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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 28, 2003
[ ] 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
November 10, 2003 was 6,321,564 shares.
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PARLEX CORPORATION
------------------
INDEX
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Part I - Financial Information Page
----
Item 1. Unaudited Condensed Consolidated Financial Statements:
Consolidated Balance Sheets - September 28, 2003 and
June 30, 2003 3
Consolidated Statements of Operations - For the Three
Months Ended September 28, 2003 and September 29, 2002 4
Consolidated Statements of Cash Flows - For the Three
Months Ended September 28, 2003 and September 29, 2002 5
Notes to Unaudited Condensed Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
Item 4. Controls and Procedures 31
Part II - Other Information 32
Item 3. Defaults Upon Senior Securities 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 33
Exhibit Index 34
2
PARLEX CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- ---------------------------------------------------------------------------------
ASSETS September 28, 2003 June 30, 2003
<s> <c> <c>
CURRENT ASSETS:
Cash and cash equivalents $ 1,293,307 $ 1,513,523
Accounts receivable - net 16,475,290 13,835,589
Inventories - net 19,107,524 17,082,878
Refundable income taxes 134,605 279,381
Deferred income taxes 313,109 313,109
Other current assets 2,133,704 2,077,409
Assets held for sale 1,092,614 -
------------ ------------
Total current assets 40,550,153 35,101,889
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - NET 45,811,943 46,893,216
INTANGIBLE ASSETS - NET 34,942 1,130,005
GOODWILL - NET 1,157,510 1,157,510
OTHER ASSETS 2,404,275 1,750,061
------------ ------------
TOTAL $ 89,958,823 $ 86,032,681
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 4,977,790 $ 3,813,117
Accounts payable 13,232,744 13,396,274
Accrued liabilities 4,502,777 5,170,608
Deposit on assets held for sale 974,964 -
------------ ------------
Total current liabilities 23,688,275 22,379,999
------------ ------------
LONG-TERM DEBT 13,268,534 10,802,275
------------ ------------
OTHER NONCURRENT LIABILITIES 1,173,711 1,187,280
------------ ------------
MINORITY INTEREST IN PARLEX SHANGHAI 477,902 415,583
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock - -
Common stock 652,221 652,221
Accrued interest payable in common stock 73,195 -
Additional paid-in capital 63,223,754 61,049,486
Accumulated deficit (11,692,411) (9,605,380)
Accumulated other comprehensive income 131,267 188,842
Less treasury stock, at cost (1,037,625) (1,037,625)
------------ ------------
Total stockholders' equity 51,350,401 51,247,544
------------ ------------
TOTAL $ 89,958,823 $ 86,032,681
============ ============
See notes to unaudited consolidated financial statements.
3
PARLEX CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------
Three Months Ended
September 28, 2003 September 29, 2002
------------------ ------------------
<s> <c> <c>
REVENUES $19,704,431 $21,692,288
COSTS AND EXPENSES:
Cost of products sold 17,472,246 20,684,405
Selling, general and administrative expenses 3,740,366 2,919,516
----------- -----------
Total costs and expenses 21,212,612 23,603,921
----------- -----------
OPERATING LOSS (1,508,181) (1,911,633)
INTEREST AND NON OPERATING INCOME (EXPENSE)
Interest income 4,595 7,129
Interest expense (532,651) (204,282)
Non operating income 11,742 465
Non operating expense (218) (27,776)
----------- -----------
LOSS BEFORE INCOME TAXES
AND MINORITY INTEREST (2,024,713) (2,136,097)
BENEFIT FROM INCOME TAXES - 726,273
----------- -----------
LOSS BEFORE MINORITY INTEREST (2,024,713) (1,409,824)
MINORITY INTEREST (62,318) 18,709
----------- -----------
NET LOSS $(2,087,031) $(1,391,115)
=========== ===========
BASIC AND DILUTED LOSS PER SHARE $ (0.33) $ (0.22)
=========== ===========
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 6,312,216 6,303,216
=========== ===========
See notes to unaudited consolidated financial statements.
4
PARLEX CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------
Three Months Ended
September 28, 2003 September 29, 2002
------------------ ------------------
<s> <c> <c>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(2,087,031) $(1,391,115)
----------- -----------
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization of property,
plant and equipment and other assets 1,658,636 1,604,453
Amortization of deferred financing costs 143,221 -
Minority interest 62,319 (18,709)
Deferred income taxes - (726,273)
Interest payable in common stock 73,195 -
Changes in current assets and liabilities:
Accounts receivable - net (2,623,007) (422,977)
Inventories (2,006,270) 47,250
Refundable taxes 144,776 -
Other assets (108,796) 354,209
Accounts payable and accrued liabilities (1,271,072) (1,131,889)
----------- -----------
Net cash used in operating activities (6,014,029) (1,685,051)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit received for sale of land use rights 974,964 -
Additions to property, plant and equipment
and other assets (280,611) (345,283)
----------- -----------
Net cash provided by (used in) investing activities 694,353 (345,283)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bank loans 7,502,960 5,467,865
Payment of bank loans (7,846,834) (3,676,448)
Payment of Methuen sale-leaseback financing obligation (74,974) -
Proceeds from convertible note, net of costs 5,509,984 -
----------- -----------
Net cash provided by financing activities 5,091,136 1,791,417
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 8,324 12,600
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (220,216) (226,317)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,513,523 1,785,025
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,293,307 $ 1,558,708
=========== ===========
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 $ 242,874 $ 1,041,388
=========== ===========
Issuance of warrants in connection with issuance
of convertible debt $ 1,139,252 $ -
=========== ===========
Beneficial conversion feature associated
with convertible debt $ 1,035,016 $ -
=========== ===========
Interest receivable associated with Methuen
sale-leaseback financing obligation $ 33,125 $ -
=========== ===========
See notes to unaudited consolidated financial statements.
5
PARLEX CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------------------------------------------------------------
1. Basis of Presentation
---------------------
The 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 which are, in the opinion of management, necessary to present
fairly the financial position as of September 28, 2003 and the results of
operations and cash flows for the three months ended September 28, 2003 and
September 29, 2002. All adjustments made to the interim financial
statements included all those of a normal and recurring nature.
The Company followed the same accounting policies in the preparation of
these interim financial statements as described in its annual report on
Form 10-K for the year ended June 30, 2003. This filing should be read in
conjunction with the Company's annual report on Form 10-K for the year
ended June 30, 2003.
As shown in the consolidated financial statements, the Company incurred net
losses of $2,087,031 and $1,391,115 and used $6,014,029 and $1,685,051 of
cash in operations for the three months ended September 28, 2003 and
September 29, 2002, respectively. In addition, the Company had an
accumulated deficit of $11,692,411 at September 28, 2003. At September 28,
2003, the Company was not in compliance with certain financial covenants of
its guarantee of $3.8 million of debt owed by its subsidiary, Parlex
(Shanghai) Interconnect Products Co., Ltd. ("Parlex Interconnect"), to
CITIC Ka Wah Bank, Limited ("CITIC"), a Hong Kong bank. Effective October
8, 2003, CITIC entered into a Supplemental Deed with Parlex Interconnect
relating to the CITIC Loan Agreement (the "CITIC Loan Agreement Amendment"),
and with Parlex (the "Guarantee Agreement Amendment"). Among other matters,
the CITIC Loan Agreement Amendment and the Guarantee Agreement Amendment
modified certain restrictive financial covenants. The Company is and expects
to remain in compliance with all of its financial covenants, as amended.
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 consolidating manufacturing operations. Moreover, 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 its domestic operations to lower cost
international manufacturing locations, primarily those in the People's
Republic of China; 3) expanding its products in the home appliance, laptop
computer, and electronic identification markets; 4) continuing to monitor
and reduce selling, general and administrative expenses; and 5) completing
sales of non-essential assets such as its land use rights in China (see
Note 4).
