Rumours are now rife in the US that Cannondale could be close to filing for Chapter 11 bankruptcy. This is speculation, but what is known is that Cannondale's motorbike division has eaten cash, the corporation's debts are making it hard to pay key suppliers for parts and most of its 625 manufacturing staff have been laid off for the Christmas break. And Cannondale's latest SEC filing - extracts below - contain some worrying caveats...

Cannondale is ‘on the brink’, claim industry analysts

Associated Press reports that Cannondale has "furloughed" 600 manufacturing staff at its US factories and that growing uncertainty about the corporation’s ability to pay down its debt has fuelled a surge in sales of Cannondale Corp shares. 231 910 shares changed hands yesterday, far above its daily average of 13 400.

[NOTE: the graphic above was extracted from Cannondale’s NASDAQ name is ‘Bike’].

A UK industry insider, currently working in the US for a Far Eastern supplier of Cannondale, emailed with his take on the growing unease in US concerning Cannondale’s options: "It’s a very hot rumour on the other side of the pond that Cannondale are going to file for bankruptcy."

However, Tom Armstrong, a Cannondale spokesman, told Associated Press that the lay-offs are "traditional" during December and January.

"It’s something we’ve always done," he said.

This winter, except for a skeleton crew, most employees will be idle through at least mid-January.

The Bedford Gazette, Cannondale’s home-town newspaper, reports that between 80 and 100 Cannondale staffers will remain at work "on what is an extended Christmas shutdown."

Associated Press said: "Cash is hard to find at Cannondale. A number of companies in the industry are stuck with long overdue bills with no indication from Cannondale when they will be paid. And few companies are shipping Cannondale products without being paid first, or they are offering only a limited line of credit.

"Cannondale’s decision to move into motorsports has caused resentment among some long-time employees as the division has drained millions from the company’s coffers and sucked resources from its bicycle division."

The editor and publisher of DealerNews, a motorcycle trade magazine, said Cannondale’s motorbikes are "yesterday’s news."

In Cannondale’s annual report, issued to the US Securities & Exchange Commission on 12th November, there were a number of strongly worded caveats (which is normal in SEC filings but the caveats still make for grim reading).

Here are extracts from the annual report:

WE HAVE SUFFERED DECREASED SALES AND SUBSTANTIAL NET LOSSES IN RECENT PERIODS AND WE CANNOT PREDICT WHETHER OUR FUTURE OPERATIONS WILL BE PROFITABLE. Our net sales have fluctuated from $162.5 million in fiscal 2000 to $146.8 million in fiscal 2001 to $156.7 million in fiscal 2002. In addition, our net losses totaled $2.5 million in fiscal 2000, $20.3 million in fiscal 2001 (including the effect of a deferred tax asset valuation provision of $12.9 million), and $15.4 million in fiscal 2002. Our future level of sales and potential profitability depend on many factors, including our ability to enhance existing products and achieve market acceptance of new products, especially our motorsports products, the effectiveness of our dealer networks and sales teams and various economic conditions and changes affecting discretionary consumer spending. Furthermore, due to the significant production and fixed costs associated with our motorsports division, we currently realize negative margins on the sale of most of our motorsports products. We will need to substantially increase sales of our motorsports products in order to achieve positive margins on the sale of these products. As a result, we can give no assurance that we will experience any significant growth in net sales or that our future operations will return to profitability.

OUR REVENUES AND EARNINGS COULD CONTINUE TO BE NEGATIVELY AFFECTED IF WE CANNOT ANTICIPATE MARKET TRENDS, ENHANCE EXISTING PRODUCTS AND ACHIEVE MARKET ACCEPTANCE OF NEW PRODUCTS, ESPECIALLY OUR MOTORSPORTS PRODUCTS. Our ability to return to the growth pattern that characterized our operations in prior years is dependent to a large part on our ability to successfully anticipate and respond to changing consumer demands and trends in a timely manner, including the introduction of new or updated products at prices acceptable to customers. While the substantial part of our sales historically has been attributable to mountain and road bikes, we believe that our introduction of our motorsports product lines will provide diversification of our products. Our ability to achieve market acceptance for these products will depend upon our ability to:

o establish a strong and favorable brand image;

o establish a reputation for high quality; and

o continue to develop our network of independent motorsports dealers to sell these products.

The demand for and market acceptance of our motorsports products are subject to substantial uncertainty. Because the market for our motorsports products is new for us and evolving, we cannot predict the size and future growth rate, if any, of this market. We also can give no assurance that the market for our motorsports products will develop or that large demand for these products will emerge or be sustainable. In addition, we may incur significant costs in our attempt to establish market acceptance for our motorsports products.

