UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 2003
Commission File No. 1-15729
PARAGON TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
(Exact Name Of Registrant As Specified In Its Charter)
Delaware 22-1643428
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
600 Kuebler Road, Easton, PA 18040
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 610-252-3205
---------------------
Indicate by checkmark 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 checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Number of shares of common stock, par value $1.00 per share, outstanding as of
August 5, 2003: 4,277,095.
---------
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statement
------- -------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2003 2002
------------------- ------------------
Assets
------
Current assets:
Cash and cash equivalents...................... $ 4,501 5,385
Restricted cash................................. - 865
Receivables:
Trade (net of allowance for doubtful
accounts of $277 as of June 30,
2003 and $221 as of December
31, 2002)................................... 5,855 4,285
Notes and other receivables................... 130 940
------ ------
Total receivables........................... 5,985 5,225
------ ------
Costs and estimated earnings in excess
of billings................................... 666 128
Inventories:
Raw materials................................. 1,266 975
Work-in-process............................... 104 109
Finished goods................................ 142 291
------ ------
Total inventories........................... 1,512 1,375
------ ------
Deferred income tax benefits.................... 1,410 1,771
Prepaid expenses and other current assets....... 510 695
------ ------
Total current assets........................ 14,584 15,444
------ ------
Property, plant and equipment, at cost:
Land............................................ - 27
Buildings and improvements...................... 228 3,768
Machinery and equipment......................... 3,794 4,291
------ ------
4,022 8,086
Less: accumulated depreciation................. 2,498 5,877
------ ------
Net property, plant and equipment............. 1,524 2,209
------ ------
Investment in joint venture........................ 576 1,325
Goodwill 17,657 17,657
Other assets, at cost less accumulated
amortization of $183 as of June 30,
2003 and $143 as of December 31, 2002........... 28 68
------ ------
Total assets....................................... $ 34,369 36,703
====== ======
See accompanying notes to consolidated financial statements.
2
Item 1. Financial Statements (Continued)
------- --------------------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2003 2002
------------------- ------------------
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Current installments of long-term debt.......... $ 1,150 1,437
Accounts payable................................ 3,217 2,403
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 1,817 2,271
Accrued salaries, wages, and
commissions................................... 463 544
Income taxes payable............................ 445 154
Accrued royalties payable....................... 110 114
Accrued product warranties...................... 946 894
Accrued pension and retirement
savings plan liabilities...................... 42 170
Accrued restructuring expenses.................. 182 216
Deferred gain on sale-leaseback................. 165 -
Accrued other liabilities....................... 1,084 1,269
------ ------
Total current liabilities................... 9,621 9,472
------ ------
Long-term liabilities:
Long-term debt, excluding current
installments:
Term loan................................... 575 4,263
Subordinated notes payable.................. 2,000 3,000
------ ------
Total long-term debt...................... 2,575 7,263
Other long-term liability....................... 335 401
Deferred gain on sale-leaseback................. 605 -
Deferred income taxes payable................... 1,595 1,713
Deferred compensation........................... 33 25
------ ------
Total long-term liabilities................... 5,143 9,402
------ ------
Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 4,277,095 shares as
of June 30, 2003 and 4,256,098
shares as of December 31, 2002.............. 4,277 4,256
Additional paid-in capital.................... 7,583 7,313
Retained earnings............................. 7,949 6,504
Accumulated other comprehensive loss.......... (204) (244)
------ ------
Total stockholders' equity.................. 19,605 17,829
------ ------
Total liabilities and stockholders' equity.. $ 34,369 36,703
====== ======
See accompanying notes to consolidated financial statements.
3
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Operations (Unaudited)
For the Three and Six Months Ended June 30, 2003 and 2002
(In Thousands, Except Share And Per Share Data)
Three Months Ended Six Months Ended
------------------------------ -------------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net sales................. $ 10,983 9,908 19,547 20,660
Cost of sales............. 8,059 7,422 14,419 15,285
--------- --------- --------- ---------
Gross profit on sales..... 2,924 2,486 5,128 5,375
========= ========= ========= =========
Selling, general and
administrative
expenses............... 1,874 2,182 3,871 4,523
Product development
costs.................. 139 93 302 159
Restructuring charges
(credit)............... - - (170) -
Interest expense.......... 151 266 369 538
Interest income........... (22) (17) (46) (53)
Equity in income of
joint venture.......... (89) (36) (251) (42)
Other income, net......... (124) (203) (1,620) (524)
--------- --------- --------- ---------
1,929 2,285 2,455 4,601
--------- --------- --------- ---------
Earnings before
income taxes........... 995 201 2,673 774
Income tax expense........ 378 78 1,045 308
--------- --------- --------- ---------
Net earnings.............. $ 617 123 1,628 466
========= ========= ========= =========
Basic earnings
per share.............. $ .14 .03 .38 .11
========= ========= ========= =========
Diluted earnings
per share.............. $ .14 .03 .38 .11
========= ========= ========= =========
Weighted average
shares outstanding..... 4,266,799 4,226,635 4,262,213 4,224,492
Dilutive effect of
stock options.......... 89,955 52,695 78,021 70,194
Dilutive effect of
phantom stock units.... - - - 6,703
--------- --------- --------- ---------
Weighted average
shares outstanding
assuming dilution...... 4,356,754 4,279,330 4,340,234 4,301,389
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
4
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income (Unaudited)
For the Three and Six Months Ended June 30, 2003 and 2002
(In Thousands)
Three Months Ended Six Months Ended
------------------------------ -------------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net earnings................ $ 617 123 1,628 466
Other comprehensive
income (loss), net of tax:
Interest rate swap:
Change in fair value
of derivative, net
of tax............. - 3 (8) 44
----- ----- ----- -----
Total other
comprehensive
income (loss)... - 3 (8) 44
----- ----- ----- -----
Comprehensive
income.......... $ 617 126 1,620 510
===== ===== ===== =====
See accompanying notes to consolidated financial statements.
