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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 September 30, 2003
Commission File No. 1-15729
PARAGON TECHNOLOGIES, INC.
- --------------------------------------------------------------------------------
(Exact Name Of Registrant As Specified In Its Charter)
Delaware 22-1643428
- --------------------------------------------------- ---------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
600 Kuebler Road, Easton, PA 18040
- --------------------------------------------------- ---------------------
(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
October 31, 2003: 4,277,595.
---------
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002
(In Thousands, Except Share Data)
(UNAUDITED)
September 30, December 31,
2003 2002
------------------- -------------------
Assets
- ------
Current assets:
Cash and cash equivalents...................... $ 7,145 5,385
Restricted cash................................. - 865
Receivables:
Trade (net of allowance for doubtful
accounts of $302 as of September 30,
2003 and $221 as of December
31, 2002)................................... 4,569 4,285
Notes and other receivables................... 70 940
------ ------
Total receivables........................... 4,639 5,225
------ ------
Costs and estimated earnings in excess
of billings................................... 273 128
Inventories:
Raw materials................................. 852 975
Work-in-process............................... 110 109
Finished goods................................ 111 291
------ ------
Total inventories........................... 1,073 1,375
------ ------
Deferred income tax benefits.................... 1,279 1,771
Prepaid expenses and other current assets....... 726 695
------ ------
Total current assets........................ 15,135 15,444
------ ------
Property, plant and equipment, at cost:
Land............................................ - 27
Buildings and improvements...................... 228 3,768
Machinery and equipment......................... 3,829 4,291
------ ------
4,057 8,086
Less: accumulated depreciation................. 2,631 5,877
------ ------
Net property, plant and equipment............. 1,426 2,209
------ ------
Investment in joint venture........................ - 1,325
Goodwill........................................... 17,657 17,657
Other assets....................................... 10 68
------ ------
Total assets....................................... $ 34,228 36,703
====== ======
See accompanying notes to consolidated financial statements.
2
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002
(In Thousands, Except Share Data)
(UNAUDITED)
September 30, December 31,
2003 2002
------------------- -------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Current installments of long-term debt.......... $ - 1,437
Accounts payable................................ 2,758 2,403
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 1,427 2,271
Accrued salaries, wages, and
commissions................................... 463 544
Income taxes payable............................ 1,749 154
Accrued royalties payable....................... 110 114
Accrued product warranties...................... 919 894
Accrued pension and retirement
savings plan liabilities...................... 14 170
Accrued restructuring expenses.................. 168 216
Deferred gain on sale-leaseback................. 165 -
Accrued other liabilities....................... 2,098 1,269
------ ------
Total current liabilities................... 9,871 9,472
------ ------
Long-term liabilities:
Long-term debt, excluding current
installments:
Term loan................................... - 4,263
Subordinated notes payable.................. - 3,000
------ ------
Total long-term debt...................... - 7,263
Other long-term liability....................... - 401
Deferred gain on sale-leaseback................. 564 -
Deferred income taxes payable................... 1,533 1,713
Deferred compensation........................... 35 25
------ ------
Total long-term liabilities................... 2,132 9,402
------ ------
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 4,277,595 shares as
of September 30, 2003 and 4,256,098
shares as of December 31, 2002.............. 4,278 4,256
Additional paid-in capital.................... 7,586 7,313
Retained earnings............................. 10,361 6,504
Accumulated other comprehensive loss.......... - (244)
------ ------
Total stockholders' equity.................. 22,225 17,829
------ ------
Total liabilities and stockholders' equity.. $ 34,228 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 Nine Months Ended September 30, 2003 and 2002
(In Thousands, Except Share And Per Share Data)
Three Months Ended Nine Months Ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Net sales................. $ 8,742 9,010 28,289 29,670
Cost of sales............. 6,508 7,119 20,927 22,404
--------- --------- --------- ---------
Gross profit on sales..... 2,234 1,891 7,362 7,266
--------- --------- --------- ---------
Selling, general and
administrative
expenses............... 2,992 2,251 6,863 6,774
Product development
