earnings, capital requirements, financial requirements and other
factors that our board of directors will consider. For the foreseeable
future, we will use earnings from operations, if any, to finance our
growth, and we will not pay dividends to our common stockholders. You
should not rely on an investment in our common stock if
38
you require dividend income. The only return on your investment in our
common stock, if any, would most likely come from any appreciation of our
common stock.
We may have exposure to additional income tax liabilities.
As a multinational corporation, we are subject to income taxes in both the
United States and various foreign jurisdictions. Our domestic and
international tax liabilities are subject to the allocation of revenues and
expenses in different jurisdictions and the timing of recognizing revenues
and expenses. Additionally, the amount of income taxes paid is subject to
our interpretation of applicable tax laws in the jurisdictions in which we
file. From time to time, we are subject to income tax audits. While we
believe we have complied with all applicable income tax laws, there can be
no assurance that a governing tax authority will not have a different
interpretation of the law and assess us with additional taxes. Should we be
assessed with significant additional taxes, there could be a material
adverse affect on our results of operations or financial condition.
We could use preferred stock to resist takeovers, and the issuance of
preferred stock may cause additional dilution.
Our Articles of Organization authorizes the issuance of up to 1,000,000
shares of preferred stock, of which 40,625 shares are issued and
outstanding as a result of our preferred stock offering completed in June
2004. Our Articles of Organization gives our board of directors the
authority to issue preferred stock without approval of our stockholders. We
may issue additional shares of preferred stock to raise money to finance
our operations. We may authorize the issuance of the preferred stock in one
or more series. In addition, we may set the terms of preferred stock,
including:
* dividend and liquidation preferences;
* voting rights;
* conversion privileges;
* redemption terms; and
* other privileges and rights of the shares of each authorized series.
The issuance of large blocks of preferred stock could possibly have a
dilutive effect to our existing stockholders. It can also negatively impact
our existing stockholders' liquidation preferences. In addition, while we
include preferred stock in our capitalization to improve our financial
flexibility, we could possibly issue our preferred stock to friendly third
parties to preserve control by present management. This could occur if we
become subject to a hostile takeover that could ultimately benefit Parlex
and Parlex's stockholders.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------------------------------------------------------------------
The following discussion about our market risk disclosures involves forward-
looking statements. Actual results could differ materially from those
projected in the forward-looking statements.
We are exposed to market risk related to changes in U.S. and foreign interest
rates and fluctuations in exchange rates. We do not use derivative financial
instruments.
39
Interest Rate Risk
Our primary bank facility bears interest at our lender's prime rate plus
2.0%. We also have a subsidiary bank note for $1,500,000 at LIBOR plus 2.5%.
The prime rate is affected by changes in market interest rates. These
variable rate lending facilities create exposure for us relating to interest
rate risk; however, we do not believe our interest rate risk to be material.
As of December 31, 2004, we had an outstanding balance under our primary bank
facility of $5,942,000 and an outstanding balance of $1,500,000 under our
subsidiary note. A hypothetical 10% change in interest rates would impact
interest expense by approximately $51,000 over the next fiscal year, and such
amount would not have a material effect on our financial position, results of
operations and cash flows.
The remainder of our long-term debt bears interest at fixed rates and is
therefore not subject to interest rate risk.
Currency Risk
Sales of Parlex Shanghai, Parlex Interconnect, Poly-Flex Circuits Limited and
Parlex Europe are typically denominated in the local currency, which is also
each company's functional currency. This creates exposure to changes in
exchange rates. The changes in the Chinese/U.S. and U.K./U.S. exchange rates
may positively or negatively impact our sales, gross margins and retained
earnings. Based upon the current volume of transactions in China and the
United Kingdom and the stable nature of the exchange rate between China and
the U.S., we do not believe the market risk is material. We do not engage in
regular hedging activities to minimize the impact of foreign currency
fluctuations. Parlex Shanghai and Parlex Interconnect had combined net assets
as of December 31, 2004 of approximately $21.1 million. Poly-Flex Circuits
Limited and Parlex Europe had combined net assets as of December 31, 2004 of
approximately $6.2 million. We believe that a 10% change in exchange rates
would not have a significant impact upon our financial position, results of
operation or outstanding debt. As of December 31, 2004, Parlex Shanghai and
Parlex Interconnect had combined outstanding debt of approximately
$7.7 million. As of December 31, 2004, Poly-Flex Circuits Limited had no
outstanding debt.
Item 4. Controls and Procedures
- -------------------------------
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the reports that we are
required to file under the Securities and Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our principal executive officer
and our principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. Management necessarily applied its
judgment in assessing the costs and benefits of such controls and
procedures, which, by their nature, can provide only reasonable assurance
regarding management's control objectives. Management believes that there
are reasonable assurances that our controls and procedures will achieve
management's control objectives.
We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
our Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Exchange
Act Rule 13a-15 as of December 31, 2004. Based upon the foregoing, our
Chief Executive Officer and our Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to Parlex (and its consolidated subsidiaries)
required to be included in our Exchange Act reports.
40
Changes in Internal Controls Over Financial Reporting
There have been no changes in our internal control over financial reporting
during our most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
41
PART II - OTHER INFORMATION
---------------------------
Item 4. Submission of Matters to a Vote of Security Holders
(a) Parlex's Annual Meeting of Stockholders was held on November 23, 2004.
There was no solicitation in opposition to management's nominees as listed
in our proxy statement and all such nominees were elected as Class I
directors for a three-year term.
(b) At the Annual Meeting, stockholders elected the following Class I
directors whose terms expire in 2007:
Name For Withheld
Lester Pollack 5,461,294 847,453
Richard W. Hale 6,293,652 15,095
Lynn J. Davis 6,272,452 36,295
The following directors' terms continued after the 2004 Annual Meeting:
Peter J. Murphy, Herbert W. Pollack, Sheldon Buckler and Russell D. Wright.
Item 6. EXHIBITS
Exhibits - See Exhibit Index to this report.
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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.
PARLEX CORPORATION
------------------
By: /s/ Peter J. Murphy
-------------------------------------
Peter J. Murphy
President and Chief Executive Officer
By: /s/ Jonathan R. Kosheff
-------------------------------------
Jonathan R. Kosheff
Treasurer & CFO
(Principal Accounting and Financial Officer)
February 14, 2005
-----------------
Date
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EXHIBIT INDEX
EXHIBIT DESCRIPTION OF EXHIBIT
- ------- ----------------------
10.1 Seventh Loan Modification Agreement, dated December 22, 2004 by
and between Parlex Corporation and Silicon Valley Bank (filed
herewith)
31.1 Certification of Registrant's Chief Executive Officer required
by Rule 13a-14(a) (filed herewith)
31.2 Certification of Registrant's Chief Financial Officer required
by Rule 13a-14(a) (filed herewith)
32.1 Certification of Registrant's Chief Executive Officer pursuant
To 18 U.S.C. 1350 (furnished herewith)
32.2 Certification of Registrant's Chief Financial Officer pursuant
To 18 U.S.C. 1350 (furnished herewith)
44