5
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 2003 and 2002
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2003 2002
------------------- -------------------
Cash flows from operating activities:
Net earnings ........................................ $ 1,628 466
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation of plant and equipment.............. 283 320
Amortization of intangibles...................... 40 20
Gain on disposition of property,
plant and equipment, net of unearned
profit on sale-leaseback....................... (1,361) (108)
Amortization of deferred gain on sale-
leaseback...................................... (56) -
Restructuring credit............................. (170) -
Cash dividend received from joint venture........ 1,000 -
Equity in income of joint venture................ (251) (42)
Issuance of common shares as interest
payment on subordinated notes.................. 90 -
Change in operating assets and liabilities:
Receivables.................................. (760) (125)
Costs and estimated earnings in
excess of billings........................ (538) 99
Inventories.................................. (137) 348
Deferred income tax benefits................. 361 -
Prepaid expenses and other
current assets............................ 185 216
Accounts payable............................. 814 (472)
Customers' deposits and billings
in excess of costs and estimated
earnings for completed and
uncompleted contracts..................... (454) 982
Accrued salaries, wages, and
commissions............................... (81) (36)
Income taxes payable......................... 291 9
Accrued royalties payable.................... (4) 5
Accrued pension and retirement
savings plan liabilities.................. 42 16
Accrued product warranties................... 52 291
Accrued restructuring expenses............... (34) (226)
Accrued other liabilities.................... (174) 69
Deferred income taxes payable ............... (145) -
Deferred compensation........................ 8 (119)
------ ------
Net cash provided by operating activities............ 629 1,713
------ ------
Cash flows from investing activities:
Proceeds from the disposition of
property, plant and equipment ..................... 2,734 198
Proceeds from the divestment of a
joint venture...................................... - 125
Additions to property, plant and equipment........... (145) (174)
------ ------
Net cash provided by investing activities............ 2,589 149
------ ------
See accompanying notes to consolidated financial statements.
6
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Six Months Ended June 30, 2003 and 2002
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2003 2002
------------------- -------------------
Cash flows from financing activities:
Sale of common shares in connection with
employee incentive stock option plan............. 8 33
Decrease in restricted cash........................ 865 -
Repayment of long-term debt........................ (4,975) (1,155)
------ ------
Net cash used by financing activities.......... (4,102) (1,122)
------ ------
Increase (decrease) in cash and
cash equivalents................................. (884) 740
Cash and cash equivalents,
beginning of period.............................. 5,385 6,114
------ ------
Cash and cash equivalents,
end of period.................................... $ 4,501 6,854
====== ======
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest..................................... $ 293 417
====== ======
Income taxes................................. $ (370) 45
====== ======
See accompanying notes to consolidated financial statements.
7
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
(1) The information contained in this Form 10-Q report is unaudited. In the
opinion of the management of Paragon Technologies, Inc. ("Paragon" or the
"Company"), the interim financial statements furnished reflect all
adjustments and accruals that are necessary to present a fair statement of
results for the interim periods. The financial statements include the
accounts of the Company and Ermanco Incorporated ("Ermanco"), a wholly
owned subsidiary company, after elimination of intercompany balances and
transactions. Results for interim periods are not necessarily indicative of
results expected for the fiscal year. This quarterly report should be read
in conjunction with, and is qualified in its entirety by reference to, the
Consolidated Financial Statements of the Company and the related Notes
thereto appearing in our annual report on Form 10-K for the year ended
December 31, 2002 as filed with the Securities and Exchange Commission.
Refer to the Company's Form 10-K for the year ended December 31, 2002 for
more complete financial information.
(2) Restructuring
-------------
In June 2001, the Company restructured its business operations, including
curtailment of a defined benefit plan, and recorded a charge of $1,538,000
for restructuring costs. The Company received approval from the Pension
Benefit Guaranty Corporation in 2002 to terminate the defined benefit plan.
In December 2002, the Company partially settled its obligations by making
lump-sum distributions to those participants who elected that payment
option and correspondingly recorded a restructuring credit of $859,000. In
February 2003, the Company settled its remaining obligations by purchasing
annuities for those participants who elected that payment option and
correspondingly recorded a restructuring credit of $170,000.
A roll-forward of restructuring activities is as follows (in thousands):
Beginning Ending
Balance Charge/ Cash Balance
January 1 (Credit) Spending Reclassification June 30
------------ ------------- ------------ ------------------- ------------
2003............ $ 216 (170) (34) 170 182
2002............ $ 494 - (226) - 268
The $182,000 restructuring accrual at June 30, 2003 relates to severance
and other personnel costs and professional fees for the 2001 restructuring
that are still expected to be paid.
The amount reclassified out of the restructuring accrual was previously
included in accrued pension and retirement savings plan liabilities.
(3) Warranty
--------
The Company's products are warranted against defects in materials and
workmanship for a specified period. The Company provides an accrual for
estimated future warranty costs and potential product liability claims
based upon a percentage of cost of sales and warranty experience.
8
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
A roll-forward of warranty activities is as follows (in thousands):
Beginning Ending
Balance Balance
January 1 Additions Deductions June 30
----------- ------------ ----------- -----------
2003............ $ 894 168 (116) 946
2002............ $ 863 408 (117) 1,154
Deductions include payments of warranty costs and reversal of unused
expired warranty accruals.
(4) Major Segments of Business
--------------------------
Operating segments are defined as components of an enterprise in which
separate financial information is available and evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company identified such segments based on both
management responsibility and types of products offered for sale. The
Company operates in two major market segments.
SI Systems
----------
The Company's Easton, Pennsylvania operations (hereafter referred to as "SI
Systems") is a specialized systems integrator supplying SI Systems' branded
automated material handling systems to manufacturing, assembly, order
selection, and distribution operations. The systems are marketed, designed,
sold, installed, and serviced by its own staff or agents, generally as
labor-saving devices to improve productivity, quality, and reduce costs. SI
Systems also operates as a project manager in connection with the
installation, integration, and service of its products generally utilizing
subcontractors. SI Systems' branded products are utilized to automate the
movement or selection of products and are often integrated with other
automated equipment such as conveyors and robots. SI Systems' branded
integrated material handling solutions involve both standard and specially
designed components and include integration of non-proprietary automated
handling technologies so as to provide turnkey solutions for its customers'
unique material handling needs. SI Systems' staff develops and designs
computer control programs required for the efficient operation of its
systems and for optimizing distribution operations. SI Systems' branded
products are sold to customers located primarily in North America,
including the U.S. government.
Ermanco
-------
The Company's Spring Lake, Michigan operations (hereafter referred to as
"Ermanco") is a manufacturer of Ermanco branded light to medium duty unit
handling conveyor and sortation products, serving the material handling
industry through a worldwide network of approximately 100 experienced
material handling equipment distributors and licensees. Ermanco also
provides complete conveyor systems for a variety of applications, including
distribution and manufacture of computers and electronic products,
utilizing primarily its own manufactured conveyor products, engineering
services by its own staff or subcontractors, and subcontracted installation
services. Ermanco supplies material handling systems and equipment to both
national and international markets. Ermanco offers services ranging from
the delivery of basic transportation conveyors to turnkey installations of
complex, fully
9
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
automated work-in-process production lines and distribution centers,
utilizing sophisticated, custom-designed controls software. Many of
Ermanco's sales are to distributors who have non-exclusive agreements with
the Company.