costs.................. 60 94 363 253
Restructuring charges
(credit)............... - - (170) -
Interest expense.......... 306 265 675 803
Interest income........... (9) (35) (55) (88)
Equity in income of
joint venture.......... (5) (11) (256) (53)
Other income, net......... (5,022) (4) (6,644) (528)
--------- --------- --------- ---------
(1,678) 2,560 776 7,161
--------- --------- --------- ---------
Earnings (loss) before
income taxes........... 3,912 (669) 6,586 105
Income tax expense
(benefit).............. 1,500 (267) 2,545 41
--------- --------- --------- ---------
Net earnings (loss)....... $ 2,412 (402) 4,041 64
========= ========= ========= =========
Basic earnings
(loss) per share....... $ .56 (.09) .95 .02
========= ========= ========= =========
Diluted earnings
(loss) per share....... $ .55 (.09) .93 .01
========= ========= ========= =========
Weighted average
shares outstanding..... 4,277,345 4,235,887 4,266,778 4,227,911
Dilutive effect of
stock options.......... 133,799 - 98,206 65,696
Dilutive effect of
phantom stock units.... - - - 4,692
--------- --------- --------- ---------
Weighted average
shares outstanding
assuming dilution...... 4,411,144 4,235,887 4,364,984 4,298,299
========= ========= ========= =========
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 Nine Months Ended September 30, 2003 and 2002
(In Thousands)
Three Months Ended Nine Months Ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Net earnings (loss).............. $ 2,412 (402) 4,041 64
Other comprehensive
loss, net of tax:
Interest rate swap:
Change in fair value
of derivative, net
of tax.................. - (49) (8) (5)
------ ------ ------ ------
Total other
comprehensive
loss................. - (49) (8) (5)
------ ------ ------ ------
Comprehensive
income (loss)........ $ 2,412 (451) 4,033 59
====== ====== ====== ======
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 Nine Months Ended September 30, 2003 and 2002
(In Thousands, Except Share Data)
Nine Months Ended
----------------------------------------
September 30, September 30,
2003 2002
------------------- -------------------
Cash flows from operating activities:
Net earnings ........................................ $ 4,041 64
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation of plant and equipment.............. 415 488
Amortization of intangibles...................... 57 32
Gain on disposition of property,
plant and equipment, net of unearned
profit on sale-leaseback....................... (1,361) (94)
Gain on sale of SI/BAKER joint venture........... (4,919) -
Amortization of deferred gain on sale-
leaseback...................................... (96) -
Restructuring credit............................. (170) -
Cash dividend received from joint venture........ 1,000 -
Equity in income of joint venture................ (256) (53)
Non-cash interest charges associated
with settlement of interest rate
swap contract.................................. 188 -
Issuance of common shares as interest
payment on subordinated notes.................. 90 150
Change in operating assets and liabilities:
Receivables.................................. 586 1,224
Costs and estimated earnings in
excess of billings........................ (145) 24
Inventories.................................. 302 994
Deferred income tax benefits................. 492 -
Prepaid expenses and other
current assets............................ (31) (91)
Other noncurrent assets...................... 1 -
Accounts payable............................. 355 (350)
Customers' deposits and billings
in excess of costs and estimated
earnings for completed and
uncompleted contracts..................... (844) (1,014)
Accrued salaries, wages, and
commissions............................... (81) (132)
Income taxes payable......................... 1,595 (44)
Accrued royalties payable.................... (4) 16
Accrued product warranties................... 25 229
Accrued pension and retirement
savings plan liabilities.................. 14 38
Accrued restructuring expenses............... (48) (272)
Accrued other liabilities.................... 829 245
Deferred income taxes payable ............... (233) 896
Deferred compensation........................ 10 (115)
------ ------
Net cash provided by operating activities............ 1,812 2,235
------ ------
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 Nine Months Ended September 30, 2003 and 2002
(In Thousands, Except Share Data)
Nine Months Ended
----------------------------------------
September 30, September 30,
2003 2002
------------------- -------------------
Cash flows from investing activities:
Proceeds from the disposition of
property, plant and equipment ..................... 2,734 200
Proceeds from the divestment of
joint ventures, net of advisory fees............... 5,500 125
Additions to property, plant and equipment........... (180) (229)
------ ------
Net cash provided by investing activities............ 8,054 96
------ ------
Cash flows from financing activities:
Sale of common shares in connection with
employee incentive stock option plan............. 12 33
Decrease in restricted cash........................ 865 -