Furthermore, in June and July 2003, 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 long-term financing
to support its current working capital needs. Based on the current credit
agreements, management believes it has sufficient cash to fund operations
through at least December 2004.
6
2. Inventories
-----------
Inventories of raw materials are stated at the lower of cost (first-in,
first-out) or market. Work in process and finished goods are valued as a
percentage of completed cost, not in excess of net realizable value. Raw
material, work in process and finished goods inventory associated with
programs cancelled by customers are fully reserved for as obsolete.
Reductions in obsolescence reserves are recognized when the underlying
products are disposed of or sold. Inventories consisted of:
September 28, June 30,
2003 2003
------------- --------
<s> <c> <c>
Raw materials $ 8,422,890 $ 7,736,473
Work in process 9,053,623 8,285,396
Finished goods 4,443,124 4,034,733
----------- -----------
Total cost 21,919,637 20,056,602
Reserve for obsolescence (2,812,113) (2,973,724)
----------- -----------
Inventory, net $19,107,524 $17,082,878
=========== ===========
3. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost and are depreciated using
the straight-line method over their estimated useful lives. Property, plant
and equipment consisted of:
September 28, June 30,
2003 2003
------------- --------
<s> <c> <c>
Land and land improvements $ 589,872 $ 589,872
Buildings 18,543,295 18,543,295
Machinery and equipment 59,881,918 59,625,945
Leasehold improvements and other 6,330,084 6,321,658
Construction in progress 4,791,053 4,591,458
------------ ------------
Total cost 90,136,222 89,672,228
Less: accumulated depreciation (44,324,279) (42,779,012)
------------ ------------
Property, plant and equipment, net $ 45,811,943 $ 46,893,216
============ ============
4. Intangible Assets
-----------------
Intangible assets consisted of:
September 28, June 30,
2003 2003
------------- --------
<s> <c> <c>
Land use rights $ - $1,145,784
Patents 58,560 58,560
---------- ----------
Total cost 58,560 1,204,344
Accumulated amortization (23,618) (74,339)
---------- ----------
Intangible assets, net $ 34,942 $1,130,005
========== ==========
7
In July 2003, Parlex Interconnect executed an agreement to sell its land
use rights for approximately $1.2 million. The Company has received
approximately $1.0 million in cash, which has been recorded as a deposit
on assets held for sale, on the consolidated balance sheet at September 28,
2003. At September 28, 2003, the land use rights have been recorded on the
consolidated balance sheet as assets held for sale and, accordingly, the
Company has ceased amortizing the asset. Management expects the sale to
close in the second quarter of fiscal 2004.
The Company has reassessed the remaining useful lives of the intangible
assets at September 28, 2003 and determined the useful lives are
appropriate in determining amortization expense. Amortization expense for
the three months ended September 28, 2003 and September 29, 2002 was $2,449
and $7,601, respectively.
5. Other Assets
------------
Other assets consisted of:
September 28, June 30,
2003 2002
------------- --------
<s> <c> <c>
Deferred loss on sale-leaseback of Poly-Flex Facility $1,373,818 $1,373,818
Deferred financing costs on sale-leaseback of Methuen facility (see Note 7) 292,484 203,353
Deferred financing costs on the Loan Security Agreement (see Note 7) 192,269 138,081
Deferred financing costs on Convertible Subortinated Note (see Note 7) 594,253 -
Other 89,907 48,019
---------- ----------
Total cost 2,542,731 1,763,271
Less accumulated amortization (138,456) (13,210)
---------- ----------
Total, net $2,404,275 $1,750,061
========== ==========
Deferred Loss on Sale Leaseback of Poly-Flex Facility - In June 2003, Poly-
Flex sold its operating facility in Cranston, Rhode Island for a total
purchase price of $3,000,000 in cash. Under the terms of the Purchase and
Sale Agreement, Poly-Flex entered into a five-year lease of the Poly-Flex
Facility with the buyer. The Company recorded no 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
$1,386,000 of excess net book value over the sales price was recorded as a
deferred loss and included in Other Assets on the 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 $69,000 for the quarter ended September 28,
2003.
Amortization of deferred financing costs was $57,000 for the quarter ended
September 28, 2003.
6. Accrued Liabilities - Facility Exit Costs
-----------------------------------------
The following is a summary of the facility exit costs activity during
fiscal 2004:
Facility
Facility 2004 Activity Exit Costs
Exit Costs --------------------------------------- Accrued
Accrued Cash Asset Change September 28,
June 30, 2003 Payments Write-offs in Estimates 2003
------------- -------- ---------- ------------ -------------
<s> <c> <c> <c> <c> <c>
Lease costs $439,855 $(108,072) $ - $ - $331,783
Facility refurbishment costs 143,666 - - - 143,666
-------- --------- ------ ------ --------
Total $583,521 $(108,072) $ - $ - $475,449
======== ========= ====== ====== ========
During fiscal 2004, lease costs of $108,072 for the Salem, New Hampshire
facility, consisting of rent expense and utilities for the period July 1,
2003 through September 28, 2003, were paid and charged to the facility exit
costs accrual. The accrued facility exit costs at September 28, 2003
represent nine months of lease payments and the
8
estimated costs to refurbish the facility at the early lease termination
date. The Company expects the balance of accrued facility exit costs at
September 28, 2003 to be paid within the next nine months.
7. Indebtedness
------------
Long-term debt consisted of:
September 28, June 30,
2003 2003
------------- --------
<s> <c> <c>
Loan and security agreement $ 2,305,034 $ 3,306,150
Term notes 6,633,321 5,975,645
Finance obligation on sale-leaseback of Methuen Facility 5,291,749 5,333,597
Convertible subordinated notes 4,016,220 -
----------- -----------
Total long-term debt 18,246,324 14,615,392
Less current portion 4,977,790 3,813,117
----------- -----------
Long-term debt - net $13,268,534 $10,802,275
=========== ===========
Loan and Security Agreement ("the Loan Agreement") - The Company executed a
Loan Agreement with a bank on June 11, 2003. The Loan Agreement provided
the Company's bank with a secured interest in substantially all of its
assets. The Company may borrow up to $10,000,000, 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
$1,000,000, which reduces the Company's availability for borrowings under
the Loan Agreement. 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 related to maintenance of $750,000 in minimum cash balances or
excess availability under the Loan Agreement.
On September 23, 2003, the Company executed a Modification Agreement ("the
Modification Agreement") with its bank. The Modification Agreement
increases the interest rate on borrowings to the bank's prime rate (4.0% at
September 28, 2003) plus 1.5% (decreasing to prime plus 0.75% after one
quarter of positive operating income and to prime plus 0.25% after two
quarters of positive net income, respectively) and amends the financial
covenants. At September 28, 2003, the Company had available borrowing
capacity under the Loan Agreement of $2,468,000. Since the available
borrowing capacity exceeded $750,000 at September 28, 2003, none of the
Company's cash balance was subject to restriction at September 28, 2003.
The Company was in compliance with the Loan Agreement financial covenants as
of September 28, 2003.
Parlex Shanghai Term Note - On August 20, 2003, Parlex Shanghai entered
into a short-term bank note, due August 20, 2004, bearing interest at
5.841%. Amounts outstanding under this short-term note total $1.2 million
as of September 28, 2003. The note replaced a similar short-term note that
terminated on August 22, 2003. On March 7, 2003, Parlex Shanghai entered
into a short-term bank note, due February 25, 2004, bearing interest at
5.841%. Amounts outstanding under this short-term note total $1.3 million
at September 28, 2003.
Parlex Interconnect Term Notes - In June 2002, Parlex Interconnect executed
a $5,000,000 Loan Agreement (the "CITIC Loan Agreement") with CITIC. The
CITIC Loan Agreement contains certain restrictive covenants and a cross
default provision that would permit the lender to accelerate the repayment of
Parlex Interconnect's obligation under the CITIC Loan Agreement in the event
the Company defaults on other financing arrangements. As a condition of
the approval of this CITIC Loan Agreement, the Company's subsidiary, Parlex
Asia Pacific Ltd., and the Company have provided a guarantee of the payment
of this loan. Under the provisions of its guarantee, the Company
9
is required to comply with certain financial covenants. At September 28,
2003, the Company was not in compliance with the financial covenants of the
guarantee.
