===========================================================================
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 March 31, 2005
[ ] 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 May
9, 2005 was 6,475,302 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 - March 31, 2005 and
June 30, 2004 3
Condensed Consolidated Statements of Operations - For the
Three and Nine Months Ended March 31, 2005 and March 28, 2004 4
Condensed Consolidated Statements of Cash Flows - For the
Nine Months Ended March 31, 2005 and March 28, 2004 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 40
Item 4. Controls and Procedures 40
Part II - Other Information
Item 3. Defaults Upon Senior Securities 42
Item 6. Exhibits 42
Signatures 43
Exhibit Index 44
2
PARLEX CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
- ---------------------------------------------------------------------------
ASSETS March 31, 2005 June 30, 2004
CURRENT ASSETS:
Cash and cash equivalents $ 3,940,821 $ 1,626,275
Accounts receivable - net 21,731,710 21,999,646
Inventories - net 23,182,945 20,326,134
Refundable income taxes 38,602 380,615
Deferred income taxes 42,958 42,958
Other current assets 2,462,462 2,381,471
------------ ------------
Total current assets 51,399,498 46,757,099
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - NET 42,681,911 44,979,740
INTANGIBLE ASSETS - NET 30,550 32,746
GOODWILL - NET 1,157,510 1,157,510
DEFERRED INCOME TAXES 40,000 40,000
OTHER ASSETS - NET 1,781,888 2,283,136
------------ ------------
TOTAL $ 97,091,357 $ 95,250,231
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 14,341,766 $ 12,861,077
Accounts payable 17,186,468 16,479,547
Dividends payable 66,113 39,317
Accrued liabilities 5,251,594 4,277,587
------------ ------------
Total current liabilities 36,845,941 33,657,528
------------ ------------
LONG-TERM DEBT 13,466,033 10,534
------------ ------------
OTHER NONCURRENT LIABILITIES 831,027 1,025,091
------------ ------------
MINORITY INTEREST IN PARLEX SHANGHAI 687,971 570,963
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value - 1,000,000 shares
authorized; 40,625 shares issued and outstanding 40,625 40,625
Common stock, $.10 par value - 30,000,000 shares
authorized; 6,462,179 shares issued and outstanding
at March 31, 2005; 6,632,810 shares issued and
6,422,810 shares outstanding at June 30, 2004 646,218 663,281
Accrued interest payable in common stock 83,331 87,924
Additional paid-in capital 66,012,012 66,979,397
Accumulated deficit (22,293,392) (17,771,307)
Accumulated other comprehensive income 771,591 499,675
Less treasury stock, at cost - (1,037,625)
------------ ------------
Total stockholders' equity 45,260,385 49,461,970
------------ ------------
TOTAL $ 97,091,357 $ 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 Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
-------------- -------------- -------------- --------------
REVENUES: $29,132,080 $23,164,660 $90,822,846 $66,428,184
COSTS AND EXPENSES:
Cost of products sold 26,502,577 21,258,693 79,527,348 59,536,501
Selling, general and administrative expenses 4,119,467 3,817,667 13,338,451 11,517,407
----------- ----------- ----------- -----------
Total costs and expenses 30,622,044 25,076,360 92,865,799 71,053,908
----------- ----------- ----------- -----------
OPERATING LOSS (1,489,964) (1,911,700) (2,042,953) (4,625,724)
INTEREST INCOME (EXPENSE)
Interest income 16,935 2,031 56,803 9,052
Interest expense (761,781) (642,173) (2,298,468) (1,839,678)
----------- ----------- ----------- -----------
LOSS BEFORE INCOME TAXES
AND MINORITY INTEREST (2,234,810) (2,551,842) (4,284,618) (6,456,350)
PROVISION FOR INCOME TAXES (4,754) (47,858) (120,460) (47,858)
----------- ----------- ----------- -----------
LOSS BEFORE MINORITY INTEREST (2,239,564) (2,599,700) (4,405,078) (6,504,208)
MINORITY INTEREST (36,110) 9,624 (117,008) (100,133)
----------- ----------- ----------- -----------
NET LOSS (2,275,674) (2,590,076) (4,522,086) (6,604,341)
PREFERRED STOCK DIVIDENDS (66,113) - (201,279) -
----------- ----------- ----------- -----------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $(2,341,787) $(2,590,076) $(4,723,365) $(6,604,341)
=========== =========== =========== ===========
BASIC AND DILUTED NET LOSS PER SHARE $ (0.36) $ (0.40) $ (0.73) $ (1.04)
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 6,461,887 6,409,110 6,448,864 6,351,243
=========== =========== =========== ===========
See notes to unaudited condensed consolidated financial statements.