Repayment of long-term debt........................ (8,700) (1,730)
Settlement of interest rate swap contract.......... (283) -
------ ------
Net cash used by financing activities.......... (8,106) (1,697)
------ ------
Increase in cash and
cash equivalents................................. 1,760 634
Cash and cash equivalents,
beginning of period.............................. 5,385 6,114
------ ------
Cash and cash equivalents,
end of period.................................... $ 7,145 6,748
====== ======
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest..................................... $ 456 618
====== ======
Income taxes................................. $ (118) 51
====== ======
Supplemental disclosures of noncash financing activities:
Equity impact from exercise of non-
qualified stock options........................ $ 40 -
====== ======
Withholding of common shares for
income tax withholding obligations
arising from exercise of non-
qualified stock options........................ $ (31) -
====== ======
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 Nine Months Ended September 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 September 30
------------ ------------- ------------ ------------------- ------------------
2003............ $ 216 (170) (48) 170 168
2002............ $ 494 - (272) - 222
The $168,000 restructuring accrual at September 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 Nine Months Ended September 30, 2003 and 2002
A roll-forward of warranty activities is as follows (in thousands):
Beginning Ending
Balance Balance
January 1 Additions Deductions September 30
------------- ------------------ ----------------- -------------------
2003.................. $ 894 159 (134) 919
2002.................. $ 863 414 (185) 1,092
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 Nine Months Ended September 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 nine months ended September 30, 2003 and 2002
are as follows (in thousands):
For the three months ended September 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 2,112 5,519 7,631 87.3%
Aftermarket sales............ 697 414 1,111 12.7%
------ ------ ------ -----
Total sales.................. $ 2,809 5,933 8,742 100.0%
====== ====== ====== =====
As a % of total sales........ 32.1% 67.9% 100.0%
For the three months ended September 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 2,706 5,363 8,069 89.5%
Aftermarket sales............ 630 311 941 10.5%
------ ------ ------ -----
Total sales.................. $ 3,336 5,674 9,010 100.0%
====== ====== ====== =====
As a % of total sales........ 37.0% 63.0% 100.0%
For the nine months ended September 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 6,989 17,844 24,833 87.8%
Aftermarket sales............ 2,219 1,237 3,456 12.2%
------ ------ ------ -----
Total sales.................. $ 9,208 19,081 28,289 100.0%
====== ====== ====== =====
As a % of total sales........ 32.5% 67.5% 100.0%
For the nine months ended September 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Systems sales................ $ 8,411 17,560 25,971 87.5%
Aftermarket sales............ 2,345 1,354 3,699 12.5%
------ ------ ------ -----
Total sales.................. $ 10,756 18,914 29,670 100.0%
====== ====== ====== =====
As a % of total sales........ 36.3% 63.7% 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 nine months ended
September 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 Nine Months Ended September 30, 2003 and 2002
For the three months ended September 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 2,231 5,698 7,929 90.7%
International sales.......... 578 235 813 9.3%
------ ------ ------ -----
Total sales.................. $ 2,809 5,933 8,742 100.0%
====== ====== ====== =====
For the three months ended September 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 3,299 5,308 8,607 95.5%
International sales.......... 37 366 403 4.5%
------ ------ ------ -----
Total sales.................. $ 3,336 5,674 9,010 100.0%
====== ====== ====== =====
For the nine months ended September 30, 2003:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 8,076 17,933 26,009 91.9%
International sales.......... 1,132 1,148 2,280 8.1%
------ ------ ------ -----
Total sales.................. $ 9,208 19,081 28,289 100.0%
====== ====== ====== =====
For the nine months ended September 30, 2002:
% of Total
SI Systems Ermanco Total Sales
--------------- -------------- -------------- --------------
Domestic sales............... $ 10,567 17,484 28,051 94.5%
International sales.......... 189 1,430 1,619 5.5%
------ ------ ------ -----
Total sales.................. $ 10,756 18,914 29,670 100.0%
====== ====== ====== =====
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 nine months ended September 30, 2003 and 2002 are as
follows (in thousands):
As a %
of Total Sales
-----------------
For the three months ended September 30, 2003.......... $ 732 8.4%
For the three months ended September 30, 2002.......... 376 4.2%
For the nine months ended September 30, 2003........... $ 1,252 4.4%
For the nine months ended September 30, 2002........... 3,102 10.5%
The Company identifies operating segments based on the types of products