Effective October 8, 2003, CITIC executed the CITIC Loan Agreement Amendment
and the Guarantee Agreement Amendment. Among other matters, the CITIC Loan
Agreement Amendment reduced Parlex Interconnect's total borrowing capacity
from $5,000,000 to $3,800,000, established a new repayment schedule and added
a restrictive financial covenant regarding EBITDA as of December 31, 2003 for
Parlex Interconnect. Under the new repayment schedule, $1,300,000 is due in
2004, $1,500,000 is due in 2005 and $1,000,000 is due in 2006. The Guarantee
Agreement Amendment modified the restrictive financial covenants with Parlex
consisting of Current Ratio, Tangible Net Worth and Total Liabilities to
Tangible Net Worth. The Company was in compliance with its amended financial
covenants, as of September 28, 2003.
Finance Obligation on Sale Leaseback of Methuen Facility - In June 2003,
Parlex sold its Methuen Facility for a total maximum purchase price of
$9,000,000 which consisted of $5,350,000 in cash at the closing, a
promissory note in the amount of $2,650,000 ("Note") and up to $1,000,000
in additional cash under the terms of an Earn Out Clause. Under the terms
of the Purchase and Sale Agreement, Parlex simultaneously entered into a
lease agreement relating to the Methuen Facility with a minimum lease term
of 15 years.
As the repurchase option contained in the lease and the receipt of a
promissory 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 $2,650,000 promissory note and
related interest thereon, and the $1,000,000 under the Earn Out Clause will
be recorded as an increase to the finance obligation as cash payments
are received. The Company records the principal portion of the monthly
lease payments as a reduction to the finance obligation and the interest
portion of the monthly lease payments is recorded as interest expense. The
closing costs for the transaction have been capitalized and are being
amortized as interest expense over the initial 15-year lease term. Upon
expiration of the repurchase option (June 30, 2015), the Company will
reevaluate its accounting to determine whether a gain or loss should be
recorded on this sale-leaseback transaction.
Convertible Subordinated Notes - On July 28, 2003, Parlex sold an aggregate
$6,000,000 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
deduction for approximately $500,000 in finders' fees and other transaction
expenses. 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 interest by the 'Initial Conversion
Price' (a defined term) which was established at $8 per share, (the market
price of the stock on the date of the execution of the agreement.) However,
if the number of shares to be issued are not then covered by an effective
registration statement, then each holder of each Note may choose, in its sole
discretion, to have the interest paid in either shares or in cash, with the
exception of the first interest payment, which shall in any event be payable
in shares. Based on the filing of a registration statement during the
quarter, the Company expects that all interest payments will be paid in stock.
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 $73,195 within stockholders' equity at September 28,
2003, as the interest is required to be paid in the form of common stock.
Based on the conversion price of $8.00 per common share at September 28,
2003, the Company issued 9,348 shares of common stock in October 2003 as
payment for the accrued interest.
The Notes are convertible immediately by the investors, in whole or in
part, into shares of common stock at an initial conversion price equal to
$8.00. The conversion price is subject to adjustment in the event of stock
splits, dividends and certain combinations. Furthermore, the Notes
contained a beneficial conversion feature representing 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 $1,035,000, which has been
10
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 4-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 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 interest accrued.
8. Stockholders' Equity
--------------------
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 September 28, 2003:
Weighted-Average
Fiscal Year Number Exercise Expiration
Granted Outstanding Price Date
----------- ----------- ---------------- ----------
<s> <c> <c> <c>
2003 25,000 $6.89 June 10, 2008
2004 300,000 8.00 July 28, 2007
2004 22,500 8.00 July 28, 2008
------- -----
Total 347,500 $7.92
======= =====
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 the 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 has been
recorded as deferred financing costs and is being amortized to interest
expense over the life of the Loan Agreement. Amortization expense for the
three months ended September 28, 2003 was $12,600.
In connection with the sale of the Convertible Subordinated Notes, the
investors and the investment adviser received warrants to purchase an
aggregate of 322,500 shares of common stock, at an initial exercise price
of $8.00 per share. The exercise price of the warrants is subject to
adjustment in the event of stock splits, dividends and certain
combinations. The relative fair value of the warrants issued to the
investors and to the investment adviser on July 28, 2003 was approximately
$1,035,000 and $104,000, respectively. The relative fair value of the
warrants was recorded as an increase in additional paid-in capital and as
original issuance discount recorded against the carrying value of the
Notes. The original issue discount is being amortized to interest expense
over the 4-year life of the Notes. Amortization expense for the three
months ended September 28, 2003 was $46,600.
9. Revenue Recognition
-------------------
Revenue on product sales is recognized when persuasive evidence of an
agreement exists, the price is fixed or determinable, delivery has occurred
and there is reasonable assurance of collection of the sales proceeds. The
Company generally obtains written purchase authorizations from its
customers for a specified amount of product, at a specified price and
considers delivery to have occurred at the time title to the product passes
to the customer. Title passes to the customer according to the shipping
terms negotiated between the Company and the customer. License fees and
royalty income are recognized when earned.
11
10. Stock-Based Compensation
------------------------
The Company accounts for stock-based compensation to employees and
nonemployee directors in accordance with Accounting Principles Board
("APB") Opinion No. 25 using the intrinsic-value method as permitted by
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation." SFAS No. 123 encourages, but does not
require, the recognition of compensation expense for the fair value of
stock options and other equity instruments issued to employees and
nonemployee directors.
Had the Company used the fair-value method to measure compensation, the
Company's net loss and basic and diluted loss per share would have been as
follows:
Three Months Ended
September 28, 2003 September 29, 2002
------------------ ------------------
<s> <c> <c>
Net loss - as reported $(2,087,031) $(1,391,115)
Add stock-based compensation expense
included in reported net loss - -
Deduct stock-based compensation expense
determined under the fair-value method (191,000) (192,000)
----------- -----------
Net loss - pro forma $(2,278,031) $(1,583,115)
=========== ===========
Basic and diluted loss per share - as reported $ (0.33) $ (0.22)
Basic and diluted loss per share - pro forma $ (0.36) $ (0.25)
The fair value of the options at the date of grant were estimated using the
Black-Scholes option pricing model with the following assumptions:
September 28, 2003 September 29, 2002
------------------ ------------------
<s> <c> <c>
Average risk-free interest rate 2.4% 2.6%
Expected life of option grants 3.5 years 3.5 years
Expected volatility of underlying stock 77% 67%
Expected dividend rate None None
12
The following table presents combined activity for stock options for the
three months ended September 28, 2003:
Three Months Ended September 28, 2003
Weighted-
Shares Average
Under Exercise
Option Price
------ ---------
<s> <c> <c>
Outstanding options at beginning of period 507,775 $13.26
Granted 82,000 8.39
Surrendered - -
Exercised - -
------- ------
Outstanding options at end of period 589,775 $12.59
======= ======
Exercisable options at end of period 325,339 $14.15
Weighted average fair value of options
granted during the period $ 4.11
The following table presents weighted average price and life information
about significant option groups outstanding and exercisable at September
28, 2003:
Options Outstanding Options Exercisable
---------------------------------------- --------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Exercise Number Contractual Exercise Exercise
Prices Outstanding Life (Years) Price Number Price
-------- ----------- ------------ --------- ------ ---------
<s> <c> <c> <c> <c> <c>
$ 3.60 - $ 7.20 12,000 1.6 $ 6.05 12,000 $ 6.05
7.21 - 10.80 133,500 9.3 9.11 17,000 10.25
10.81 - 14.40 307,525 7.6 12.16 161,339 12.35
14.41 - 18.00 68,750 5.8 16.17 67,500 16.17
18.01 - 21.60 66,000 4.1 18.78 66,000 18.78
21.61 - 25.20 2,000 6.6 22.00 1,500 22.00
------- --- ------ ------- ------
$ 3.60 - $25.20 589,775 7.3 $12.59 325,339 $14.15
======= === ====== ======= ======
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 recent history of operating
losses, uncertain future operating results, and past non-compliance with
certain of its debt covenant requirements, the Company has determined 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 September 28, 2003. 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
13
net deferred tax assets will be utilized, all or a portion of the valuation
allowance previously provided for will be eliminated.