4
PARLEX CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
- ---------------------------------------------------------------------------
Nine Months Ended
March 31, 2005 March 28, 2004
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,522,086) $ (6,604,341)
------------ ------------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Non-cash operating items:
Depreciation of property, plant and equipment 4,086,373 4,127,103
Amortization of deferred loss on sale-leaseback,
deferred financing costs and intangible assets 855,252 749,546
Interest payable in common stock 249,862 254,948
Minority interest 117,008 100,133
Gain on sale of China land use rights - (86,531)
Changes in current assets and liabilities:
Accounts receivable - net 368,648 (2,991,203)
Inventories - net (2,776,479) (2,739,505)
Refundable income taxes 367,328 144,776
Other assets 371,657 (819,826)
Accounts payable and accrued liabilities (580,750) (1,339,997)
------------ ------------
Net cash used in operating activities (1,463,187) (9,204,897)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of China land use rights - 1,179,145
Additions to property, plant and equipment and other assets (706,752) (484,485)
------------ ------------
Net cash (used in) provided by investing activities (706,752) 694,660
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of warrants - 600,000
Proceeds from bank loans 76,328,433 46,430,209
Payment of bank loans (74,848,723) (43,167,484)
Payment of capital lease (80,401) (9,104)
Payment of Methuen sale-leaseback financing obligation (168,797) (229,452)
Cash received for interest on sale-leaseback note receivable 85,372 99,378
Proceeds from sale-leaseback note receivable 1,900,000 -
Proceeds from sale-leaseback earnout provision 275,000 -
Proceeds from other notes, payable 179,249 -
Repayment of other notes, payable (46,391) -
Dividend paid to series A preferred stock investors (174,482) -
Receipt of joint venture deposit 1,000,000 -
Proceeds from convertible note, net of costs - 5,472,002
------------ ------------
Net cash provided by financing activities 4,449,260 9,195,549
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 35,225 43,109
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,314,546 728,421
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,626,275 1,513,523
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,940,821 $ 2,241,944
============ ============
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 $ 952,493 $ 1,696,044
============ ============
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 $ 254,456 $ 254,948
============ ============
Sale-leaseback earnout proceeds placed in escrow $ 400,000 $ -
============ ============
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
March 31, 2005 and the results of operations and cash flows for the
three and nine months ended March 31, 2005 and March 28, 2004. 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 condensed consolidated financial statements, the
Company incurred net losses of $4,522,086 and $6,604,341 and used cash
of $1,463,187 and $9,204,897 in operations for the nine months ended
March 31, 2005 and March 28, 2004, respectively. In addition, the
Company had an accumulated deficit of $22,293,392 at March 31, 2005.
As of March 31, 2005, the Company had a cash balance of $3,940,821.
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 venture company and the transaction closes (see Note 14).
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
6
2006 and increasing the borrowing limit from $10.0 million to $12.0
million. In February 2005, the landlord for the Company's Methuen,
Massachusetts facility completed the sale of the property to a third
party. Under the terms of the transaction, the Company received cash
of approximately $2.2 million. The proceeds represented repayment of
the outstanding financing the Company originally provided under the
initial sale-leaseback transaction and a settlement of amounts due
under terms of an earn out provision (see Note 8). During the first
nine months ended March 31, 2005, the Company used cash in operations
of approximately $1,463,000. 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 March 2006. 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 March 31, 2005, the
Company was not in compliance with certain financial covenants of its
loan agreement with SVB. The Company has received a waiver from the
bank of its non-compliance at March 31, 2005 and the bank has continued
to allow the Company to borrow against the loan agreement.
2. 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 Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
Net loss attributable to common stockholders $(2,341,787) $(2,590,076) $(4,723,365) $(6,604,341)
Add stock-based compensation expense
included in reported net loss - - - -
Deduct stock-based compensation expense
determined under the fair-value method (96,000) (158,000) (276,000) (520,000)
----------- ----------- ----------- -----------
Net loss - attributable to common stockholders -
pro forma $(2,437,787) $(2,748,076) $(4,999,365) $(7,124,341)
=========== =========== =========== ===========
Basic and diluted net loss per share - as reported $ (0.36) $ (0.40) $ (0.73) $ (1.04)
Basic and diluted net loss per share - pro forma $ (0.38) $ (0.43) $ (0.78) $ (1.12)
7
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 Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
Average risk-free interest rate 3.0% 3.3% 3.0% 3.5%
Expected life of option grants 3.5 years 3.5 years 3.5 years 3.5 years
Expected volatility of underlying stock 69% 71% 69% 78%
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 Company's
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.