---------------------------------------------
The Company's systems vary in configuration and capacity. Historically,
system prices across the Company's product lines have ranged from $100,000
to several million dollars per system. Systems and aftermarket sales by
brand during the three and six months ended June 30, 2003 and 2002 are as
follows (in thousands):
For the three months ended June 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 2,270 7,548 9,818 89.4%
Aftermarket sales............ 756 409 1,165 10.6%
------ ------ ------ -----
Total sales.................. $ 3,026 7,957 10,983 100.0%
====== ====== ====== =====
As a % of total sales........ 27.6% 72.4% 100.0%
For the three months ended June 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 2,665 5,808 8,473 85.5%
Aftermarket sales............ 856 579 1,435 14.5%
------ ------ ------ -----
Total sales.................. $ 3,521 6,387 9,908 100.0%
====== ====== ====== =====
As a % of total sales........ 35.5% 64.5% 100.0%
For the six months ended June 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 4,877 12,325 17,202 88.0%
Aftermarket sales............ 1,521 824 2,345 12.0%
------ ------ ------ -----
Total sales.................. $ 6,398 13,149 19,547 100.0%
====== ====== ====== =====
As a % of total sales........ 32.7% 67.3% 100.0%
For the six months ended June 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 5,705 12,197 17,902 86.7%
Aftermarket sales............ 1,715 1,043 2,758 13.3%
------ ------ ------ -----
Total sales.................. $ 7,420 13,240 20,660 100.0%
====== ====== ====== =====
As a % of total sales........ 35.9% 64.1% 100.0%
The Company's products are sold worldwide through its own sales personnel,
along with a network of independent distributors and licensees. Domestic
and international sales by brand during the three and six months ended June
30, 2003 and 2002 are as follows (in thousands):
10
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
For the three months ended June 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 2,561 7,270 9,831 89.5%
International sales.......... 465 687 1,152 10.5%
------ ------ ------ -----
Total sales.................. $ 3,026 7,957 10,983 100.0%
====== ====== ====== =====
For the three months ended June 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 3,459 5,689 9,148 92.3%
International sales.......... 62 698 760 7.7%
------ ------ ------ -----
Total sales.................. $ 3,521 6,387 9,908 100.0%
====== ====== ====== =====
For the six months ended June 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 5,844 12,236 18,080 92.5%
International sales.......... 554 913 1,467 7.5%
------ ------ ------ -----
Total sales.................. $ 6,398 13,149 19,547 100.0%
====== ====== ====== =====
For the six months ended June 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 7,268 12,176 19,444 94.1%
International sales.......... 152 1,064 1,216 5.9%
------ ------ ------ -----
Total sales.................. $ 7,420 13,240 20,660 100.0%
====== ====== ====== =====
The Company also engages in sales with the U.S. government, which is one
of the Company's major customers. Sales to the U.S. government during
the three and six months ended June 30, 2003 and 2002 are as follows (in
thousands):
As a %
of Total Sales
-----------------
For the three months ended June 30, 2003............... $ 396 3.6%
For the three months ended June 30, 2002............... 1,207 12.2%
For the six months ended June 30, 2003................. $ 520 2.7%
For the six months ended June 30, 2002................. 2,726 13.2%
The Company identifies operating segments based on the types of products
offered for sale as follows:
For the Three Months Ended
June 30, 2003 (In Thousands): SI Systems Ermanco Total
------------------------------------------- ------------ ------------ ------------
Sales..................................... $ 3,026 7,957 10,983
Earnings before interest expense,
interest income, equity in income of
joint venture, and income taxes......... 183 852 1,035
Total assets.............................. 5,214 29,155 34,369
Capital expenditures...................... 8 15 23
Depreciation and amortization
expense................................. 35 101 136
11
Item 1. Financial Statements (Continued)
------- --------------------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
For the Three Months Ended
June 30, 2002 (In Thousands): SI Systems Ermanco Total
------------------------------------------- ------------ ------------ ------------
Sales..................................... $ 3,521 6,387 9,908
Earnings (loss) before interest
expense, interest income, equity
in income of joint venture, and
income taxes............................ 422 (8) 414
Total assets.............................. 10,524 30,682 41,206
Capital expenditures...................... 6 96 102
Depreciation and amortization
expense................................. 60 100 160
For the Six Months Ended
June 30, 2003 (In Thousands): SI Systems Ermanco Total
------------------------------------------- ------------ ------------ ------------
Sales..................................... $ 6,398 13,149 19,547
Earnings before interest expense,
interest income, equity in income of
joint venture, and income taxes......... 1,769 976 2,745
Total assets.............................. 5,214 29,155 34,369
Capital expenditures...................... 34 111 145
Depreciation and amortization
expense................................. 82 201 283
For the Six Months Ended
June 30, 2002 (In Thousands): SI Systems Ermanco Total
------------------------------------------- ------------ ------------ ------------
Sales $ 7,420 13,240 20,660
Earnings before interest expense,
interest income, equity in income
of joint venture, and income taxes 1,119 98 1,217
Total assets 10,524 30,682 41,206
Capital expenditures 21 153 174
Depreciation and amortization
expense 120 200 320
All of the Company's sales originate in the United States, and there are no
long-lived assets existing outside the United States.
(5) New Accounting Pronouncements
-----------------------------
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("FAS 146") which addresses
financial accounting and reporting for costs associated with exit or
disposal activities. This Statement nullifies Emerging Issues Task Force
Issue 94-3. "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." FAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred and establishes that fair value is the objective for
initial measurement of the liability. The Statement is effective for exit
or disposal activities that are initiated after December 31, 2002. The
application of FAS 146 did not have an effect on the Company's financial
statements.
12
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others." This Interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees issued. The
Interpretation also clarifies that a guarantor is required to recognize, at
inception of a guarantee, a liability for the fair value of the obligation
undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after
December 31, 2002 and did not have an effect on the Company's financial
statements. The disclosure requirements were effective for the Company's
2002 financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses the consolidation by business
enterprises of variable interest entities as defined in the Interpretation.
The Interpretation applies immediately to variable interests in variable
interest entities entered into after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31, 2003.
The application of this Interpretation did not have an effect on the
Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("FAS
150"). FAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It applies specifically to a number of financial
instruments that companies have historically presented within their
financial statements either as equity or between the liabilities section
and the equity section, rather than as liabilities. FAS 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The application of FAS 150 is not expected
to have a material impact on the Company's financial statements.