offered for sale as follows:
For the Three Months Ended
September 30, 2003 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------ ---------- ---------- ----------
Sales..................................... $ 2,809 5,933 8,742
Earnings (loss) before interest
expense, interest income, equity
in income of joint venture, and
income taxes............................ 4,973 (769) 4,204
Total assets.............................. 6,487 27,741 34,228
Capital expenditures...................... 4 31 35
Depreciation and amortization
expense................................. 32 100 132
11
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2003 and 2002
For the Three Months Ended
September 30, 2002 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------ ---------- ---------- ----------
Sales..................................... $ 3,336 5,674 9,010
Earnings (loss) before interest
expense, interest income, equity
in income of joint venture, and
income taxes............................ (43) (407) (450)
Total assets.............................. 8,809 30,251 39,060
Capital expenditures...................... 34 21 55
Depreciation and amortization
expense................................. 56 112 168
For the Nine Months Ended
September 30, 2003 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------ ---------- ---------- ----------
Sales..................................... $ 9,208 19,081 28,289
Earnings before interest expense,
interest income, equity in income of
joint venture, and income taxes......... 6,742 208 6,950
Total assets.............................. 6,487 27,741 34,228
Capital expenditures...................... 38 142 180
Depreciation and amortization
expense................................. 114 301 415
For the Nine Months Ended
September 30, 2002 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------ ---------- ---------- ----------
Sales..................................... $ 10,756 18,914 29,670
Earnings (loss) before interest
expense, interest income, equity
in income of joint venture, and
income taxes............................ 1,075 (308) 767
Total assets.............................. 8,809 30,251 39,060
Capital expenditures...................... 55 174 229
Depreciation and amortization
expense................................. 176 312 488
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 Nine Months Ended September 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 did not have an
effect on the Company's financial statements.
(6) Other Comprehensive Loss
------------------------
On September 19, 2003, the Company settled the liability associated with
the fair value of its interest rate swap by paying $330,000 to its
principal bank, inclusive of $47,000 of accrued interest. The Company's
exposure to market risk from changes in interest rates was hedged by using
the interest rate swap. At the time of settlement, the interest rate swap
had a notional amount of $3,737,500 and was scheduled to expire, pursuant
to quarterly amortization of $287,500, on September 30, 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.
Gross Tax Effect Net
----- ---------- ---
Accumulated other comprehensive
loss at December 31, 2002.................. $(401) (157) (244)
Loss reclassified from other
comprehensive income....................... 160 62 98
Amortization of other
comprehensive income....................... 357 138 219
Change in fair value of derivative............ (116) (43) (73)
--- --- ---
Accumulated other comprehensive
loss at September 30, 2003................. $ - - -
=== === ===
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 Nine Months Ended September 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
nine months ended September 30, 2003, $41,000 and $97,000, respectively, of
the deferred gain was recognized. Future contractual obligations over the
remaining term of the lease are as follows:
2003............................... $ 52,000
2004............................... 211,000
2005............................... 218,000
2006............................... 224,000
2007............................... 231,000
2008............................... 34,000
-------
Total............................ $ 970,000
=======
(8) Investment in SI/BAKER Joint Venture
------------------------------------
On September 19, 2003 (the "Closing Date"), the Company sold (the "Sale")
its entire ownership interest in SI/BAKER, INC. ("SI/BAKER"), a joint
venture of Paragon and McKesson Automation Systems Inc., a Louisiana
corporation formerly known as Automated Prescription Systems, Inc.
("McKesson"), to McKesson pursuant to the terms of that certain Stock
Purchase Agreement dated September 19, 2003 by and among Paragon, McKesson
and SI/BAKER (the "Agreement"). Pursuant to the Agreement, Paragon (a) sold
100 shares of common stock of SI/BAKER to McKesson and (b) made certain
other covenants, in consideration for (x) the payment by McKesson to
Paragon of $5,600,000 in cash and (y) certain other covenants of McKesson
and SI/BAKER. The terms of the Sale did not provide for any contingent
consideration payable to Paragon. The amount of consideration was
determined by arms-length negotiations between Paragon and McKesson.