12. Loss Per Share
--------------
Basic loss per share is calculated on the weighted-average number of common
shares outstanding during the year. Diluted loss per share is calculated on
the weighted-average number of common shares and common share equivalents
resulting from outstanding options and warrants except where such items
would be antidilutive.
The loss utilized to calculate loss per share for the three months ended
September 28, 2003 and September 29, 2002 was equal to the reported net
loss for each period.
A reconciliation between shares used for computation of basic and dilutive
income per share is as follows:
Three Months Ended
September 28, September 29,
2003 2002
------------- -------------
<s> <c> <c>
Shares for basic computation 6,312,216 6,303,216
Effect of dilutive stock options and warrants - -
--------- ---------
Shares for dilutive computation 6,312,216 6,303,216
========= =========
Antidilutive shares were not included in the per-share calculations for the
three months ended September 28, 2003 and September 29, 2002 due to the
reported net losses for those periods. Antidilutive shares totaled
approximately 937,000 and 564,000 for the three months ended September 28,
2003 and September 29, 2002, respectively. All antidilutive shares relate
to outstanding stock options except for 347,500 antidilutive shares at
September 28, 2003 relating to warrants issued in connection with certain
debt financings (see Note 8).
13. Comprehensive Loss
------------------
Comprehensive loss for the three months ended September 28, 2003 and
September 29, 2002 is as follows:
Three Months Ended
September 28, 2003 September 29, 2002
------------------ ------------------
<s> <c> <c>
Net loss $(2,087,031) $(1,391,115)
Other comprehensive (loss) income:
Foreign currency translation adjustments (57,575) 103,589
----------- -----------
Total comprehensive loss $(2,144,606) $(1,287,526)
=========== ===========
At September 28, 2003 and September 29, 2002, the Company's accumulated
other comprehensive loss pertains entirely to foreign currency translation
adjustments.
14
14. Related Party Transactions
--------------------------
The Company purchased $386,000 of equipment during the three months ended
September 29, 2002 from a company in which a then executive officer of
Parlex had a financial interest. Effective February 24, 2003, the executive
officer was no longer employed by the Company. At September 28, 2003, the
Company had recorded within accounts payable $200,000 for equipment
purchases from this party.
15. Reclassifications
-----------------
Certain prior period amounts have been reclassified to conform to the
current year presentation.
16. Recent Adoption of Accounting Pronouncements
--------------------------------------------
On July 1, 2003, the Company adopted SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150"). SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics
of both liabilities and equity. SFAS No. 150 requires that an issuer
classify a financial instrument that is within its scope as a liability (or
an asset in some circumstances). The requirements of this statement apply
to issuers' classification and measurement of freestanding financial
instruments, including those that comprise more than one option or forward
contract.
The adoption of SFAS No. 150 did not have a material effect on the
Company's financial statements.
15
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 23. The
following discussion contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, and is subject to
the safe-harbor created by such Act. Forward-looking statements express our
expectations or predictions of future events or results. They are not
guarantees and are subject to many risks and uncertainties. There are a
number of factors - many beyond our control - that could cause actual
events or results to be significantly different from those described in the
forward-looking statement. Any or all of our forward-looking statements in
this report or in any other public statements we make may turn out to be
wrong. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They use words such
as "anticipate," "estimate," "expect," "project," "intend," "plan,"
"believe" or words of similar meaning. They may also use words such as
"will," "would," "should," "could" or "may". Our actual results could
differ materially from the results contemplated by these forward-looking
statements as a result of many factors, including those discussed below and
elsewhere in this Quarterly Report on Form 10-Q.
Our significant accounting policies are more fully described in Note 2 to
our consolidated financial statements, and Part IV, Item 15 "Exhibits,
Financial Statement Schedules and Reports on Form 8-K" of our Annual Report
on Form 10-K for the year ended June 30, 2003. 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 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
$16.7 million in property and equipment and approximately $18.6 million in
research and development to develop materials and enhance our manufacturing
processes. We believe that these expenditures will help us to meet customer
demand for our products, and enable us to continue to be a technological
leader in the flexible interconnect industry. Our research and development
expenses are included in our cost of products sold.
In 2003 and 2002, we were adversely affected by the economic downturn and its
impact on our key customers and markets. We have incurred operating losses
during these periods of $29.8 million, and have used cash to fund operations
and working capital of $2.4 million during this time. We have taken certain
steps to improve operating margins, including closure of facilities,
downsizing of our employee base, and transfer of manufacturing operations to
lower cost locations, such as the People's Republic of China. In addition to
transferring certain domestic manufacturing processes to lower cost
international manufacturing locations, as part of our business strategy, we
continue to pursue markets and customer opportunities requiring domestic
manufacturing support. We believe there are strategic prospects available
in the military/aerospace market that would represent a significant
domestic manufacturing opportunity.
16
In addition, we have worked closely with our lenders to manage through this
difficult time and have obtained additional capital in 2003 and in early
fiscal 2004 through sale leaseback transactions of selected corporate assets
and the issuance of convertible subordinated debt. As a result of the
difficult environment facing us, we have had difficulty maintaining
compliance with the terms and conditions of certain of our financing
facilities. On September 28, 2003, we were not in compliance with certain
financial covenants of our guarantee of $3.8 million of debt owed by our
subsidiary, Parlex Interconnect, to CITIC, a Hong Kong bank. Therefore,
effective October 8, 2003, CITIC entered into a Supplemental Deed with Parlex
Interconnect relating to the CITIC Loan Agreement (the "CITIC Loan Agreement
Amendment"), and with us (the "Guarantee Agreement Amendment"). Among other
matters, the CITIC Loan Agreement Amendment and the Guarantee Agreement
Amendment modified certain restrictive financial covenants such as EBITDA,
Current Ratio, Tangible NET Worth and Total Liabilities to Tangible Net
Worth. We were in compliance with our financial covenants as of September 28,
2003, as they were amended and we expect to remain in compliance with all of
our financial covenants, as amended.
Critical Accounting Policies
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. Actual results
will differ from these estimates under different assumptions or conditions.
Revenue recognition and accounts receivable. We recognize revenue on product
sales when persuasive evidence of an agreement exists, the price is fixed and
determinable, delivery has occurred and there is reasonable assurance of
collection of the sales proceeds. We generally obtain written purchase
authorizations from our customers for a specified amount of product, at a
specified price and consider delivery to have occurred at the time title to
the product passes to the customer. Title passes to the customer according to
the shipping terms negotiated between the customer and us. License fees and
royalty income are recognized when earned. We have demonstrated the ability
to make reasonable and reliable estimates of product returns in accordance
with SFAS No. 48 and of allowances for doubtful accounts based on significant
historical experience. We maintain allowances for doubtful accounts for
estimated losses resulting from the inability of 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.
Goodwill. Effective July 1, 2001, we adopted the provisions of SFAS No.142,
"Goodwill and Other Intangible Assets". Accordingly, goodwill is not
amortized but is tested for impairment, for each reporting unit, on an
annual basis and between annual tests in certain circumstances. We evaluate
goodwill for impairment by comparing our market capitalization, as adjusted
for a control premium, to our recorded net asset value. In order to compute
the control premium adjustment, we have utilized the control premium
realized by competitors or electronic
17
manufacturers of similar size and operating characteristics in
acquisitions. 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.