WE FACE SUBSTANTIAL COMPETITION FROM A NUMBER OF MANUFACTURERS IN EACH OF OUR PRODUCT LINES, INCLUDING IN THE MOTORSPORTS MARKET, WHICH WE MAY NOT BE ABLE TO PENETRATE BECAUSE OF THE ESTABLISHED MANUFACTURING CAPABILITIES, MARKET POSITION AND BRAND RECOGNITION OF MANY OF OUR COMPETITORS. The worldwide market for bicycles and accessories is extremely competitive and we face strong competition from a number of manufacturers in each of our product lines. A number of our competitors are larger and have greater resources than we have. Competition in the high-performance segment of the bicycle industry is based primarily on perceived value, brand image, performance features, product innovation and price. Competition in foreign markets may also be affected by duties, tariffs, taxes and the effect of various trade agreements, import restrictions and fluctuations in exchange rates. We may not be successful in the bicycle market if we cannot compete on:

o the breadth and quality of our bicycle product lines;

o the continued development and maintenance of an effective specialty bicycle retailer network;

o brand recognition; and

o price.

The motorsports market is also highly competitive. Our principal competitors in this market are foreign manufacturers that have financial resources substantially greater than ours, have established manufacturing capabilities, have established market positions and have strong brand recognition. As a result, we may not be able to penetrate the motorsports market. We may not be successful in the motorsports market if we cannot compete on:

o the design and production of quality motorcycles and ATVs;

o the development and maintenance of an effective motorsports retailer network;

o brand recognition;

o market presence;

o timely delivery of motorcycles and ATVs; and

o price.

OUR SALES ARE HIGHLY DEPENDENT ON THE EFFECTIVENESS OF OUR DEALER NETWORKS AND SALES TEAMS AND OUR DEALERS MAY NOT GIVE PRIORITY TO OUR PRODUCTS AS COMPARED TO OUR COMPETITORS’ PRODUCTS. Sales of our products are made to specialty bicycle and motorsports retailers. Our level of sales depends upon the effectiveness of these dealer networks and our internal sales teams. Most of our dealers offer competitive products manufactured by third parties. Our dealers may not give priority to our products as compared to our competitors’ products. In addition, because we have recently entered the motorsports business, we do not yet know how successful our dealers and sales team will be in selling our motorcycles, ATVs and related products over the long term.

WE RELY ON A SINGLE SUPPLIER FOR MANY OF THE SIGNIFICANT COMPONENTS IN OUR BICYCLE PRODUCTS AND WE CAN GIVE NO ASSURANCE THAT WE WILL BE ABLE TO OBTAIN COMPONENTS FROM OUR CURRENT BICYCLE AND MOTORSPORTS SUPPLIERS AT REASONABLE PRICES OR ON A TIMELY BASIS. Our ability to distribute our products on schedule is highly dependent on our timely receipt of an adequate supply of components and materials. Our bicycles, motorcycles and ATVs incorporate numerous components manufactured by other companies. Although there are many suppliers for each of our component parts, we rely on a sole source of supply for many of the significant components in our bicycle products. This reliance involves a number of significant risks, including:

o temporary unavailability of materials and interruptions in delivery of components and materials from our suppliers;

o manufacturing delays caused by unavailability or interruptions of components and materials to us; and

o fluctuations in the quality and the price of components and materials.

We have few long-term agreements with our component manufacturers, and have no long-term agreement with Shimano, our largest single supplier, or with the suppliers of many of the materials used in the manufacture of our products. As a result, we can provide no guarantee that we will be able to purchase the components and materials we need from our current suppliers at reasonable prices or on a timely basis. Although we believe we have established close relationships with our principal suppliers, our future success will depend upon our ability to maintain flexible relationships with our suppliers or to substitute new suppliers without interruption of supply. The loss of Shimano or certain other key suppliers or delays or disruptions in the delivery of components or materials could have a material adverse effect on our manufacturing operations and our operating results. For example, we have suffered recent delays in the delivery of certain components used in our bicycles. As a result, we have been unable to produce a sufficient number of bicycles to fulfill our outstanding orders during the first quarter of fiscal 2003, which in turn will have a negative impact on our operating results for the first quarter of fiscal 2003.

WE HAVE LIMITED EXPERIENCE WITH MOTORSPORTS PRODUCT MANUFACTURING OPERATIONS. While we believe that we can capitalize on many of our core competencies in producing our motorsports products, we have limited experience in designing and manufacturing motorsports products. This may lead to unforeseen expenses and delays in manufacturing and selling our motorsports products. For example, although we conduct significant testing of our motorsports products, these products could contain unforeseen defects. These defects could result in costly product recalls, product liability claims and damage to our brand name. In addition, we may encounter significant difficulties and incur unforeseen expenses in manufacturing our motorsports products in commercial quantities and on a timely basis.