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 Months Ended March 31, 2005 Nine Months Ended March 31, 2005
Weighted- Weighted-
Shares Average Shares Average
Under Exercise Under Exercise
Option Price Option Price
Outstanding options at beginning of period 677,775 $11.29 567,775 $12.54
Granted 2,000 6.69 132,500 5.99
Cancelled 5,000 14.37 25,500 12.54
Exercised - - - -
------- ------ ------- ------
Outstanding options at end of period 674,775 $11.25 674,775 $11.25
======= ====== ======= ======
Exercisable options at end of period 400,442 $13.37 400,442 $13.37
======= ====== ======= ======
Weighted average fair value of options
granted during the period $ 3.31 $2.98
====== =====
8
The following table presents weighted-average price and life
information about significant option groups outstanding and
exercisable at March 31, 2005:
Options Outstanding Options Exercisable
------------------------------------------ -------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Number Average
Exercise Number Contractual Exercise of Shares Exercise
Prices Outstanding Life (Years) Price Exercisable Price
$ 0.00 - $5.95 13,500 4.3 $ 5.55 7,500 $ 5.67
5.96 - 7.00 131,000 9.1 6.04 4,500 6.67
7.01 - 9.00 88,000 8.4 8.39 26,500 8.39
9.01 - 11.00 47,000 6.8 10.26 30,500 10.26
11.01 - 12.00 81,900 7.3 11.51 40,950 11.51
12.01 - 12.25 52,500 6.0 12.06 52,500 12.06
12.26 - 13.00 105,500 5.6 12.48 82,617 12.47
13.01 - 16.00 35,125 3.5 13.93 35,125 13.93
16.01 - 18.00 55,750 4.4 16.25 55,750 16.25
18.01 - 22.00 64,500 2.6 18.88 64,500 18.88
------- --- ------ ------- ------
$ 0.00 - $22.00 674,775 6.4 $11.25 400,442 $13.37
======= === ====== ======= ======
3. 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:
March 31, June 30,
2005 2004
Raw materials $10,725,952 $ 8,729,132
Work in process 10,591,265 9,444,722
Finished goods 4,792,416 5,049,796
----------- -----------
Total cost 26,109,633 23,223,650
Reserve for obsolescence (2,926,688) (2,897,516)
----------- -----------
Inventory, net $23,182,945 $20,326,134
=========== ===========
9
4. 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:
March 31, June 30,
2005 2004
Land and land improvements $ 589,872 $ 589,872
Buildings 18,543,295 18,543,295
Machinery and equipment 64,259,307 64,348,226
Leasehold improvements and other 6,967,567 6,695,173
Construction in progress 3,979,662 2,902,141
------------ ------------
Total cost 94,339,703 93,078,707
Less: accumulated depreciation (51,657,792) (48,098,967)
------------ ------------
Property, plant and equipment, net $ 42,681,911 $ 44,979,740
============ ============
5. Intangible Assets
-----------------
Intangible assets consisted of:
March 31, June 30,
2005 2004
Patents $ 58,560 $ 58,560
Accumulated amortization (28,010) (25,814)
-------- --------
Intangible assets, net $ 30,550 $ 32,746
======== ========
The Company has reassessed the remaining useful lives of the
intangible assets at March 31, 2005 and determined the useful lives
are appropriate in determining amortization expense. Amortization
expense for the nine months ended March 31, 2005 and March 28, 2004
was $2,196 and $3,913, respectively.
10
6. Other Assets
------------
Other assets consisted of:
March 31, June 30,
2005 2004
Deferred loss on sale-leaseback of Poly-Flex Facility, net $ 881,533 $1,087,606
Deferred financing costs on sale-leaseback of Methuen facility (see Note 7) 363,575 361,700
Deferred financing costs on the Loan and Security Agreement (see Note 7) 335,402 267,722
Deferred financing costs on Convertible Subordinated Note (see Note 7) 673,930 673,930
Other 56,968 160,650
---------- ----------
Total cost 2,311,408 2,551,608
Less: accumulated amortization (529,520) (268,472)
---------- ----------
Total Other Assets, net $1,781,888 $2,283,136
========== ==========
In 2003, Poly-Flex sold its operating facility in Cranston, Rhode
Island and 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 $206,000 for the nine months ended March 31, 2005 and
March 28, 2004.
Amortization of deferred financing costs was $261,000 and $196,000
for the nine months ended March 31, 2005 and March 28, 2004,
respectively.
7. Accrued Liabilities - Facility Exit Costs
-----------------------------------------
The following is a summary of the facility exit costs activity during
the nine months ended March 31, 2005:
Facility Facility
Exit Costs FY2005 Activity Exit Costs
Accrued Cash Accrued
June 30, 2004 Payments March 31, 2005
------------- --------------- --------------
Total facility refurbishment costs $136,952 $(7,962) $128,990
The remaining accrued facility exit costs at March 31, 2005 represent
the estimated costs to refurbish the facility. The Company expects
the balance of accrued facility exit costs at March 31, 2005 to be
paid by the end of fiscal 2005.