(6) Other Comprehensive Loss
------------------------
The Company is exposed to market risk from changes in interest rates, and
uses an interest rate swap to hedge this risk. The interest rate swap has a
notional amount of $3,737,500 and expires in 2006. Prior to April 1, 2003,
gains and losses on the interest rate swap were deferred in other
comprehensive income (loss). Effective April 1, 2003, the Company
de-designated the interest rate swap as a hedge of market risk from changes
in interest rates and accordingly, all gains and losses on the interest
rate swap are recorded as interest expense. The fair value of the interest
rate swap at June 30, 2003 was a liability of approximately $335,000.
Gross Tax Effect Net
----- ---------- ---
Accumulated other comprehensive
loss at December 31, 2002.................. $(401) (157) (244)
Loss reclassified from other
comprehensive income....................... 113 43 70
Amortization of other
comprehensive income....................... 26 10 16
Change in fair value of derivative............ (73) (27) (46)
--- --- ----
Accumulated other comprehensive
loss at June 30, 2003...................... $(335) (131) (204)
=== === ===
The Company uses derivative financial instruments as risk management tools
and not for speculative purposes.
13
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
(7) Sale-Leaseback
--------------
In February 2003, the Company sold its Easton, Pennsylvania facility.
Significant terms of the agreement of sale include a sales price of
$2,925,000 and a leaseback of 25,000 square feet of office space for five
years by the Company. The sale-leaseback resulted in a gain of $2,189,000,
of which $1,363,000 of the gain was recorded in Other income in the
Statement of Operations for the three months ended March 31, 2003. The
remaining gain of $826,000 is deferred and will be recognized as a
reduction in rent expense over the term of the lease. During the three and
six months ended June 30, 2003, $40,000 and $56,000, respectively, of the
deferred gain was recognized. Future contractual obligations over the
remaining term of the lease are as follows:
2003............................... $ 103,000
2004............................... 211,000
2005............................... 218,000
2006............................... 224,000
2007............................... 231,000
2008............................... 34,000
---------
Total............................ $ 1,021,000
=========
(8) Long-Term Debt
--------------
The Company was in violation of the covenant related to its Funds Flow
Coverage Ratio and received waivers from its principal bank for the
covenant violation for the quarters ended June 30, 2002 and September 30,
2002. During August 2002, the Company entered into an arrangement to amend
its credit agreements with its principal bank relative to future covenant
requirements and the maintenance of a minimum cash balance covenant. In
August 2002, the line of credit agreement was amended to extend the
expiration date of the facility and decrease the amount available under the
facility. During November 2002, the Company prepaid, without penalty,
$1,200,000 of the term loan reducing the balance of the term loan to
$5,987,500 and placed $1,150,000 in escrow with the Company's principal
bank. Beginning with the quarter ended December 31, 2002, the escrow amount
was scheduled to be reduced by $287,500 every quarter and applied to the
principal portion of the term loan until the escrow amount reached zero.
The Company also amended its credit agreements relative to future covenant
requirements, and certain conditions were added regarding the sale of the
Company's Easton facility. In November 2002, the line of credit agreement
was also amended to decrease the amount available under the facility to
$1,000,000. In February 2003, in accordance with the loan agreement, as
amended, in connection with the sale-leaseback, the Company prepaid,
without penalty, $1,387,500 of the term loan.
In June 2003 the Company amended its credit agreements relative to the term
of the line of credit agreement, future covenant requirements, interest
rate on the term loan, and quarterly debt repayments. Upon receiving
approval from its principal bank and in accordance with its loan
agreements, the Company prepaid $1,000,000 of its subordinated debt, and
also utilizing cash held in escrow with its principal bank the Company
prepaid $2,012,500 of its term debt with its principal bank. As of June 30,
2003, the balance of the term loan was $1,725,000, and the balance of the
subordinated debt was $2,000,000. The Company is obligated to repay equal
14
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
quarterly payments of $287,500 plus accrued interest through December 31,
2004 under its term debt with its principal bank. The credit agreements
were amended, reducing the interest rate on the term loan to a rate equal
to the three-month LIBOR Market Index Rate plus 2.65% and also to reduce
the minimum cash balance covenant to $2,000,000, and the line of credit
agreement was amended to extend the expiration date of the facility to June
30, 2004.
In accordance with its loan agreements, as amended, beginning on June 30,
2003, quarterly interest payments on the subordinated debt may be made in
the form of cash if the Company is in compliance with all the financial
covenants set forth in the Loan Agreement, as amended, with the Company's
principal bank.
(9) Stock-Based Compensation
------------------------
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure" ("FAS 148"), which amends SFAS
No. 123, to provide alternative methods of accounting for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements.
The Company grants stock options for a fixed number of shares to employees
and non-employee directors with an exercise price equal to the fair value
of the shares at the date of grant. The Company has elected to continue to
account for its stock-based compensation plans under the guidelines of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and, accordingly, recognizes no compensation expense on options
granted to employees for the stock option grants. The Company recognizes
compensation expense on options granted to non-employee directors. To date,
the effect of options granted to non-employee directors has been
immaterial. Additional disclosure as required under the guidelines of SFAS
No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), is included
below. If the Company had elected to recognize stock-based compensation
expense for options granted to employees based on the fair value of granted
options at the grant date (as determined under FAS 123), net earnings (in
thousands) and basic and diluted earnings per share for the three and six
months ended June 30, 2003 and 2002, would have been as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------ ------------- -------------
Net earnings, as reported............ $ 617 123 1,628 466
Deduct: total stock-based
employee compensation
determined under fair value
method, net of related tax
effects........................... (69) (75) (141) (146)
----- ----- ----- -----
Pro forma net earnings............... $ 548 48 1,487 320
===== ===== ===== =====
Earnings per share:
Basic-- as reported............... $ .14 .03 .38 .11
===== ===== ===== =====
Basic-- pro forma................. $ .13 .01 .35 .08
===== ===== ===== =====
Diluted-- as reported............. $ .14 .03 .38 .11
===== ===== ===== =====
Diluted-- pro forma............... $ .13 .01 .34 .07
===== ===== ===== =====
15
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Six Months Ended June 30, 2003 and 2002
The above pro forma net earnings and basic and diluted earnings per share
were computed using the fair value of granted options at the date of grant
as calculated by the Black-Scholes option pricing method. No options were
granted to employees during the three and six months ended June 30, 2003
and the year ended December 31, 2002.
(10) Subsequent Event
----------------
In August 2003, the Company amended its credit agreements with its
principal bank to eliminate its minimum cash balance covenant, and upon
receiving approval from its principal bank and in accordance with its loan
agreements, the Company prepaid $500,000 of its term debt with its
principal bank and $500,000 of its subordinated debt. As of the date of the
prepayment, the balance of the term debt with the Company's principal bank
was $1,225,000, while the balance of the subordinated debt was $1,500,000.