Immediately prior to the Sale, (a) 1 of the 2 members of the board of
directors of SI/BAKER was also a director and officer of Paragon, (b) one
of the officers of SI/BAKER was an officer of Paragon, and (c) Paragon was
a major stockholder of SI/BAKER, holding 50% of SI/BAKER's outstanding
voting equity. Additionally, Paragon has a business relationship with
SI/BAKER, as certain of Paragon's products and services are offered to
SI/BAKER and have been used in SI/BAKER products sold to SI/BAKER's
customers. Prior to the Sale, there were no other material relationships
between Paragon and its affiliates, and SI/BAKER. The Sale resulted in a
gain of $4,919,000 as recorded in Other income, net in the Statements of
Operations for the three and nine months ended September 30, 2003.
Pursuant to the Agreement, (a) the Investment Agreement dated January 27,
1993, as amended, between Paragon and McKesson governing the joint venture
relationship was terminated as of the Closing Date; (b) Paragon and
SI/BAKER entered into a Master Purchase Agreement (the "Supply Agreement")
whereby Paragon will supply automated dispensing products and related
software services to SI/BAKER at agreed upon prices and pursuant to agreed
upon terms and conditions; (c) Paragon granted McKesson a license to
certain intellectual property; and (d) for a period of three years
following the Closing Date, Paragon, SI/BAKER, and McKesson agreed to
certain non-competition and non-solicitation covenants.
14
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2003 and 2002
Paragon used the proceeds of the Sale to prepay (a) $1,225,000 of its
outstanding term debt with its principal bank, (b) $1,500,000 of its
outstanding subordinated debt, thereby eliminating Paragon's outstanding
long-term debt, and (c) $330,000 of liability associated with the fair
value of the interest rate swap agreement for the term debt with Paragon's
principal bank, inclusive of $47,000 of accrued interest.
(9) Long-Term Debt
--------------
In February 2003, in accordance with the loan agreement, as amended, in
connection with the sale-leaseback of the Company's Easton, Pennsylvania
facility, the Company prepaid, without penalty, $1,387,500 of the term loan
with its principal bank.
In June 2003, the Company amended its credit agreements relative to
extending the expiration date of its $1,000,000 line of credit agreement to
June 30, 2004, 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.
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. Also, the Company's
principal bank no longer requires the Company to comply with the Borrowing
Base requirement as defined in its credit agreements.
In September 2003, the Company used the proceeds from the sale of its
investment in the SI/BAKER joint venture to prepay $1,225,000 of its
outstanding term debt with its principal bank and $1,500,000 of its
outstanding subordinated debt, thereby eliminating the Company's
outstanding long-term debt, and $330,000 of liability associated with the
fair value of the interest rate swap agreement for the term debt with the
Company's principal bank, inclusive of $47,000 of accrued interest. As of
September 30, 2003, the balance of the term loan with the Company's
principal bank and the balance of the subordinated debt were $0, and the
financial covenants pertaining to the former term debt with the Company's
principal bank no longer apply.
15
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2003 and 2002
(10) 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
(loss) (in thousands) and basic and diluted earnings (loss) per share for
the three and nine months ended September 30, 2003 and 2002, would have
been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------ ------------- -------------
Net earnings (loss), as reported..... $ 2,412 (402) 4,041 64
Deduct: total stock-based
employee compensation
determined under fair value
method, net of related tax
effects........................... (59) (73) (200) (219)
----- ----- ----- -----
Pro forma net earnings (loss)........ $ 2,353 (475) 3,841 (155)
===== ===== ===== =====
Earnings (loss) per share:
Basic-- as reported............... $ .56 (.09) .95 .02
====== ===== ===== =====
Basic-- pro forma................. $ .55 (.11) .90 (.04)
====== ===== ===== =====
Diluted-- as reported............. $ .55 (.09) .93 .01
====== ===== ===== =====
Diluted-- pro forma............... $ .53 (.11) .88 (.04)
====== ===== ===== =====
The above pro forma net earnings (loss) and basic and diluted earnings
(loss) 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 nine months ended
September 30, 2003 and the year ended December 31, 2002.
16
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2003 and 2002
(11) Legal Proceeding
----------------
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 that
certain of the Company's products infringe patents held by the competitor
and also asserting claims for breach of contract, unjust enrichment, unfair
competition, tortious interference with prospective economic advantage and
violation of New Jersey's consumer fraud act as a result of alleged
improper use of the competitor's trade secrets, technology and other
proprietary information. Based on these allegations, the competitor is
seeking monetary damages and injunctive relief against the Company.