11
8. Long-term Debt
--------------
Long-term debt consisted of:
March 31, June 30,
2005 2004
Loan and Security Agreement $ 3,951,182 $ 3,618,091
Parlex Shanghai term notes 7,662,569 8,870,792
Parlex Interconnect term note 604,120 -
Parlex Asia banking facility 1,750,829 -
Finance obligation on sale-leaseback of Methuen Facility 8,400,820 5,909,245
Convertible Subordinated Note 4,792,482 4,404,351
Other 645,797 593,277
----------- -----------
Total long-term debt 27,807,799 23,395,756
Less: current portion of long-term debt 14,341,766 12,861,077
----------- -----------
Long-term debt $13,466,033 $10,534,679
=========== ===========
A summary of the current portion of our long-term debt described
above is as follows:
March 31, June 30,
2005 2004
Loan and Security Agreement $ 3,951,182 $ 3,618,091
Parlex Shanghai term notes 7,662,569 8,870,792
Parlex Interconnect term note 604,120 -
Parlex Asia banking facility 1,750,829 -
Finance obligation on sale-leaseback of Methuen Facility 136,960 263,849
Other 236,106 108,345
----------- -----------
Total current portion of long-term debt $14,341,766 $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 eight amendments to the
Loan Agreement. The Loan Agreement provided Silicon Valley Bank with
a secured interest in 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 March 31, 2005, 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 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
12
receivable 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 (5.75% at March 31, 2005)
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 as of the period ending
December 31, 2004 and each month thereafter until May 31, 2005 and to
$750,000 on a three month trailing basis as of the period ending June
30, 2005 and each month thereafter. The Seventh Modification
Agreement also extended the maturity date of the Loan Agreement from
July 11, 2005 to July 11, 2006. On May 10, 2005, the Company
executed an Eighth Loan Modification Agreement (the "Eighth
Modification Agreement") with Silicon Valley Bank. The Eighth
Modification Agreement changed the EBITDA requirement to $1.00 on a
monthly basis as of the period ending April 30, 2005 and May 31, 2005
and $750,000 on a trailing three month basis as of the period ending
June 30, 2005 and each month thereafter. As of March 31, 2005, the
Company was not in compliance with certain Loan Agreement financial
covenants. The Company has received a waiver from bank of its non-
compliance at March 31, 2005, and the bank has continued to allow the
Company to borrow against the Loan Agreement. At March 31, 2005, the
Company had available borrowing capacity under the Loan Agreement of
approximately $4.8 million. As the available borrowing capacity
exceeded $750,000 at March 31, 2005, none of the Company's cash
balance was subject to restriction at March 31, 2005.
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 March 31, 2005 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 - A summary of the Parlex Shanghai term
notes are as follows:
March 31, 2005
(in millions)
Due March 2006 at 5.58% and guaranteed by Parlex Interconnect $2.5
Due January 2006 at LIBOR plus 2.5% and guaranteed by Parlex Asia 1.5
Due June 2005 at 5.58% and guaranteed by Parlex Interconnect 1.3
Due June 2005 at 5.58% and guaranteed by Parlex Interconnect 1.0
Due April 2005 at 5.31% and guaranteed by Parlex Interconnect 0.7
Due March 2006 at 5.58% and guaranteed by Parlex Interconnect 0.6
----
Total Parlex Shanghai term notes $7.6
====
Subsequent to March 31, 2005, Parlex Shanghai renewed its $700,000
short-term note due April 2005. The note has been extended until
April 2006 at an interest rate of 5.58%.
Parlex Interconnect Term Note - 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.
13
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%. Amounts outstanding as of March
31, 2005 totaled $1.8 million.
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 (the "Earn Out"). In June
2004, Parlex received $750,000 reducing the principal balance of the
Note to $1.9 million. On February 25, 2005, the landlord sold the
Methuen Facility and paid the Company the remaining principal balance
due on the Note of $1.9 million and agreed to pay the sum of $675,000
in full settlement of the Earn Out. Per the terms of the sale of the
Methuen Facility, $400,000 of the $675,000 was placed in escrow as
security for the Company's remaining lease obligations.
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 under the transaction as a finance obligation. The
Note and related interest thereon, and the additional cash under the
terms of the Earn Out, were recorded as an increase to the finance
obligation as cash payments were 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 in June 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 $83,331
within stockholders' equity at March 31, 2005, 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 74,963 shares of common stock from October 2003 to January
2005 in satisfaction of previously recorded interest and issued
13,123 shares of common stock in April 2005 as payment for the
interest accrued at March 31, 2005.
14
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.
9. 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 at $80.00 per unit for proceeds of approximately $2.95
million, net of issuance costs of approximately $300,000. In
connection with the private placement, investors received rights to
purchase additional shares of the Series A Preferred Stock (the
"Over-Allotment Right"). The warrants are exercisable immediately
and entitle holders to purchase 203,125 shares of common stock 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 Series A Preferred Stock is redeemable at the Company's option 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.
15
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.
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 March
31, 2005:
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 nine months ended March
31, 2005 and March 28, 2004 was $38,000.
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 $1.0 million 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 the
Company's 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 $216,900 for the nine
months ended March 31, 2005.
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
16
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
approximately $1.0 million, as authorized but unissued shares. This
aggregate cost has been allocated to the common stock's par value and
additional paid-in capital.
10. 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.
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 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
March 31, 2005. 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.
17
The net loss attributable to common stockholders for each period is
as follows:
Three Months Ended Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
-------------- -------------- -------------- --------------
Net loss $(2,275,674) $(2,590,076) $(4,522,086) $(6,604,341)
Dividends accrued on Series A preferred stock (66,113) - (201,279) -
----------- ----------- ----------- -----------
Net loss attributable to common stockholders $(2,341,787) $(2,590,076) $(4,723,365) $(6,604,341)
=========== =========== =========== ===========
Antidilutive shares were not included in the per-share calculations
for the three and nine months ended March 31, 2005 and March 28, 2004
due to the reported net losses for those periods. Antidilutive
shares totaled approximately 1.2 million and 844,000 for the nine
months ended March 31, 2005 and March 28, 2004, respectively. All
antidilutive shares relate to outstanding stock options except for
484,625 and 272,500 antidilutive shares for the nine months ended
March 31, 2005 and March 28, 2004, respectively relating to warrants
issued in connection with certain debt and equity financings (see
Note 9).