---------------------------------------------
16
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Liquidity and Capital Resources
-------------------------------
The Company's cash and cash equivalents decreased to $4,501,000 at June 30,
2003 from $5,385,000 at December 31, 2002. The decrease resulted from the
repayment of long-term debt of $4,975,000 and purchases of capital equipment of
$145,000. Partially offsetting the decrease in cash and cash equivalents from
these uses was cash provided by operating activities totaling $629,000,
inclusive of a $1,000,000 cash dividend received from the SI/BAKER joint
venture, proceeds of $2,734,000 from the disposition of property, plant and
equipment, and a decrease of $865,000 in restricted cash during the six months
ended June 30, 2003. Cash provided by operating activities during the six months
ended June 30, 2002 were $1,713,000.
Acquisition of Ermanco Incorporated
-----------------------------------
On September 30, 1999, the Company acquired all of the outstanding common
stock of Ermanco. Under the terms of the Stock Purchase Agreement, the Company
acquired all of the outstanding common stock of Ermanco for a purchase price of
$22,801,000 consisting of $15,301,000 in cash, $3,000,000 in promissory notes
payable to the fourteen stockholders of Ermanco, and 481,284 shares of the
Company's common stock with a value of $4,500,000 based on the average closing
price of $9.35 of the Company's common stock for the five trading days
immediately preceding the date of the Stock Purchase Agreement, August 6, 1999.
In order to complete the Ermanco acquisition, the Company obtained
financing from its principal bank. The Company entered into a line of credit
facility which may not exceed the lesser of $1,000,000, as amended, or an amount
based on a borrowing base formula tied principally to accounts receivable,
inventory, fair market value of the Company's property and plant, and
liquidation value of equipment. This amount will be reduced by the unpaid
principal balance of the term loan described below. The line of credit facility
is to be used primarily for working capital purposes. As of June 30, 2003, the
Company did not have any borrowings under the line of credit facility, and the
facility expires effective June 30, 2004. The line of credit facility is not
critical to the Company's operations.
The Company financed $14,000,000 of the acquisition through a seven-year
term loan from its principal bank. During the first two years of the term loan,
the Company was obligated to repay equal quarterly payments of $312,500 plus
accrued interest. After September 30, 2001, the Company commenced making equal
quarterly payments of $575,000 plus interest, continuing until the loan is fully
repaid. In connection with an amendment entered into in November 2002, the
Company prepaid, without penalty, $1,200,000 of the term loan and placed
$1,150,000 in escrow with the Company's principal bank. Beginning with the
quarter ended December 31, 2002, the escrow amount was scheduled to be reduced
by $287,500 every quarter and applied to the principal portion of the term loan
until the escrow amount reached zero. The interest rate on the term loan is
variable at a rate equal to the three-month LIBOR Market Index Rate plus 2.65%,
which was 3.75% as of June 30, 2003. The Company also entered into an interest
rate swap agreement for a portion of the term loan to hedge the floating
interest rate. At June 30, 2003, the notional amount of the seven-year interest
rate swap was $3,737,500, and it fixes interest at a rate of 9.38%. As of June
30, 2003, the liability associated with the fair value of the cash flow hedge
was approximately $335,000.
In February 2003, the Company sold its Easton, Pennsylvania facility.
Significant terms of the agreement of sale include a sales price of $2,925,000
and also a leaseback of 25,000 square feet of office space for five years by the
Company. In accordance with the loan agreement in connection with the sale, the
Company prepaid, without penalty, $1,387,500 of the term loan and increased the
escrow amount by $387,500.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Acquisition of Ermanco Incorporated (Continued)
-----------------------------------
In June 2003, the Company amended its credit agreements relative to the
term of the line of credit agreement, future covenant requirements, interest
rate on the term loan, and quarterly debt repayments. Upon receiving approval
from its principal bank and in accordance with its loan agreements, the Company
prepaid $1,000,000 of its subordinated debt, and also utilizing cash held in
escrow with its principal bank the Company prepaid $2,012,500 of its term debt
with its principal bank. As of June 30, 2003, the balance of the term loan was
$1,725,000, and the balance of the subordinated debt was $2,000,000. The Company
is obligated to repay equal quarterly payments of $287,500 plus accrued interest
through December 31, 2004 under its term debt with its principal bank. The
credit agreements were amended, reducing the interest rate on the term loan to a
rate equal to the three-month LIBOR Market Index Rate plus 2.65%, and also to
reduce the minimum cash balance covenant to $2,000,000, and the line of credit
agreement was amended to extend the expiration date of the facility to June 30,
2004.
In August 2003, the Company amended its credit agreements with its
principal bank to eliminate its minimum cash balance covenant, and upon
receiving approval from its principal bank and in accordance with its loan
agreements, the Company prepaid $500,000 of its term debt with its principal
bank and $500,000 of its subordinated debt. As of the date of the prepayment,
the balance of the term debt with the Company's principal bank was $1,225,000,
while the balance of the subordinated debt was $1,500,000.
To obtain the line of credit and term loan, the Company granted the bank a
security interest in all personal property, including, without limitation, all
accounts, deposits, documents, equipment, fixtures, general intangibles, goods,
instruments, inventory, letters of credit, money, securities, and a first
mortgage on all real estate. The line of credit facility and term loan contain
various restrictive covenants relating to additional indebtedness, asset
acquisitions or dispositions, investments, guarantees, payment of dividends,
maintenance of certain financial ratios. The Company was in compliance with all
covenants as of June 30, 2003.
On September 30, 1999, the Company also issued promissory notes to fourteen
stockholders of Ermanco, two of which are directors of the Company (Messrs.
Shulman and Kirschner), in the original aggregate principal amount of
$3,000,000. The notes have a term of seven years and bear interest at an annual
rate of 10% through September 30, 2002, 12% from October 1, 2002 through
September 30, 2004, and 14% from October 1, 2004 through September 30, 2006. The
weighted average interest rate on the promissory notes is 11.714% over the term
of the notes. Interest shall be payable quarterly, in cash or under certain
conditions, in the Company's common stock upon approval of the Company's Board
of Directors. The promissory notes may be prepaid prior to the end of the
seven-year term provided that there is no debt outstanding under the Company's
line of credit facility and term loan. From July 1, 2001 through March 31, 2003,
the Company was prohibited from making any cash payments on subordinated debt
and interest. However, the bank waived the restriction from paying interest on
the subordinated debt in the form of cash for the fourth quarter ended December
31, 2001 and the quarter ended March 31, 2002. In accordance with its loan
agreements, as amended, beginning on June 30, 2003, quarterly interest payments
on the subordinated debt may be made in the form of cash if the Company is in
compliance with all the financial covenants set forth in the Loan Agreement, as
amended, with the Company's principal bank.