In September 2003, the Company filed an answer denying the material
allegations of the complaint and asserting counterclaims against the
competitor. Discovery has commenced and all fact discovery is to be
completed by June 30, 2004. A status conference with the court has been
scheduled for July 14, 2004 at which point the schedule for the remainder
of the case will be addressed. 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.
Management has accrued an estimate of $1,020,000 for defense costs
associated with the resolution of the action filed against the Company.
This estimate has been developed in consultation with outside counsel and
is based upon an analysis of potential legal costs to vigorously defend
the charges asserted against the Company by the competitor, up to and
including trial.
It is possible, however, that future results of operations, financial
position, or cash flows for any particular quarterly or annual period could
be materially affected by changes in assumptions or the effectiveness of
strategies related to this legal proceeding. Management of the Company
believes that the amount of the liability for defense costs can be
reasonably estimated based on consultation with outside counsel; however,
at this time it is not possible to predict with certainty the outcome of
the litigation or range of possible loss, if any, to the Company. Were an
unfavorable ruling to occur against the Company, there exists the
possibility of a material adverse impact on the net earnings of the period
in which the ruling occurs. The Company will continue to analyze the
reserve established for the litigation as circumstances pertaining to the
litigation unfold.
(12) Subsequent Event
----------------
On October 8, 2003, the Company announced the resignation of William R.
Johnson as President and Chief Executive Officer and a member of the Board
of Directors of the Company to pursue other opportunities, and the Company
also announced the appointment of Leonard S. Yurkovic as President and
Chief Executive Officer of the Company.
17
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2003 and 2002
The Company entered into a Separation Agreement and Release (the
"Agreement") with Mr. Johnson whereby the Company agreed to provide Mr.
Johnson with compensation and other contractual benefits pursuant to the
terms of Mr. Johnson's Amended and Restated Executive Employment Agreement
(the "Employment Agreement") dated October 1, 2001. As part of the
Agreement, Mr. Johnson and the Company mutually agreed that the Employment
Agreement terminated effective October 1, 2003 thereby terminating Mr.
Johnson's employment relationship and all other positions with the Company,
and Mr. Johnson also released the Company from any and all claims for wages
and benefits including, without limitation, salary, stock options,
severance pay, vacation pay, and bonuses, and other employment-related
claims. In consideration for entering into the Agreement, Mr. Johnson
received a payment of $356,000 less applicable tax withholdings. In the
event Mr. Johnson elects continuing COBRA health coverage, the Company
shall reimburse Mr. Johnson for his premiums for COBRA continued health
benefits coverage through October 1, 2004. In addition, in the event the
Company wishes to consult with Mr. Johnson concerning his former areas of
responsibility within the Company, the Company shall pay Mr. Johnson $1,250
per day for such consultancy plus actual travel expenses.
------------------------------------
18
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 increased to $7,145,000 at
September 30, 2003 from $5,385,000 at December 31, 2002. The increase resulted
from cash provided by operating activities totaling $1,812,000, inclusive of a
$1,000,000 cash dividend received from the SI/BAKER joint venture, proceeds of
$5,500,000, net of advisory fees, from the sale of the Company's ownership
interest in 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 nine months ended September 30, 2003. Partially
offsetting the increase in cash and cash equivalents from these sources was the
repayment of long-term debt of $8,700,000, the settlement of the interest rate
swap contract of $283,000, and purchases of capital equipment of $180,000 during
the nine months ended September 30, 2003. Cash provided by operating activities
during the nine months ended September 30, 2002 were $2,235,000.
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 $1,000,000, as amended. The line of credit
facility is to be used primarily for working capital purposes. As of September
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. The interest rate on the term loan was
variable at a rate equal to the three-month LIBOR Market Index Rate plus 2.65%.
The Company also entered into an interest rate swap agreement for a portion of
the term loan to hedge the floating interest rate.
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.
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, as amended, in connection with
the sale-leaseback of the Company's Easton, Pennsylvania facility, the Company
prepaid, without penalty, $1,387,500 of the term loan with its principal bank.
In June 2003, the Company amended its credit agreements relative to
extending the expiration date of its $1,000,000 line of credit agreement to June
30, 2004, 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.
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.
19
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Liquidity and Capital Resources (Continued)
- -------------------------------
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 Company's principal bank no longer requires the
Company to comply with the Borrowing Base requirement as defined in its credit
agreement.
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, with an original term of seven years, bore 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.