13. Comprehensive Loss
------------------
Comprehensive loss for the three and nine months ended March 31, 2005
and March 28, 2004 is as follows:
Three Months Ended Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
-------------- -------------- -------------- --------------
Net loss $(2,275,674) $(2,590,076) $(4,522,086) $(6,604,341)
Other comprehensive income (loss):
Foreign currency translation adjustments (93,357) 197,048 271,916 340,959
----------- ----------- ----------- -----------
Total comprehensive loss $(2,369,031) $(2,393,028) $(4,250,170) $(6,263,382)
=========== =========== =========== ===========
At March 31, 2005 and June 30, 2004, the Company's accumulated other
comprehensive loss pertains entirely to foreign currency translation
adjustments.
14. Joint Venture
-------------
On December 22, 2004, Parlex entered into a Joint Venture Agreement
(amended March 28, 2005), 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 $3.0 million, a 49% interest in a new
entity to be formed by Parlex. Under the terms of the Agreements, the
Company 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 July
1, 2005 (the "Outside Closing Date").
Upon execution of the Agreements, the Company received a deposit of
an aggregate $1.0 million of the total purchase price. Specifically,
Infineon paid $500,000 to the Company as consideration for the
License Agreement, pursuant to which the Company 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 the Company 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, the Company is required to repay
the $1.0 million, or Infineon shall be entitled to offset such amount
against certain Company invoices submitted to Infineon.
18
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 effect on 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 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 March 31, 2005, 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.
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 3 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
technology 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. Beginning 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 aggregate 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
20
have 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. At March 31, 2005, we were not in compliance with
certain financial covenants of our loan agreement with Silicon Valley Bank.
We have received a written waiver from the bank, for our non-compliance at
March 31, 2005, and the bank has continued to allow us to borrow against the
loan agreement. Our fiscal third quarter ending March 31 is typically
adversely impacted by the cyclical nature of certain strategic markets we
serve. This is particularly true in the computer and peripheral market where
annual model year design change occurs in January. Coupled with the Chinese
New Year holidays, the third quarter is historically the weakest for our
rapidly growing China operations. New production awards began ramping up in
March 2005. As such, we anticipate a strong recovery in volume production
during the fourth quarter ending June 30, 2005. In the future, we expect to
be in compliance with all our bank covenants.
We have $5.4 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 our
Chinese operation's strong operating results. In fiscal 2004, revenues from
our Chinese operations grew 65%. In the nine months ended March 31, 2005,
revenues from our Chinese operations grew 56% compared to the nine months
ended March 28, 2004. 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
21
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
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 March 31, 2005 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.
22
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 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 Nine Months Ended
March 31, 2005 March 28, 2004 March 31, 2005 March 28, 2004
Total revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of products sold 91.0 % 91.8 % 87.6 % 89.6 %
----- ----- ----- -----
Gross profit 9.0 % 8.2 % 12.4 % 10.4 %
Selling, general and administrative expenses 14.1 % 16.5 % 14.7 % 17.3 %
----- ----- ----- -----
Operating loss (5.1)% (8.3)% (2.3)% (6.9)%
Loss from operations before income taxes
and minority interest (7.7)% (11.0)% (4.7)% (9.7)%
----- ----- ----- -----
Net loss (7.8)% (11.2)% (5.0)% (9.9)%
----- ----- ----- -----
Three Months Ended March 31, 2005 Compared to Three Months Ended March 28, 2004
- -------------------------------------------------------------------------------
Total Revenues. Total revenues for the three months ended March 31, 2005
were $29.1 million versus $23.2 million for the three months ended March
28, 2004. This represents an increase of $6.0 million or 26%. 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 third 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. We are
looking to lease this equipment for installation in our Mexico facility.
This 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 $10.7 million from $7.3
million in the prior year representing a 47% increase for the same period
year over year. Strong growth occurred in the computer and peripheral,
automotive and telecommunications markets year over year. Revenues from
our smart card business were well below expectations caused by delayed
orders from Infineon. No production orders were received thereby leaving
our manufacturing line essentially idle other than for prototyping.
Product qualification problems with Infineon's end customer triggered the
delay. New volume production orders were placed in April 2005. Revenue in
our China operations from markets such as electronic identification is
particularly important in our third quarter given the cyclical nature of
other markets served. Markets such as computer and peripherals are
adversely affected by seasonally lower demand coupled with design change
implementations occurring in the third quarter. In addition, Chinese New
Year holidays interrupt third quarter production schedules. Polymer thick
film revenues totaled $8.9 million representing a 9% increase versus the
same period of the prior year. Revenue increases continue to be driven by
accelerated growth in
23
the medical market, particularly in disposable medical devices. Strong
performance occurred in particular in our United States manufacturing
operations. We began to increase production on several new appliance
orders late in the third quarter.
Revenues in our Methuen, Massachusetts multilayer manufacturing operations
increased 43% 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 continued to
make progress with this transition during the third quarter although we
remain two quarters away from completion. Increased manufacturing levels
in our Methuen facility are critical to improving absorption within a
significantly under utilized operation.