Commitments and Contingencies
-----------------------------
Ermanco's operations are located in a 94,000 square foot steel building in
Spring Lake, Michigan. The building is leased from a limited liability company
that is affiliated with the Company through a common director and officer of the
Company, Messrs. Shulman and Kirschner. The leasing agreement requires fixed
monthly rentals of
18
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Commitments and Contingencies (Continued)
-----------------------------
$32,858 (with annual increases of 2.5%), which includes a variable portion based
on the lessor's borrowing rate and the unpaid mortgage balance. The terms of the
lease require the payment of all taxes, insurance, and other ownership related
costs of the property. The lease expires on September 30, 2004.
In connection with the February 2003 sale of the Company's Easton,
Pennsylvania facility, the Company entered into a leaseback arrangement for
25,000 square feet of office space. The leasing agreement requires fixed monthly
rentals of $17,188 (with annual increases of 3%). The terms of the lease also
require the payment of a proportionate share of the facility's operating
expenses. The lease expires on February 21, 2008.
The Company also leases certain automobiles and office equipment, office
space, computer equipment, and software under various operating leases with
terms extending through September 2007.
On March 4, 1996, SI/BAKER established a $3,000,000 line of credit facility
(the "Facility") with its principal bank (the "bank"). Under the terms of the
Facility, SI/BAKER's parent companies, Paragon Technologies, Inc. and McKesson
Automation Systems Inc., provided a limited guarantee and surety in an amount
not to exceed $1,000,000 for a combined guarantee of $2,000,000 to the bank for
the payment and performance of the related note, including any further renewals
or modifications of the facility. The Facility was not critical to the
operations of SI/BAKER; therefore, no renewal was requested and the facility and
limited guarantee were cancelled effective June 30, 2003.
Other Liquidity and Capital Resource Matters
--------------------------------------------
The Company anticipates that its financial resources, consisting of cash
generated from operations, will be adequate to satisfy its future cash
requirements through the next year. If the Company is unable to meet the terms
of its financial covenants relating to its outstanding indebtedness and is
unable to receive a waiver from its lender, a default could result under the
Company's borrowing agreements. A default may result in the acceleration of the
Company's indebtedness and cause the Company's debt to become immediately due
and payable. If acceleration occurs, the Company may not be able to repay its
debt, and the Company may not be able to borrow sufficient additional funds to
refinance such debt. Sales volume, as well as cash liquidity, may experience
fluctuations due to the unpredictability of future contract sales and the
dependence upon a limited number of large contracts with a limited number of
customers.
The Company plans to consider all strategic alternatives to increase
shareholder value, including expansion opportunities as they arise, although the
ongoing operating results of the Company, the restrictive covenants associated
with the financing obtained from the Company's principal bank, the economics of
the expansion, and the circumstances justifying the expansion will be key
factors in determining the amount of resources the Company will devote to
further expansion.
Results Of Operations
---------------------
(a) Six Months Ended June 30, 2003 Versus Six Months Ended June 30, 2002
--------------------------------------------------------------------
The Company's net earnings for the six months ended June 30, 2003 was
$1,628,000 compared to net earnings of $466,000 for the six months ended June
30, 2002. Contributing to net earnings for the six months ended June 30,
2003 was other income from the sale-leaseback of the Company's Easton,
Pennsylvania facility of $1,363,000, and a restructuring credit of $170,000
pertaining to the final settlement of the remaining pension obligations
associated with the Company's terminated pension plan. Contributing to net
earnings for the six months ended June 30, 2002 was other income from the
short-term licensing of certain real property of $300,000, and a gain on the
sale of excess fixed assets of $108,000.
19
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
---------------------
(a) Six Months Ended June 30, 2003 Versus Six Months Ended June 30, 2002
--------------------------------------------------------------------
(Continued)
Net Sales and Gross Profit on Sales
-----------------------------------
Net sales of $19,547,000 for the six months ended June 30, 2003 decreased
5.4% compared to net sales of $20,660,000 for the six months ended June 30,
2002. The sales decrease of $1,113,000 was primarily attributable to a lower
volume of SI Systems' branded orders associated with the current economic
slowdown and competitive pricing pressures. The decline in SI Systems' branded
sales was primarily due to the prior year comparable period containing a greater
amount of sales related to the Order Picking, Fulfillment, and Replenishment
product line. The Company's business is largely dependent upon a limited number
of large contracts with a limited number of customers. This dependence can cause
unexpected fluctuations in sales volume. Various external factors affect the
customers' decision-making process on expanding and upgrading their current
production or distribution sites. The customers' timing and placement of new
orders is often affected by factors such as the current economy, current
interest rates, and future expectations. The Company believes that its business
is not subject to seasonality, although the rate of new orders can vary
substantially from month to month. Fluctuations in the Company's sales and
earnings occur with increases or decreases in major installations, since the
Company recognizes sales on a percentage of completion basis for its system
contracts.
Gross profit, as a percentage of sales, was 26.2% for the six months ended
June 30, 2003 compared to 26.0% for the six months ended June 30, 2002. Gross
profit, as a percentage of sales, for the six months ended June 30, 2003 was
favorably impacted by approximately 3.0% due to a reduction in overhead costs
during the six months ended June 30, 2003 as compared to the six months ended
June 30, 2002. Gross profit, as a percentage of sales, for the six months ended
June 30, 2002 was favorably impacted by approximately 2.8% as a result of the
reversal of previously established contract accruals due to changes in cost
estimates.
Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses of $3,871,000 were lower by
$652,000 for the six months ended June 30, 2003 than in the six months ended
June 30, 2002. The decrease of $652,000 was comprised of cost savings of
approximately $650,000 attributable to a reduction of office associates in the
prior fiscal year and an emphasis on cost reduction. Also contributing to the
higher selling, general and administrative expenses in the six months ended June
30, 2002 were approximately $80,000 in professional fees primarily associated
with enhancing operational efficiency. Partially offsetting the aforementioned
favorable variance was approximately $125,000 in marketing expenses associated
with the Company's participation in a biannual industry trade show in the first
quarter of 2003.
Product Development Costs
-------------------------
Product development costs, including patent expense, of $302,000 were
higher by $143,000 for the six months ended June 30, 2003 than in the six months
ended June 30, 2002. Development programs in the six months ended June 30, 2003
included the new NBA-23(TM) narrow belt accumulation conveyor, computer software
for warehousing and distribution center operations, and improvements to the
Company's Order Picking, Fulfillment, and Replenishment product line.