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 adequate
consideration has been made for such issues, there is the possibility that
the ultimate resolution of such issues could have an adverse effect on the
results of our operations.
Off-Balance Sheet Arrangements. We have not created, and are not party to,
any special-purpose or off-balance sheet entities for the purpose of raising
capital, incurring debt or operating parts of our business that are not
consolidated into our financial statements. We do not have any arrangements
or relationships with entities that are not consolidated into our financial
statements that are reasonably likely to materially affect our liquidity or
the availability of capital resources, except as may be set forth below
under "Liquidity and Capital Resources."
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
Consolidated Financial Statements and the Notes thereto.
Three Months Ended
September 28, September 29,
2003 2002
------------- -------------
<s> <c> <c>
Total revenues 100.0 % 100.0 %
Cost of products sold 88.7 % 95.4 %
----- -----
Gross profit 11.3 % 4.6 %
Selling, general and administrative expenses 19.0 % 13.5 %
----- -----
Operating loss (7.7)% (8.9)%
Loss from operations before income taxes
and minority interest (10.3)% (9.8)%
----- -----
Net loss (10.6)% (6.4)%
===== =====
Three Months Ended September 28, 2003 Compared to Three Months Ended
- --------------------------------------------------------------------
September 29, 2002
- ------------------
Total Revenues. Total revenues for the three months ended September 28,
2003 were $19.7 million versus $21.7 million for the three months ended
September 29, 2002. This represents a decrease of $2.0 million or 9%. This
decrease is primarily attributable to the discontinuation of our
unprofitable domestic PALFlex operation, which occurred in February 2003.
PALFlex is a proprietary adhesiveless double-sided copper flexible circuit
roll to roll manufacturing process. Revenues generated from our PALFlex
operations in the first quarter of fiscal 2004 were $700,000 versus $3.0
million in the first quarter of fiscal 2003. Excluding PALFlex revenues
from both quarters,
18
total revenues were essentially flat. Decreases in revenues from our Multi-
Layer ($600,000) and Laminated Cable ($900,000) operations were offset by
strong growth ($1.6 million) in our China operations.
Shortfalls in our Multi-Layer revenues were due in part to delays in the
production of several key programs. Approximately $1.0 million of planned
shipments for the first quarter of fiscal 2004 remained in backlog.
Decreases in our Laminated Cable operations continue to reflect soft demand
in North American electronics manufacturing in general. Demand in our China
operations remained strong in the first quarter of fiscal 2004 due to
increases in the computer and peripheral market, where Hewlett Packard
remained our single largest customer, and in the automotive market where
strong growth occurred.
Cost of Products Sold. Cost of products sold was $17.5 million, or 89% of
total revenues, for the three months ended September 28, 2003, versus $20.7
million, or 95% of total revenues, for the three months ended September 29,
2002. Cost of products sold were favorably impacted year over year by the
closing of our significantly unprofitable domestic PALFlex operations in
February 2003. In addition, increases in capacity utilization in China
resulted in further margin improvements. Our Methuen facility continued to
experience low capacity utilization and correspondingly, significant
unfavorable manufacturing variances. Expected growth in our Multi-Layer
business, primarily in the military market, and the relocation of our
Laminated Cable operations from Salem, New Hampshire to Methuen
Massachusetts, which was completed in January 2003, are anticipated to
improve margins in fiscal 2004.
During the past year, we have made a significant investment to improve our
margins through the transfer of labor intensive manufacturing operations to
more cost-effective locations. A large portion of the final assembly,
inspection, and test procedures previously performed in our Methuen,
Massachusetts and Salem, New Hampshire facilities are now performed in
Mexico. During fiscal 2003, we completed the transfer of our PALFlex
operations to China. Although the transfer of manufacturing capabilities
is costly, this investment is core to our long-term strategy for cost
effective manufacturing. Although these cost reduction measures are
expected to improve our gross margins, a return to profitability is
predicated upon operational performance, a favorable product mix and
increased sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $3.7 million for the three months ended
September 28, 2003 versus $2.9 million for the comparable period in the
prior year. Due to the reorganization of our sales force in mid-2002 and
the staffing of several open regional positions in fiscal 2003, selling
expenses increased $330,000 in the first quarter of fiscal 2004. Further,
in the first quarter of fiscal 2003, the Company reduced its reserves for
bad debts by approximately $360,000. We believe our reserves for bad debts
to be adequate at September 28, 2003 and have historically experienced few
bad debt write-offs.
Interest Income. Interest income was $5,000 for the three months ended
September 28, 2003 compared to $7,000 for the three months ended September
29, 2002, and primarily consists of interest income on our cash balances.
Interest Expense. Interest expense was $533,000 for the three months ended
September 28, 2003 and $204,000 for the three months ended September 29,
2002. Interest expense represents interest incurred on our short and long-
term borrowings and interest expense associated with deferred compensation.
The increase in interest expense in the three months ended September 28,
2003 is due to interest associated with the sale-leaseback of the Methuen
Facility, $194,000, and the convertible debt, $183,000.
Non operating income. Non operating income was $12,000 for the three
months ended September 28, 2003 versus $500 for the three months ended
September 29, 2002. Non operating income primarily represents currency
exchange rate gains.
19
Non operating expense. Non operating expense was $200 for the three months
ended September 28, 2003 compared to $28,000 for the three months ended
September 29, 2002. Non operating expense primarily represents currency
exchange rate losses.
Our loss before income taxes and the minority interest in our Chinese joint
venture, Parlex Shanghai, was $2.0 million in the three months ended
September 28, 2003 compared to $2.1 million in the three months ended
September 29, 2002. 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% for the three
months ended September 28, 2003 versus an effective tax rate benefit of
(34%) for the three months ended September 29, 2002. Our effective tax rate
is impacted by the proportion of our estimated annual income being earned
in domestic versus 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, 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 September 28, 2003. In the
prior year, we recorded an income tax benefit of $726,000 on our U.S
operating losses for the three months ended September 29, 2002.
Liquidity and Capital Resources
- -------------------------------
As of September 28, 2003, we had approximately $1.3 million in cash and
cash equivalents.
Net cash used by operations during the three months ended September 28, 2003
was $6.0 million. Net operating losses of $2.1 million after adjustment for
minority interest, interest payable in common stock, depreciation and
amortization, used $150,000 of operating cash and $5.8 million for our
working capital requirements.
Net cash provided by investing activities was $694,000 for the three months
ended September 28, 2003. This included a $975,000 deposit for the sale of
our Chinese land use rights offset with funds used to purchase capital
equipment and other assets. As of September 28, 2003, we have an additional
$243,000 of capital equipment financed under our accounts payable. We have
implemented plans to control our capital expenditures in order to enhance
cash flows and maintain compliance with restrictive covenants under our
Loan Agreement. Cash provided by financing activities was $5.1 million for
the three months ended September 28, 2003 including proceeds of $5.5
million from the sale of our convertible subordinated notes and $344,000,
which represents the net repayments and borrowings on our bank debt. The
bank borrowings include $6.0 million from our primary lender, Silicon
Valley Bank, and $1.5 million from our Parlex Shanghai lender. Payments
include $7.0 million to Silicon Valley Bank and $845,000 to retire one
of Parlex Shanghai's local short-term bank notes.
Loan and Security Agreement ("Loan Agreement") - We executed a Loan
Agreement with Silicon Valley Bank on June 11, 2003. The Loan Agreement
provided the bank with a secured interest in substantially all of our
assets. We may borrow up to $10,000,000, based on a borrowing base of
eligible account 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 $1,000,000,
which reduces our availability for borrowings under the Loan Agreement. The
Loan Agreement contains certain restrictive covenants, including but not
limited to, limitations on debt incurred by our foreign subsidiaries,
acquisitions, sales and transfers of assets, and prohibitions against cash
dividends, mergers and repurchases of stock without prior bank approval.