Cost of Products Sold. Cost of products sold was $26.5 million, or 91% of
total revenues, for the three months ended March 31, 2005, versus $21.3
million, or 92% of total revenues, for the three months ended March 28,
2004. Slight reduction in the cost of products sold as a percentage of
total revenues, and a corresponding improvement in our gross margin, was in
large part driven by manufacturing volume increases. Revenues increased
26% 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 41% of revenues in the third
quarter of fiscal 2004 to 40% of revenues for the third quarter of fiscal
2005. 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 costs. Raw material costs and in particular copper prices
escalated more than 25% during the past fiscal year. Similarly, base
flexible materials such as polyimide rose substantially during the year
with worldwide supply constraints. In many cases this has forced us to
increase our 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.
Margins were also adversely impacted by the lack of production orders for
our smart card line. In addition to fixed costs such as depreciation and
facility expense, idle labor was essentially a fixed cost for this quarter.
Lower production levels elsewhere in our China operations provided little
opportunity to leverage resources. Substantial investment in training
coupled with production commencing in April required retaining the current
workforce.
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 40%. 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. By the first quarter of fiscal 2003, revenues in this
market were immaterial. We have seen little or no recovery in this market
to date. 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 third
quarter of fiscal 2005 shipments totaled approximately $529,000. We expect
manufacturing to increase significantly over the remainder of the 2005
fiscal year improving facility utilization and further reducing multilayer
operating losses.
24
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $4.1 million for the three months ended March
31, 2005 versus $3.8 million for the comparable period in the prior year.
Increases can be primarily attributed to higher commissions of $200,000 due
to increases in revenues, higher public company costs of $200,000 including
legal, audit and insurance, continued escalation of fringe costs of
$100,000 in particular medical expenses, and infrastructure investment in
China of $100,000. These increases were in part offset by a reduction in
bad debt expense of $300,000 associated with a settlement of an accounts
receivable dispute.
Interest Income. Interest income was $17,000 for the three months ended
March 31, 2005 compared to $2,000 for the three months ended March 28,
2004. The balance represents interest income on our cash balances.
Interest Expense. Interest expense was $762,000 for the three months ended
March 31, 2005 compared to $642,000 for the three months ended March 28,
2004. Interest expense for the period ended March 31, 2005 included
$423,000 for amortized deferred financing costs and $83,000 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 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 $2.2 million in the three months ended March
31, 2005 compared to $2.6 million in the three months ended March 28, 2004.
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 0.2% for the three
months ended March 31, 2005, versus 1.9% for the three months ended March
28, 2004. 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 March 31, 2005. In fiscal 2003, we established a
valuation allowance against all of our remaining net U.S. deferred tax
assets.
Nine months Ended March 31, 2005 Compared to Nine months Ended March 28, 2004
- -----------------------------------------------------------------------------
Total Revenues. Total revenues for the nine months ended March 31, 2005
were $90.8 million versus $66.4 million for the nine months ended March 28,
2004. This represents an increase of $24.4 million or 37%. Increases were
recorded in each of our business units with particularly strong growth in
our China (56%), Multilayer (48%) and Polymer Thick Film (21%) operations.
Strong revenues were recorded in our China operations for the first nine
months of fiscal 2005. Our China operation's sales increased to 42% of the
Company's total revenues versus 37% for the first nine months of fiscal
2004. Foreign sourced revenues increased to 55% of total revenues for the
first nine months of fiscal 2005. China revenue increases of $13.8
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 nine months were $18.1 million. New design awards for
calendar year 2005 are likely to sustain our preferred supplier position
with Hewlett Packard for the next twelve months. Polymer thick film
revenues increased $4.7 million over the same period of the prior year with
growth occurring primarily in the disposable medical market. Several new
program design wins in the
25
appliance market will contribute to growth here over the next twelve
months. Multilayer revenues increased $4.5 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 $79.5 million, or 88% of
total revenues, for the nine months ended March 31, 2005, versus $59.5
million, or 90% of total revenues, for the nine months ended March 28,
2004. Increased capacity utilization in China resulted in margin
improvement. Gross margins in China were 19% for the first nine months of
fiscal 2005 versus 18% for the comparable period of the prior year.
However, margins were adversely affected by the suspended production of our
smart card products. Delayed orders from Infineon caused by product
qualification problems with their end customer resulted in idle production
for the quarter. Polymer thick film gross margins decreased from 17% to
14% for the first nine 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 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 management,
quality and production control.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $13.3 million for the nine months ended March
31, 2005 versus $11.5 million for the comparable period in the prior year.
Increases can be primarily attributed to higher commissions of $700,000 on
a 37% increase in revenues, higher public company costs of $500,000
including legal, audit and insurance, continued escalation of fringe costs
which amounted to $400,000 with a particular increase in medical expenses,
and infrastructure investment in China of $500,000. These increases were
in part offset by a reduction in bad debt expense of $300,000 associated
with the settlement of an accounts receivable dispute.
Interest Income. Interest income was $57,000 for the nine months ended
March 31, 2005 compared to $9,000 for the nine months ended March 28, 2004.
Interest income for the nine months ended March 31, 2005 included $26,000
of interest income on our tax refunds. The balance represents interest
income on our cash balances.