Development programs in the six months ended June 30, 2002 were aimed at
enhancements to the Company's sortation and accumulation conveyor technologies
and the Order Picking, Fulfillment, and Replenishment product line.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
---------------------
(a) Six Months Ended June 30, 2003 Versus Six Months Ended June 30, 2002
--------------------------------------------------------------------
(Continued)
Restructuring Charges (Credit)
-----------------------------
In June 2001, the Company restructured its business operations, including
curtailment of a detailed benefit plan, and recorded a charge of $1,538,000 for
restructuring costs. The Company received approval from the Pension Benefit
Guaranty Corporation in 2002 to terminate the defined benefit plan. In December
2002, the Company partially settled its obligations by making lump-sum
distributions to those participants who elected that payment option and
correspondingly recorded a restructuring credit of $859,000 during the fourth
quarter of 2002. In February 2003, the Company settled its remaining obligations
by purchasing annuities for those participants who elected that payment option
and correspondingly recorded a restructuring credit of $170,000 during the three
months ended March 31, 2003.
Interest Expense and Interest Income
------------------------------------
Interest expense of $369,000 was lower by $169,000 for the six months ended
June 30, 2003 than for the six months ended June 30, 2002. The decrease in
interest expense was attributable to the reduced level of long-term debt due to
principal payments and lower interest rates and the reversal of approximately
$50,000 of previously accrued interest on subordinated notes payable.
Interest income of $46,000 for the six months ended June 30, 2003 decreased
by $7,000, when compared to the six months ended June 30, 2002. The decrease in
interest income was attributable to a reduction in the level of interest rates
pertaining to short-term investments.
Equity in Income of Joint Venture
---------------------------------
Equity in income of joint venture represents the Company's proportionate
share (50%) of its investment in the SI/BAKER joint venture that is being
accounted for under the equity method. The favorable variance of $209,000 for
the six months ended June 30, 2003 in the equity in income of the SI/BAKER joint
venture was primarily due to its sales of $8,389,000 as compared to the six
months ended June 30, 2002 of $4,536,000, plus a reduction of $260,000 in
product development expenses. The increase in sales for the six months ended
June 30, 2003 compared to the six months ended June 30, 2002 was due to a
significant amount of progress made on orders received during the first half of
2003. Partially offsetting the favorable variance was SI/BAKER's increases of
(1) $112,000 in selling, general and administrative expenses, and (2) $154,000
in revenue-based royalty costs due to the parent companies.
Other Income, Net
-----------------
The favorable variance of $1,096,000 in other income, net for the six
months ended June 30, 2003 as compared to the six months ended June 30, 2002 was
primarily attributable to the gain on the sale-leaseback of the Company's
Easton, Pennsylvania facility of $1,363,000, and an increase in revenue-based
royalty income from the Company's SI/BAKER joint venture of $77,000. Partially
offsetting the favorable variance in other income, net was the prior year
comparable period containing income from the short-term licensing of certain
real property relating to the Company's Easton, Pennsylvania facility of
$300,000, and a gain on the sale of excess fixed assets associated with the
Company's Easton, Pennsylvania facility of $108,000.
Income Tax Expense
------------------
The Company recognized income tax expense of $1,045,000 during the six
months ended June 30, 2003, compared to income tax expense of $308,000 in the
comparable prior year period. Income tax expense was generally recorded at
statutory federal and state tax rates.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
---------------------
(a) Six Months Ended June 30, 2003 Versus Six Months Ended June 30, 2002
---------------------------------------------------------------------
(Continued)
Backlog of Orders
-----------------
The total backlog of orders at June 30, 2003 and 2002 was approximately
$7,434,000 and $11,560,000, respectively. During the six months ended June 30,
2003 and 2002, the Company received orders totaling approximately $20,063,000
and $18,880,000, respectively.
(b) Three Months Ended June 30, 2003 Versus Three Months Ended June 30, 2002
------------------------------------------------------------------------
With the exception of the following Statement of Operations captions,
changes in the second quarter of calendar year 2003 compared to the prior year
were consistent with those previously noted above for the six-month period:
Net Sales and Gross Profit on Sales
-----------------------------------
Net sales of $10,983,000 for the three months ended June 30, 2003 increased
10.8% compared to net sales of $9,908,000 for the three months ended June 30,
2002. The sales increase of $1,075,000 was comprised of an increase in Ermanco's
sales of approximately $1,570,000 and a decrease in SI Systems' sales of
approximately $495,000 for the three months ended June 30, 2003 when compared to
the three months ended June 30, 2002. The improvement in Ermanco branded sales
of $1,570,000 was primarily attributable to a significant amount of progress
made on systems orders received during the first half of 2003. The decline of
$495,000 in SI Systems' branded sales was attributable to all of its product
lines.
Gross profit, as a percentage of sales, was 26.6% for the three months
ended June 30, 2003 compared to 25.1% for the three months ended June 30, 2002.
Gross profit, as a percentage of sales, for the three months ended June 30, 2003
was favorably impacted by approximately 4.7% due to a reduction in overhead
costs during the three months ended June 30, 2003 as compared to the three
months ended June 30, 2002. Gross profit, as a percentage of sales, for the
three months ended June 30, 2002 was favorably impacted by approximately 3.2% as
a result of the reversal of previously established contract accruals due to
changes in cost estimates.
Interest Expense and Interest Income
------------------------------------
Interest expense of $151,000 was lower by $115,000 for the three months
ended June 30, 2003 than for the three months ended June 30, 2002. The decrease
in interest expense was attributable to the reduced level of term debt due to
principal payments, lower interest rates, and the reversal of approximately
$50,000 of previously accrued interest on subordinated notes payable.
Interest income of $22,000 for the three months ended June 30, 2003
improved by $5,000, when compared to the three months ended June 30, 2002. The
increase in interest income was attributable to the higher level of funds
available for short-term investments.
Other Income, Net
-----------------
The unfavorable variance of $79,000 in other income, net for the three
months ended June 30, 2003 as compared to the three months ended June 30, 2002
was primarily attributable to the prior year comparable period containing income
from the short-term licensing of certain real property of the Company's Easton,
Pennsylvania facility of approximately $150,000. Partially offsetting the
unfavorable variance in other income, net was an increase of $93,000 in
revenue-based royalty income from the Company's SI/BAKER joint venture and
license agreements related to material handling system sales.