The Loan Agreement also has financial covenants related to maintenance of
$750,000 in minimum cash balances or excess availability under the Loan
Agreement.
20
On September 23, 2003, we executed a Loan Modification Agreement ("the
Modification Agreement") with Silicon Valley Bank. The Modification
Agreement increases the interest rate on borrowings to the bank's prime
rate (4.0% at September 28, 2003) plus 1.5% (decreasing to prime plus 0.75%
after one quarter of positive operating income and to prime plus 0.25%
after two quarters of positive net income, respectively) and amends the
financial covenants. At September 28, 2003, we had available borrowing
capacity under the Loan Agreement of $2,468,000. Since the available
borrowing capacity exceeded $750,000 at September 28, 2003, none of our
cash balance was subject to restriction at September 28, 2003. We are in
compliance with our financial covenants under the Loan Agreement, as
amended, as of September 28, 2003.
Parlex Shanghai Term Note - On August 20, 2003, Parlex Shanghai entered
into a short-term bank note, due August 20, 2004, bearing interest at
5.841%. Amounts outstanding under this short-term note total $1.2 million
as of September 28, 2003. The note replaced a similar short-term note that
terminated on August 22, 2003. On March 7, 2003, Parlex Shanghai entered
into a short-term bank note, due February 25, 2004, bearing interest at
5.841%. Amounts outstanding under this short-term note total $1.3 million
at September 28, 2003.
Parlex Interconnect Term Notes - In June 2002, Parlex Interconnect executed
the $5,000,000 CITIC Loan Agreement with CITIC. The CITIC Loan Agreement
contains certain restrictive covenants and a cross default provision that
would permit the lender to accelerate the repayment of Parlex Interconnect's
obligation under the CITIC Loan Agreement in the event of our default on
other financing arrangements. As a condition of the approval of this CITIC
Loan Agreement, our subsidiary, Parlex Asia Pacific Ltd., and we have
provided a guarantee of the payment of this loan. Under the provisions of the
guarantee, we are required to comply with certain financial covenants.
Effective October 8, 2003, CITIC entered into the CITIC Loan Agreement
Amendment with Parlex Interconnect, and the Guarantee Agreement Amendment
with us. Among other matters, the CITIC Loan Agreement Amendment reduced
Parlex Interconnect's total borrowing capacity from $5,000,000 to $3,800,000,
established a new repayment schedule and added a restrictive financial
covenant regarding EBITDA as of December 31, 2003 for Parlex Interconnect.
Under the new repayment schedule, $1,300,000 is due in 2004, $1,500,000 is
due in 2005 and $1,000,000 is due in 2006. The Guarantee Agreement Amendment
modified certain restrictive financial covenants with us such as Current
Ratio, Tangible Net Worth and Total Liabilities to Tangible Net Worth. We
are in compliance with the financial covenants, as amended, as of September
28, 2003.
Convertible Subordinated Notes - On July 28, 2003, we sold an aggregate
$6,000,000 of our 7% convertible subordinated notes (the "Notes") with
attached warrants to several institutional investors. We received net
proceeds of approximately $5.4 million from the transaction, after
deduction for approximately $600,000 in finders' fees and other transaction
expenses. 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 interest by the 'Initial Conversion
Price' (a defined term) which was established at $8 per share, (the market
price of the stock on the date of the execution of the agreement.) However,
if the number of shares to be issued are not then covered by an effective
registration statement, then each holder of each Note may choose, in its sole
discretion, to have the interest paid in either shares or in cash, with the
exception of the first interest payment, which shall in any event be payable
in shares. Based on the filing of a registration statement during the
quarter, we expect that all interest payments will be paid in stock.
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 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 $73,195 within stockholders' equity at September 28, 2003, as the
interest is required to be paid in the form of common stock. Based on the
conversion price of $8.00 per common share at September 28, 2003, we issued
9,348 shares of common stock in October 2003 as payment for the accrued
interest.
The Notes are convertible immediately by the investors, in whole or in
part, into shares of common stock at an initial conversion price equal to
$8.00. The conversion price is subject to adjustment in the event of stock
splits, dividends and certain combinations. Furthermore, the Notes
contained a beneficial conversion feature representing an effective initial
conversion price that was less than the fair market value of the underlying
common stock on
21
July 28, 2003. The fair value of the beneficial conversion feature was
approximately $1,035,000, 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 4-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
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 interest accrued.
Land Use Rights - In July 2003, Parlex Interconnect executed an agreement
to sell its land use rights for approximately $1.2 million. We received
approximately $1.0 million in cash in August 2003 and the balance will be
paid at closing, which we expect to occur in the second quarter of fiscal
2004.
Throughout fiscal 2003, we took a series of steps to reduce operating
expenses and to restructure operations, which consisted primarily of
reductions in workforce and consolidating manufacturing operations. We
continue to implement plans to control operating expenses, inventory
levels, and capital expenditures as well as plans to manage accounts
payable and accounts receivable to enhance cash flows and return to
profitability. Our plans include the following actions: 1) continuing to
consolidate of some of our manufacturing facilities; 2) continuing to
transfer certain manufacturing processes from our domestic operations to
our lower cost international manufacturing operations, particularly those
in the People's Republic of China; 3) expanding our products in the home
appliance, laptop computer, and electronic identification markets; 4)
continuing to monitor and reduce selling, general and administrative
expenses; and 5) completing sales of non-essential assets such as our land
use rights in China.
Furthermore, we are exploring additional and/or alternative financing
arrangements to partially replace or supplement our financing arrangements
currently in place to provide us with longer-term financing to support our
current working capital needs.
We believe that our cash on hand and cash expected to be generated during
fiscal 2004 will be sufficient to enable us to meet our financing and
operating obligations through at least December 2004. If we require
additional and/or alternative 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 new external financing. However,
there can be no assurance that we will be successful in obtaining such new
external financing.
Recent Adoption of Accounting Pronouncements
- --------------------------------------------
On July 1, 2003, we adopted SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS
No. 150"). SFAS No. 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset
in some circumstances). The requirements of this statement apply to
issuers' classification and measurement of freestanding financial
instruments, including those that comprise more than one option or forward
contract.
The adoption of SFAS No. 150 did not have a material effect on our
financial statements.
22
Factors That May Affect Future Results
- --------------------------------------
Our prospects are subject to certain uncertainties and risks. This Quarterly
Report on Form 10-Q contains certain "forward-looking statements" as defined
under the federal securities laws. 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, including but not limited to those set forth below, 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.
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. If economic and
market conditions do not 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 we are not in compliance with our financial
covenants in the future, we cannot be certain our lenders will continue to
grant us future waivers or execute amendments or modifications on terms
which are satisfactory to us. If such waivers are not received, our debt
will be immediately callable.
At September 28, 2003, we were not in compliance with certain financial
covenants of our loan guarantee of $3.8 million of debt owed by our
subsidiary, Parlex Interconnect, to CITIC, a Hong Kong bank. Effective
October 8, 2003, CITIC entered into an amendment to its loan agreement with
Parlex Interconnect and an amendment to our guarantee of the loan agreement.
In addition, we entered into an amendment of our loan agreement with our
primary lender, Silicon Valley Bank. Among other matters, these amendments
modified certain restrictive financial covenants such as EBITDA, Current
Ratio, Tangible Net Worth and Total Liabilities to Tangible Net Worth. We are
and expect to remain in compliance with all of our financial covenants, as
amended. For additional information relating to the amendments to our loan
arrangements, please see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources".
The issuance of our shares upon conversion of outstanding convertible notes
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 was $8.00 per share. The issuance of
our shares upon conversion of the convertible notes, 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 note and
warrant holders elect to convert their shares. For additional information
relating to this transaction, please see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Convertible Subordinated Notes".
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
23
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.