OUR ABILITY TO MEET OUR FINANCIAL OBLIGATIONS AND OPERATIONAL COMMITMENTS DEPENDS ON CERTAIN FACTORS BEYOND OUR CONTROL. Our ability to satisfy various financial covenants contained in our credit facilities with Pegasus and CIT and to maintain our planned levels of production depends on our future financial and operating performance. This performance is subject to various factors, including certain factors beyond our control such as, among other things, various economic conditions and changes adversely affecting discretionary consumer spending. The breach of any of the financial covenants in our credit facilities, unless waived or amended by the lenders, would constitute an event of default under our financing agreements, which would permit our lenders to accelerate the maturity of our debt. We can give no assurance that we would be able to obtain any such waiver or amendment on acceptable terms or at all. In addition, we will depend on cash generated by our operations to fund a substantial portion of our working capital needs in fiscal 2003. If we cannot generate sufficient positive cash flows from operations to continue compliance with the financial covenants contained in our financing facilities or to fund our working capital needs, we could be forced to:

o reduce or delay capital expenditures;

o limit or discontinue, temporarily or permanently, business plans, activities or operations;

o sell assets or businesses;

o obtain additional debt or equity financing; or

o restructure or refinance our debt.

THE DILUTION WHICH MAY RESULT FROM THE CONVERSION AND EXERCISE OF OUR OUTSTANDING CONVERTIBLE DEBENTURES AND WARRANTS COULD BE SIGNIFICANT. In April 2001, we issued two convertible debentures, each with a principal amount of $2.0 million, to two individual investors. The two debentures are convertible, in whole or in part, at the option of the holders into shares of our common stock at an initial conversion price of $3.75 and $4.50, respectively, or an aggregate of 977,777 shares. We have registered the resale of all 977,777 shares, which means that when a debenture is converted, in whole or in part, the holder may resell the shares received on the conversion in the public market. Furthermore, in July 2002, in connection with the sale of $25.0 million of our senior notes, we issued to Pegasus Partners II, L.P. warrants to purchase an aggregate of 2,944,552 shares of our common stock. These warrants are exercisable through July 26, 2012 at an initial exercise price of $2.05 per share. If we repay the senior notes in full by January 26, 2004, warrants to purchase 1,972,849 will be cancelled. If we do not repay the senior notes in full by that date, but repay the senior notes in full by July 26, 2004, warrants to purchase 1,472,276 shares will be cancelled. The warrants subject to cancellation are not exercisable. In connection with the issuance of these warrants, the conversion prices of the convertible debentures were reduced, which will entitle the holders of the debentures to collectively receive additional shares upon conversion. The conversion of a material portion of these debentures and/or the exercise of a material portion of these warrants will have a substantial dilutive effect on our existing stockholders.

THE PROVISIONS OF THE CONVERTIBLE DEBENTURES AND THE PEGASUS WARRANTS WOULD SUBJECT OUR STOCKHOLDERS TO FURTHER DILUTION IF WE WERE TO ISSUE COMMON STOCK AT PRICES BELOW THE CONVERSION PRICES OF THE DEBENTURES OR THE EXERCISE PRICE OF THE WARRANTS. In addition to provisions providing for proportionate adjustments in the event of stock splits, stock dividends and similar events, the debentures provide for an adjustment of the applicable conversion prices if we issue shares of our common stock at prices lower than these conversion prices. Similarly, the warrants issued to Pegasus provide for an adjustment of both the exercise price and the number of shares issuable upon exercise of the warrants if we issue shares of our common stock at prices lower than the exercise price of the warrants. This means that if we raise equity financing at the then current market price at a time when the market price for our common stock is lower than the applicable conversion and exercise prices, then the conversion price of the debentures will be reduced, the number of shares issuable upon conversion of the debentures will be increased, the exercise price of the warrants will be reduced, the number of shares issuable upon exercise of the warrants will be increased and, as a result, the potential dilution to stockholders will be increased.

IF THE HOLDERS OF THE CONVERTIBLE DEBENTURES OR THE PEGASUS WARRANTS ELECT TO SELL A MATERIAL AMOUNT OF THEIR SHARES OF OUR COMMON STOCK, THE MARKET PRICE OF OUR SHARES MAY DECREASE. It is possible that the holders of the debentures and warrants issued to Pegasus will offer for sale all or a material portion of the shares issuable upon conversion of the debentures or the exercise of the warrants, respectively. Further, because it is possible that a significant number of these shares could be sold at one time, those sales could reduce the market price of our common stock.

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