Interest Expense. Interest expense was $2.3 million for the nine months
ended March 31, 2005 and $1.8 million for the nine months ended March 28,
2004. Interest expense for the nine months ended March 31, 2005 included
approximately $1.3 million for amortized deferred financing costs and
$250,000 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 $4.3 million in the nine months ended March
31, 2005 compared to $6.5 million in the nine months ended March 28, 2004.
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.
26
Income Taxes. Our effective tax rate was approximately 2.8% for the nine
months ended March 31, 2005 versus an effective tax rate of 0.7% for the
nine months ended March 28, 2004. 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 nine months
ended March 31, 2005 and March 28, 2004. In fiscal 2003, we established a
valuation allowance against all of our remaining net U.S. deferred tax
assets.
Liquidity and Capital Resources
- -------------------------------
As of March 31, 2005, we had approximately $3.9 million in cash and cash
equivalents.
Net cash used in operations during the nine months ended March 31, 2005 was
$1.5 million. This compares to net cash used in operations of $9.2 million
for the same period of the prior year. Net operating losses of $4.5
million, after adjustment for minority interest, interest payable in common
stock, depreciation and amortization, provided $800,000 of operating cash.
Operations consumed $2.3 million of working capital. Cash used for working
capital included $2.8 million for inventory and $600,000 for accounts
payable partially offset by $400,000 from accounts receivable, and $700,000
from other working capital sources. Inventory increases occurred in raw
material of $2.0 million, which included the purchase of connectors and
assembly components, and work in process of $1.1 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 to
distinguish us from our competition. However, 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.
Investing activities consumed $707,000 of net cash during the nine months
ended March 31, 2005, primarily to purchase capital equipment. As of March
31, 2005, we had an additional $952,000 of capital equipment financed under
our accounts payable. We have implemented a plan to control our capital
expenditures in order to enhance cash flows. Cash provided by financing
activities was $4.4 million for the nine months ended March 31, 2005,
including $1.5 million that represented the net repayments and borrowings
on our bank debt. We received net proceeds totaling $2.1 million
associated with the Methuen sale-leaseback financing of which $1.9 million
was principal, $85,000 was interest, and $275,000 was for an earn-out,
offset by lease payments of 169,000. In addition, we received $1.0 million
from Infineon Technologies as a deposit for our joint venture agreement.
Upon closing of the joint venture, currently anticipated to be in late June
2005, Infineon will pay the balance due of $2.0 million. Closing is
predicated on obtaining a business license and other necessary governmental
approvals for the joint venture company in the People's Republic of China.
Should we be unable to close the transaction, the $1.0 million deposit is
required to 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 nine months of fiscal 2005, however, have placed additional cash
demands on working capital with growth in 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 that will allow
us to continue financing our growth plans. See "Factors That May Affect
Future Results".
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
27
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 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. In February 2005, the landlord for our
Methuen, Massachusetts facility completed the sale of the property to a
third party. Under terms of the transaction, we received cash of
approximately $2.2 million. The proceeds represented repayment of the
outstanding financing we originally provided under the initial sale and a
settlement on amounts due under the terms of an earn out. 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 March 2006. 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 March 31, 2005, we were not in
compliance with certain financial covenants of our loan agreement with
Silicon Valley Bank. We have received a waiver from the bank for our non-
compliance at March 31, 2005 and the bank has continued to allow us to borrow
against the loan agreement. In the future, we expect to be in compliance with
all of our bank covenants. Our third quarter ending March 31 is typically
adversely impacted by the cyclical nature of certain strategic markets we
serve. This is particularly true in the computer and peripheral market where
annual model year design change occurs in January. Coupled with the Chinese
New Year holidays, the third quarter is historically the weakest for our
rapidly growing China operations. New customer orders began increasing in
March 2005. As such, we anticipate a strong recovery in volume production
during the fourth quarter ending June 30, 2005.
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 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 9 to the Notes to Unaudited Condensed Consolidated Financial
Statements.
28
Loan and Security Agreement (the "Loan Agreement") - We executed the Loan
Agreement with Silicon Valley Bank on June 11, 2003 and since such date we
entered into eight amendments to the Loan Agreement. 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. 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 financial
covenants, which among other things require us to maintain $750,000 in
minimum cash balances or excess availability under the Loan Agreement.
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 (5.75% at March 31, 2005) plus 2.00% (decreasing to prime
plus 1.25% after two consecutive quarters of positive operating income and
further decreasing 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
as of the period ending December 31, 2004 and each month thereafter until
May 31, 2005 and to $750,000 on a three month trailing basis as of the
period ending June 30, 2005 and each month thereafter. The Seventh
Modification Agreement also extended the maturity date of the Loan
Agreement from July 11, 2005 to July 11, 2006. On May 10, 2005, we
executed an Eighth Loan Modification Agreement (the "Eighth Modification
Agreement") with Silicon Valley Bank. The Eighth Modification Agreement
changed the EBITDA requirement to $1.00 on a monthly basis as of the
periods ending April 30, 2005 and May 31, 2005 and $750,000 on a trailing
three month basis as of the period ending June 30, 2005 and each month
thereafter. At March 31, 2005, we had available borrowing capacity under
the Loan Agreement of approximately $4.8 million. Since the available
borrowing capacity exceeded $750,000 at March 31, 2005, none of our cash
balance was subject to restriction at March 31, 2005. We have received a
written waiver from the bank for our non-compliance at March 31, 2005 and
the bank has continued to allow us to borrow against the Loan Agreement.