Interest on the promissory notes was payable quarterly, in cash or under certain
conditions, in the Company's common stock upon approval of the Company's Board
of Directors.
On September 19, 2003 (the "Closing Date"), the Company sold (the "Sale")
its entire ownership interest in SI/BAKER, INC. ("SI/BAKER"), a joint venture of
Paragon and McKesson Automation Systems Inc., a Louisiana corporation formerly
known as Automated Prescription Systems, Inc. ("McKesson"), to McKesson pursuant
to the terms of that certain Stock Purchase Agreement dated September 19, 2003
by and among Paragon, McKesson, and SI/BAKER (the "Agreement"). Pursuant to the
Agreement, Paragon (a) sold 100 shares of common stock of SI/BAKER to McKesson
and (b) made certain other covenants, in consideration for (x) the payment by
McKesson to Paragon of $5,600,000 in cash and (y) certain other covenants of
McKesson and SI/BAKER. The terms of the Sale did not provide for any contingent
consideration payable to Paragon. The Sale resulted in a gain of $4,919,000 as
recorded in Other income, net in the Statements of Operations for the three and
nine months ended September 30, 2003.
The Company used the proceeds from the sale of its Investment in the
SI/BAKER joint venture to prepay $1,225,000 of its outstanding term debt with
its principal bank and $1,500,000 of its outstanding subordinated debt, thereby
eliminating the Company's outstanding long-term debt, and $330,000 of liability
associated with the fair value of the interest rate swap agreement for the term
debt with the Company's principal bank, inclusive of $47,000 of accrued
interest. As of September 30, 2003, the balance of the term loan with the
Company's principal bank and the balance of the subordinated debt were $0, and
the financial covenants pertaining to the former term debt with the Company's
principal bank no longer apply.
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 $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.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
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. 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 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) Nine Months Ended September 30, 2003 Versus Nine Months Ended September
-----------------------------------------------------------------------
30, 2002
--------
The Company's net earnings for the nine months ended September 30, 2003
were $4,041,000 compared to net earnings of $64,000 for the nine months ended
September 30, 2002. Contributing to the net earnings for the nine months ended
September 30, 2003 was other income from the sale of the Company's ownership
interest in the SI/BAKER joint venture of $4,919,000, 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. Partially
offsetting the favorable impact of the aforementioned items was the accrual of
$1,020,000 for potential defense costs to vigorously defend the charges asserted
against the Company by a competitor relating to the Company's intellectual
property. Contributing to net earnings for the nine months ended September 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 $94,000. Partially
offsetting the favorable impact of the aforementioned items during 2002 were
severance charges of $170,000.
Net Sales and Gross Profit on Sales
- -----------------------------------
Net sales of $28,289,000 for the nine months ended September 30, 2003
decreased 4.7% compared to net sales of $29,670,000 for the nine months ended
September 30, 2002. The sales decrease of $1,381,000 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 LO-TOW(R) and Order Picking, Fulfillment,
and Replenishment product lines. 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 26.0% for the nine months ended
September 30, 2003 compared to 24.5% for the nine months ended September 30,
2002. Gross profit, as a percentage of sales, for the nine months ended
September 30, 2003 was favorably impacted by approximately 2.1% due to a
reduction in overhead costs and approximately 1.4% due to the favorable
performance on the Company's contracts and
21
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
- ---------------------
(a) Nine Months Ended September 30, 2003 Versus Nine Months Ended September
-----------------------------------------------------------------------
30, 2002
--------
Net Sales and Gross Profit on Sales (Continued)
- -----------------------------------
product mix during the nine months ended September 30, 2003 as compared to the
nine months ended September 30, 2002. Gross profit, as a percentage of sales,
for the nine months ended September 30, 2002 was favorably impacted by
approximately 2.0% 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 $6,863,000 were higher by
$89,000 for the nine months ended September 30, 2003 than in the nine months
ended September 30, 2002. The increase of $89,000 was comprised of the accrual
of $1,020,000 for potential defense costs to vigorously defend the charges
asserted against the Company by a competitor relating to the Company's
intellectual property, and approximately $125,000 in marketing expenses
associated with the Company's participation in a biannual industry trade show in
the first quarter of 2003. Partially offsetting the aforementioned unfavorable
variance was cost savings of approximately $625,000 attributable to the
Company's restructuring of its business operations in the prior fiscal year and
an emphasis on cost reduction. Also contributing to the amount of selling,
general and administrative expenses in the nine months ended September 30, 2002
were approximately $170,000 of expenses pertaining to a reduction of office
associates, approximately $115,000 in professional fees primarily associated
with enhancing operational efficiency, and approximately $150,000 of provision
related to increasing the allowance for doubtful accounts associated with
possible uncollectible receivables.