Our recently completed private placement has substantially increased our
indebtedness.
As a result of our recently completed private placement of $6.0 million
aggregate principal amount of convertible subordinated notes, we have
substantially increased our indebtedness. Although the convertible notes
provide for the payment of interest in shares of our common stock under
certain conditions, we cannot guarantee that such conditions shall exist
and, in the event they do not exist, interest payments must be made in
cash. The convertible notes may become immediately due and payable in the
event of a default by us of certain covenants. We cannot guarantee that we
will be able to meet our obligations under the terms of the convertible
notes, or that we will have sufficient funds to repay the convertible notes
in the event of a redemption or an event of default. For additional
information relating to this transaction, please see "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Convertible Subordinated Notes".
Servicing our existing debt may constrain our future operations.
Our ability to satisfy our obligations to pay interest and to repay debt is
dependent on our future performance. Our performance depends, in part, on
prevailing economic conditions and financial, business and other factors,
including factors beyond our control. To the extent that we use a
substantial portion of our cash flow from operations to pay the principal
and interest on our indebtedness, that cash flow will not be available to
fund our future operations and capital expenditures. We cannot be sure our
operating cash flow will be sufficient to fund our future capital
expenditures and debt service requirements or to fund future operations.
Our credit agreement contains restrictive covenants that could adversely
affect our business by limiting our flexibility.
Our credit agreement imposes restrictions that affect, among other things,
our ability to incur additional debt, pay dividends, sell assets, create
liens, make capital expenditures and investments, merge or consolidate,
enter into transactions with affiliates, and otherwise enter into certain
transactions outside the ordinary course of business. Our credit agreement
also requires us to maintain specified financial ratios and meet certain
financial tests. Our ability to continue to comply with these covenants
and restrictions may be affected by events beyond our control. A breach of
any of these covenants or restrictions would result in an event of default
under our credit agreement. Upon the occurrence of a breach, the lender
under our credit agreement could elect to declare all amounts borrowed
thereunder, together with accrued interest, to be due and payable,
foreclose on the assets securing our credit agreement and/or cease to
provide additional revolving loans or letters of credit, which would have a
material adverse effect on us.
We have incurred losses in each of the last three years and we may continue
to incur losses.
We incurred net losses in the recently completed three months ended
September 28, 2003, as well as in fiscal years 2003, 2002 and 2001. We had
net losses of $2.1 million in the three months ended September 28, 2003,
$19.5 million for 2003, $10.4 million for 2002 and $6.2 million for 2001.
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
24
working capital for anticipated growth. We may need to raise additional
funds either through borrowings or further equity financings. 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 harm 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 harm 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 50% of total revenues in fiscal 2003, 44% in fiscal 2002 and
55% in fiscal 2001.
We expect that a limited number of customers will continue to account for a
high percentage of our total revenues in the foreseeable future. As a
result, the loss of a significant customer or a substantial reduction in
orders by any significant customer would cause our revenues to decline and
have an adverse effect on our operating results.
If we are unable to respond effectively to the evolving technological
requirements of customers, our products may not be able to satisfy the
demands of existing and prospective customers and we may lose revenues and
market share.
The market for our products is characterized by rapidly changing technology
and continuing process development. The future success of our business will
depend in large part upon our ability to maintain and enhance our
technological capabilities. We will need to develop and market products that
meet changing customer needs, and successfully anticipate or respond to
technological changes on a cost-effective and timely basis. There can be no
assurance that the materials and processes that we are currently developing
will result in commercially viable technological processes, or that there
will be commercial applications for these technologies. In addition, we may
not be able to make the capital investments required to develop, acquire or
implement new technologies and equipment that are necessary to remain
competitive. If we fail to keep pace with technological change, our products
may become less competitive or obsolete and we may lose customers and
revenues.
25
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 six facilities worldwide, including lower cost
offshore locations in China. However, a significant portion of our
manufacturing is still performed domestically. Domestic manufacturing may be
at a competitive disadvantage with respect to price when compared to lower
cost facilities in Asia and other locations. While historically our
competitors in these locations have produced less technologically advanced
products, they continue to expand their capabilities. Further, we have
targeted markets that have historically sought domestic manufacturing,
including the military and aerospace markets. Should we be unsuccessful in
maintaining our competitive advantage or should certain target markets also
move production to lower cost offshore locations, our domestic sales will
decline resulting in significant excess capacity and reduced gross margins.
A significant downturn in any of the sectors in which we sell products could
result in a revenue shortfall.
We sell our flexible interconnect products principally to the automotive,
telecommunications and networking, diversified electronics, military, home
appliance, electronic identification and computer markets. The worldwide
electronics industry has seen a substantial downturn since 2001 impacting a
number of our target markets. Although we serve a variety of markets to avoid
a dependency on any one sector, a significant further downturn in any of
these market sectors could cause a material reduction in our revenues, which
could be difficult to replace.
We rely on a limited number of suppliers, and any interruption in our primary
sources of supply, or any significant increase in the prices of materials,
chemicals or components, would have an adverse effect on our short-term
operating results.
We purchase the bulk of our raw materials, process chemicals and components
from a limited number of outside sources. In fiscal 2003, we purchased
approximately 17% of our materials from DuPont 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 DuPont 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.
If we acquire additional businesses, these acquisitions will involve
financial uncertainties as well as personnel contingencies, and may be risky
and difficult to integrate.
We have completed two acquisitions in the past four years and we may acquire
additional businesses that could complement or expand our business. Acquired
businesses may not generate the revenues or profits that we expect and we may
find that they have unknown or undisclosed liabilities. In addition, if we
do make acquisitions, we will face a number of other risks and challenges,
including: the difficulty of integrating dissimilar operations or assets;
26
potential loss of key employees of the acquired business; assimilation of new
employees who may not contribute or perform at the levels we expect;
diversion of management time and resources; and additional costs associated
with obtaining any necessary financing.
These factors could hamper our ability to receive the anticipated benefits
from any acquisitions we may pursue, and could adversely affect our financial
condition and our stock price.
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 joint venture 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; labor union issues; 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 and research, 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.
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
27
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
22 patents issued and have 16 patent applications pending in the United
States and have several corresponding foreign patent applications pending.
Our existing patents may not effectively protect our intellectual property
and could be challenged by third parties, and our future patent applications,
if any, may not be approved. In addition, other parties may independently
develop similar or competing technologies. Competitors may attempt to copy
aspects of our products or to obtain and use information that we regard as
proprietary. If we fail to adequately protect our proprietary rights, our
competitors could offer similar products using materials, processes or
technologies developed by us, potentially harming our competitive position
and our revenues.
If we become involved in a protracted intellectual property dispute, or one
with a significant damages award or which requires us to cease selling some
of our products, we could be subject to significant liability and the time
and attention of our management could be diverted.
Although no claims have been asserted against us for infringement of the
proprietary rights of others, we may be subject to a claim of infringement in
the future. An intellectual property lawsuit against us, if successful,
could subject us to significant liability for damages and could invalidate
our proprietary rights. A successful lawsuit against us could also force us
to cease selling, or redesign, products that incorporate the infringed
intellectual property. We could also be required to obtain a license from
the holder of the intellectual property to use the infringed technology. We
might not be able to obtain a license on reasonable terms, or at all. If we
fail to develop a non-infringing technology on a timely basis or to license
the infringed technology on acceptable terms, our revenues could decline and
our expenses could increase.
We may, in the future, be required to initiate claims or litigation against
third parties for infringement of our proprietary rights or to determine the
scope and validity of our proprietary rights or the proprietary rights of
competitors. Litigation with respect to patents and other intellectual
property matters could result in substantial costs and divert our
management's attention from other aspects of our business.
Market prices of technology companies have been highly volatile, and our
stock price may be volatile as well.