22
Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------
Cautionary Statement
--------------------
Certain statements contained herein are not based on historical fact and
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 or by the Securities and Exchange Commission
rules, regulations, and releases. The Company intends that such forward-looking
statements be subject to the safe harbors created thereby. Among other things,
they regard the Company's acquisition activities, earnings, liquidity, financial
condition, and certain operational matters. Words or phrases denoting the
anticipated results of future events, such as "anticipate," "believe,"
"estimate," "expect," "may," "will," "will likely," "are expected to," "will
continue," "should," "project," and similar expressions that denote uncertainty,
are intended to identify such forward-looking statements. The Company's actual
results, performance, or achievements could differ materially from the results
expressed in, or implied by, such "forward-looking statements": (1) as a result
of risks and uncertainties identified in connection with those forward-looking
statements, including those factors identified herein, and in the Company's
other publicly filed reports; (2) as a result of risks associated with the
Company's restructuring, including the failure to achieve anticipated operating
savings, and the possibility that the restructuring charges will be greater than
anticipated; (3) as a result of factors over which the Company has no control,
including the strength of domestic and foreign economies, sales growth,
competition, and certain costs increases; (4) the results of pending litigation
related to the Company's intellectual property; or (5) if the factors on which
the Company's conclusions are based do not conform to the Company's
expectations.
Quantitative and Qualitative Disclosures
----------------------------------------
The Company's primary market risk exposure is from changes in interest
rates. The Company's policy is to manage interest rate exposure through the use
of a combination of fixed and floating rate debt instruments, and since
September 30, 1999, an interest rate swap agreement. Generally, the Company
seeks to match the terms of its debt with its purpose. The Company has available
a variable rate line of credit facility to provide working capital for
operations. On September 30, 1999, the Company entered into an interest rate
swap agreement for 50% of its new term loan from its principal bank to
effectively convert half of the term loan from a variable rate note to a fixed
rate note. A standard interest rate swap agreement involves the payment of a
fixed rate times a notional amount by one party in exchange for a floating rate
times the same notional amount from another party. The counterpart to the swap
agreement is the Company's principal bank.
The Company does not believe that its exposures to interest rate risk or
foreign currency exchange risk, risks from commodity prices, equity prices and
other market changes that affect market risk sensitive instruments, including
the interest rate swap agreement, are material to its results of operations.
Item 4. Controls and Procedures
------- -----------------------
(a) An evaluation was performed under the supervision and with the participation
of the Company's management, including its Chief Executive Officer, or CEO, and
Chief Financial Officer, or CFO, of the effectiveness of the Company's
disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act") as of June 30, 2003. Based on that evaluation, the Company's management,
including the CEO and CFO, concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in reports that it files or submits under the Exchange Act, is
recorded, processed, summarized and reported as specified in Securities and
Exchange Commission rules and forms.
(b) There were no significant changes in the Company's internal control over
financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
23
PART II -- OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings
------- -----------------
On July 10, 2003, a competitor filed an action against the Company in the
United States District Court for the District of New Jersey alleging, among
other things, that certain of the Company's products infringe patents held by
the competitor and breach of contract, wrongful use, and unlawful
misappropriation of the competitor's trade secrets, technology and other
proprietary information and unlawful claim of ownership of the competitor's
inventions and technology related to certain of the competitor's products. Based
on these allegations, the competitor is seeking monetary damages and injunctive
relief against the Company.
The Company denies the material allegations of the complaint and is
considering asserting counterclaims against the competitor. Discovery has not
yet commenced, and the matter has not yet been set for trial. Management of the
Company, supported by its legal counsel, believes the competitor's complaint is
without merit and has instructed counsel to defend vigorously against all
charges.
The Company is presently engaged in certain other legal proceedings, which,
on the basis of information furnished by counsel and others, the Company
believes present no significant risk of material loss to the Company.
Item 4. Submission of Matter to a Vote of Security Holders
------- --------------------------------------------------
The Company's Annual Meeting of Stockholders was held on June 11, 2003 with
the following item being submitted to a vote of stockholders:
1. The election of eight directors to the Board of Directors.
Details of the proposal noted above was provided to stockholders in the
form of a Notice of Annual Meeting and Proxy Statement mailed on May 19, 2003,
with such solicitation being in accordance with Regulation 14 of the Securities
and Exchange Act of 1934.
There was no solicitation in opposition to the management's nominees listed
in the Proxy Statement, and all the management's nominees were elected.
The voting results on the election of directors are set forth as follows:
1. Election of Directors:
Name of Nominee Votes For Votes Withheld Non-Voting
--------------- --------- -------------- ----------
L. Jack Bradt 3,450,455 388,213 427,709
Gilman J. Hallenbeck 3,747,392 91,276 427,709
William R. Johnson 3,466,455 372,213 427,709
Leon C. Kirschner 3,508,355 330,313 427,709
Theodore W. Myers 3,799,792 38,876 427,709
Anthony W. Schweiger 3,799,692 38,976 427,709
Steven Shulman 3,747,392 91,276 427,709
Leonard S. Yurkovic 3,560,990 277,678 427,709
24
Item 6. Exhibits and Reports on Form 8-K
------- --------------------------------
(a) Exhibits:
10.32 Eighth Amendment to Line of Credit Note and Loan
Agreement (Line of Credit) dated June 5, 2003
(filed herewith).
10.33 Loan Agreement (Term Loan A and Term Loan B)
entered into June 5, 2003 by and between Paragon
Technologies, Inc., Ermanco Incorporated, and
Wachovia Bank, National Association (filed
herewith).
10.34 Promissory Note related to Term Loan A entered into
June 5, 2003 by and between Paragon Technologies,
Inc., Ermanco Incorporated, and Wachovia Bank,
National Association (filed herewith).
10.35 Promissory Note related to Term Loan B entered into
June 5, 2003 by and between Paragon Technologies,
Inc., Ermanco Incorporated, and Wachovia Bank,
National Association (filed herewith).
10.36 Security Agreement related to Term Loan A dated
June 5, 2003 by and between Paragon Technologies,
Inc. and Wachovia Bank, National Association (filed
herewith).
31.1 Certification by Chief Executive Officer pursuant
to Rule 13a-14(a) and 15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 signed by William R. Johnson, President and
CEO (filed herewith).
31.2 Certification by Chief Financial Officer pursuant
to Rule 13a-14(a) and 15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 signed by Ronald J. Semanick, Chief
Financial Officer and Vice President - Finance and
Treasurer (filed herewith).
32.1 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 signed by William R.
Johnson, President and CEO, and Ronald J. Semanick,
Chief Financial Officer and Vice President -
Finance and Treasurer (filed herewith).
(b) The following report on Form 8-K was filed during the quarter
ended June 30, 2003:
A Form 8-K was filed on May 14, 2003 regarding the Press
Release dated May 14, 2003 announcing financial results for
the first quarter ended March 31, 2003.
25
Paragon Technologies, Inc. and Subsidiary
SIGNATURE
---------
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.
PARAGON TECHNOLOGIES, INC.
/s/ William R. Johnson
------------------------------
William R. Johnson
President & CEO
/s/ Ronald J. Semanick
------------------------------
Ronald J. Semanick
Chief Financial Officer
Dated: August 14, 2003
-------------------
26