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 March 31, 2005 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.
29
Parlex Shanghai Term Notes - A summary of the Parlex Shanghai term notes
are as follows:
March 31, 2005
(in millions)
Due March 2006 at 5.58% and guaranteed by Parlex Interconnect $2.5
Due January 2006 at LIBOR plus 2.5% and guaranteed by Parlex Asia 1.5
Due June 2005 at 5.58% and guaranteed by Parlex Interconnect 1.3
Due June 2005 at 5.58% and guaranteed by Parlex Interconnect 1.0
Due April 2005 at 5.31% and guaranteed by Parlex Interconnect 0.7
Due March 2006 at 5.58% and guaranteed by Parlex Interconnect 0.6
----
Total Parlex Shanghai term notes $7.6
====
Subsequent to March 31, 2005, Parlex Shanghai renewed its $700,000 short-
term note due April 2005. The note has been extended until April 2006 at
an interest rate of 5.58%.
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
which we guaranteed. 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%.
Amounts outstanding as of March 31, 2005 totaled $1.8 million.
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
(the "Earn Out"). In June 2004, we received $750,000 reducing the
principal balance of the Note to $1.9 million. On February 25, 2005, the
landlord sold the Methuen Facility and paid to us the remaining principal
balance due on the Note of $1.9 million and agreed to pay the sum of
$675,000 in full settlement of the Earn Out. Per the terms of the sale of
the Methuen Facility, $400,000 of the $675,000 was placed in escrow as
security for our remaining lease obligations.
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 additional cash under the terms of
the Earn Out, were recorded as an increase to the finance obligation as
cash payments were 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 in June 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
30
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 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 $83,331 within stockholders' equity at March 31,
2005, 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 74,963 shares of common stock from October 2003 to
January 2005 in satisfaction of the previously recorded interest. We also
issued 13,123 shares of common stock in April 2005 as payment for the
interest accrued as of March 31, 2005.
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.
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.
31
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.
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, most recently for the period ended
March 31, 2005. 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 these securities, please see
"Market for Registrant's Common Equity and Related Stockholder Matters -
Recent Sales of Unregistered Securities - 7% Convertible Subordinated Notes
and Warrants" and "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.
32
Substantial leverage and debt service obligations may adversely affect us.
We have a substantial amount of indebtedness. As of March 31, 2005, we had
approximately $28.0 million of consolidated debt of which $14.3 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 26% 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, 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 have incurred net losses in the recently completed nine months ended
March 31, 2005, as well as each of the last three fiscal years. We had net
losses of $4.5 million in the nine months ended March 31, 2005, $8.2
33
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.
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.
34
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.
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.
35
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 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.
36
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.
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
17 patents issued and have 7 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
37
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.
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
38
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 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,
39
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.
Interest Rate Risk
Our primary bank facility bears interest at our lender's prime rate plus
2.0%. We also have two subsidiary bank notes at LIBOR plus 2.5% and LIBOR
plus 2.0%. 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 March 31, 2005, we had an outstanding balance under our
primary bank facility of $3,951,000 and an outstanding balance of $3,251,000
under our subsidiary note. A hypothetical 10% change in interest rates would
impact interest expense by approximately $45,000 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, Parlex (Shanghai) Interconnect
Technologies ("Parlex Technologies"), 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, Parlex Interconnect and Parlex Technologies
had combined net assets as of March 31, 2005 of approximately $22.4 million.
Poly-Flex Circuits Limited and Parlex Europe had combined net assets as of
March 31, 2005 of approximately $6.1 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 March 31, 2005,
Parlex Shanghai and Parlex Interconnect had combined outstanding debt of
approximately $8.3 million. As of March 31, 2005, 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
40
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 March 31, 2005. 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 our Company (and its consolidated
subsidiaries) required to be included in our Exchange Act reports.
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 3. Defaults Upon Senior Securities
As of March 31, 2005, we were not in compliance with our EBITDA
financial covenant under our Loan Agreement with Silicon Valley
Bank. Although the bank could have called for early repayment of
the debt, no such demand was made. We have received a waiver from
the bank for our non-compliance at March 31, 2005.
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)
May 13, 2005
------------
Date
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EXHIBIT INDEX
EXHIBIT DESCRIPTION OF EXHIBIT
- ------- -----------------------
10.1 Eighth Loan Modification Agreement, dated May 10, 2005 by and
between Parlex Corporation and Silicon Valley Bank. (filed
herewith)
10.2 First Amendment to Lease, dated June 29, 2004, by and between
Taurus Methuen LLC, as landlord, and Parlex Corporation, as
tenant. (filed herewith)
10.3 Second Amendment to Lease, dated February 18, 2005, by and
between Taurus Methuen LLC, as landlord, and Parlex Corporation,
as tenant. (filed herewith)
10.4 First Amendment to Joint Venture Agreement, dated March 28,
2005, by and between Parlex Asia Pacific Ltd and Infineon
Technologies Asia Pacific Pte. Ltd. (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