From time to time the U.S. stock market has experienced significant price and
trading volume fluctuations, and the market prices for the common stock of
technology companies in particular have been extremely volatile. In the
past, broad market fluctuations that have affected the stock price of
technology companies have at times been unrelated or disproportionate to the
operating performance of these companies. Any significant fluctuations in
the future might result in a material decline in the market price of our
common stock.
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.
28
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, product or activities that have
not been subject to regulation previously. The costs of complying with new
or more stringent regulations, or with more vigorous enforcement of these
regulations, could be significant.
Environmental laws require us to maintain and comply with a number of
permits, authorizations and approvals and to maintain and update training
programs and safety data regarding materials used in our processes.
Violations of these requirements could result in financial penalties and
other enforcement actions. We could also be required to halt one or more
portions of our operations until a violation is cured. Although we attempt
to operate in compliance with these environmental laws, we may not succeed in
this effort at all times. The costs of curing violations or resolving
enforcement actions that might be initiated by government authorities could
be substantial.
Undetected problems in our products could directly impair our financial
results.
If flaws in design, production, assembly or testing of our products were to
occur by us or our suppliers, we could experience a rate of failure in our
products that would result in substantial repair or replacement costs and
potential damage to our reputation. Continued improvement in manufacturing
capabilities, control of material and manufacturing quality and costs and
product testing, are critical factors in our future growth. There can be no
assurance that our efforts to monitor, develop, modify and implement
appropriate test and manufacturing processes for our products will be
sufficient to permit us to avoid a rate of failure in our products that
results in substantial delays in shipment, significant repair or replacement
costs or potential damage to our reputation, any of which could have a
material adverse effect on our business, results of operations or financial
condition.
Our stock is thinly traded.
Our stock is thinly traded and you may have difficulty in reselling your
shares quickly. The low trading volume of our common stock is outside of our
control, and we cannot guarantee that trading volume will increase in the
near future.
We do not expect to pay dividends in the foreseeable future.
We have never paid cash dividends on our common stock and we do not expect
to pay cash dividends on our common stock any time in the foreseeable
future. In addition, our current financing agreements prohibit the payment
of dividends. The future payment of dividends directly depends upon our
future earnings, capital requirements, financial requirements and other
factors that our board of directors will consider. For the foreseeable
future, we will use earnings from operations, if any, to finance our
growth, and we will not pay dividends to our common stockholders. You
should not rely on an investment in our common stock if 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,
29
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 no shares are issued and outstanding.
Our Articles of Organization gives our board of directors the authority to
issue preferred stock without approval of our stockholders. We may issue
additional shares of preferred stock to raise money to finance our
operations. We may authorize the issuance of the preferred stock in one or
more series. In addition, we may set the terms of preferred stock,
including:
* dividend and liquidation preferences;
* voting rights;
* conversion privileges;
* redemption terms; and
* other privileges and rights of the shares of each authorized
series.
The issuance of large blocks of preferred stock could possibly have a
dilutive effect to our existing stockholders. It can also negatively
impact our existing stockholders' liquidation preferences. In addition,
while we include preferred stock in our capitalization to improve our
financial flexibility, we could possibly issue our preferred stock to
friendly third parties to preserve control by present management. This
could occur if we become subject to a hostile takeover that could
ultimately benefit Parlex and Parlex's stockholders.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
The following discussion about our market risk disclosures involves forward-
looking statements. Actual results could differ materially from those
projected in the forward-looking statements.
We are exposed to market risk related to changes in U.S. and foreign interest
rates and fluctuations in exchange rates. We do not use derivative financial
instruments.
We also have a $10,000,000 Loan and Security Agreement that bears interest at
our lender's prime rate plus 1.5%. The prime rate is affected by changes in
market interest rates. As of September 28, 2003, we have an outstanding
balance under our Loan and Security Agreement of $2,305,000. We have the
option to repay borrowings at anytime without penalty and therefore believe
that our market risk is not material. A 10% change in interest rates would
impact interest expense by approximately $20,000. We do not consider this to
be material or significant.
The remainder of our long-term debt bears interest at fixed rates and is
therefore not subject to market risk.
Sales of Parlex Shanghai, Parlex Interconnect, Poly-Flex Circuits Limited and
Parlex Europe are typically denominated in the local currency, which is also
each company's functional currency. This creates exposure to changes in
exchange rates. The changes in the Chinese/U.S. and U.K./U.S. exchange rates
may positively or negatively impact our sales, gross margins and retained
earnings. Based upon the current volume of transactions in China and the
United Kingdom and the stable nature of the exchange rate between China and
the U.S. and the United Kingdom and the U.S., we do not believe the market
risk is material. We do not engage in regular hedging activities to minimize
the impact of foreign currency fluctuations. Parlex Shanghai and Parlex
Interconnect had combined net assets as of September 28, 2003, of
approximately $14.0 million. Poly-Flex Circuits Limited and Parlex Europe had
30
combined net assets as of September 28, 2003 of approximately $5.2 million.
We believe that a 10% change in exchange rates would not have a significant
impact upon Parlex Shanghai's or Poly-Flex Circuits Limited's financial
position, results of operation or outstanding debt. As of September 28, 2003,
Parlex Shanghai and Parlex Interconnect had combined outstanding debt of
approximately $6.6 million. As of September 28, 2003, Poly-Flex Circuits
Limited had no outstanding debt.
Item 4. Controls and Procedures
- --------------------------------
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the reports that we are
required to file under the Securities and Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our principal executive officer
and our principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. Management necessarily applied its
judgment in assessing the costs and benefits of such controls and
procedures, which, by their nature, can provide only reasonable assurance
regarding management's control objectives. Management believes that there
are reasonable assurances that our controls and procedures will achieve
management's control objectives.
We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
our Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Exchange
Act Rule 13a-15 as of September 28, 2003. Based upon the foregoing, our
Chief Executive Officer and our Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to Parlex (and its consolidated subsidiaries)
required to be included in our Exchange Act reports.
Changes in Internal Controls Over Financial Reporting
As of the period ended June 30, 2003, we noted deficiencies in our
disclosure controls and procedures. The deficiencies related a failure to
adhere to certain corporate policies and procedures specifically relating
to the shipment of product under certain conditions. We believe this has
not had any material impact on our consolidated financial statements,
however, we have taken steps to correct these deficiencies. We have
communicated our revenue recognition policy to our financial and management
employees and we perform end of reporting period transaction reviews to
ensure proper sales cut-off.
The evaluation referred to above did not identify any other significant
change in our internal control over financial reporting that occurred
during the period covered by this Quarterly Report on form 10-Q that has
materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
31
PART II - OTHER INFORMATION
---------------------------
Item 3. DEFAULTS UPON SENIOR SECURITIES
As of September 28, 2003, we were not in compliance with certain financial
covenants under our guarantee of Parlex Interconnect's debt to CITIC. As of
September 28, 2003, the outstanding balance owed to CITIC under the
guarantee was approximately $3,800,000. Although the bank could have called
for early repayment of the debt, no such demand was made.
Effective October 8, 2003, CITIC entered into an Amendment to the Loan
Agreement with Parlex Interconnect and an Amendment to the Guarantee
Agreement with us. As a result of the execution of the amendment to the Loan
Agreement and the amendment to the Guarantee Agreement, we are as of
September 28, 2003 in compliance with the revised financial covenants.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index to this report.
(b) Reports on Form 8-K
On July 31, 2003, we filed a Current Report on Form 8-K pursuant to Item 5
to report the sale of $6.0 million of 7% convertible subordinated notes to
several institutional investors.
On September 3, 2003, we furnished a Current Report on Form 8-K pursuant to
Items 9 and 12 containing the press release realting to our financial
results for the quarter and year ended June 30, 2003.
32
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)
November 17, 2003
-----------------
Date
33
EXHIBIT INDEX
EXHIBIT DESCRIPTION OF EXHIBIT
10.1 Employment Agreement, dated September 1, 2002, between Parlex
Corporation and Jonathan R. Kosheff (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)
34