Product Development Costs
- -------------------------
Product development costs, including patent expense, of $363,000 were
higher by $110,000 for the nine months ended September 30, 2003 than in the nine
months ended September 30, 2002. Development programs in the nine months ended
September 30, 2003 included the new NBA-23(TM) narrow belt accumulation
conveyor, computer software for warehousing and distribution center operations,
and improvements to the narrow belt sorter and the Company's Order Picking,
Fulfillment, and Replenishment product line. Development programs in the nine
months ended September 30, 2002 were aimed at improvements to the Company's
sortation and accumulation conveyor technologies and the Order Picking,
Fulfillment, and Replenishment product line.
Restructuring Charges (Credits)
- ------------------------------
In 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.
22
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
- ---------------------
(a) Nine Months Ended September 30, 2003 Versus Nine Months Ended September
-----------------------------------------------------------------------
30, 2002 (Continued)
--------
Interest Expense and Interest Income
- ------------------------------------
Interest expense of $675,000 was lower by $128,000 for the nine months
ended September 30, 2003 than for the nine months ended September 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 $174,000 of previously accrued interest on subordinated notes
payable and the impact of the change in the fair value of the interest rate swap
agreement. Partially offsetting the favorable variance were non-cash interest
charges of $306,000 associated with the settlement of the interest rate swap
contract.
Interest income of $55,000 for the nine months ended September 30, 2003
decreased by $33,000, when compared to the nine months ended September 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 Ventures
- ----------------------------------
Equity in income of joint venture represents the Company's proportionate
share (50%) of its investment in the SI/BAKER joint venture that was being
accounted for under the equity method until the September 19, 2003 Closing Date
of the Sale of the Company's ownership interest in the SI/BAKER joint venture.
The favorable variance of $203,000 for the nine months ended September 30, 2003
in the equity in income of the SI/BAKER joint venture was primarily due to its
sales of $11,279,000 as compared to sales of $5,886,000 for the nine months
ended September 30, 2002, plus a reduction of $244,000 in product development
expenses. The increase in sales for the nine months ended September 30, 2003
compared to the nine months ended September 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)
$218,000 in selling, general and administration expenses, and (2) $216,000 in
revenue-based royalty costs due to the parent companies.
Other Income, Net
- -----------------
The favorable variance of $6,116,000 in other income, net for the nine
months ended September 30, 2003 as compared to the nine months ended September
30, 2002 was primarily attributable to the gain on the sale of the Company's
ownership interest in the SI/BAKER joint venture of $4,919,000, the gain on the
sale-leaseback of the Company's Easton, Pennsylvania facility of $1,363,000, and
an increase of $213,000 in revenue-based royalty income from the Company's
SI/BAKER joint venture and license agreements related to material handling
systems sales. 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 of the Company's Easton, Pennsylvania
facility of $300,000, and a gain on the sale of excess fixed assets primarily
associated with Company's Easton, Pennsylvania facility of $94,000.
Income Tax Expense
- ------------------
The Company recognized income tax expense of $2,545,000 during the nine
months ended September 30, 2003, compared to income tax expense of $41,000 in
the comparable prior year period. Income tax expense was generally recorded at
statutory federal and state tax rates.
Backlog of Orders
- -----------------
The total backlog of orders at September 30, 2003 and 2002 was
approximately $8,170,000 and $9,845,000, respectively. During the nine months
ended September 30, 2003 and 2002, the Company received orders totaling
approximately $29,534,000 and $26,174,000, respectively.
23
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
- ---------------------
(b) Three Months Ended September 30, 2003 Versus Three Months Ended September
-------------------------------------------------------------------------
30, 2002
--------
With the exception of the following Statement of Operations captions,
changes in the third quarter of calendar year 2003 compared to the prior year
were consistent with those previously noted above for the nine-month period:
Net Sales and Gross Profit on Sales
- -----------------------------------
Net sales of $8,742,000 for the three months ended September 30, 2003
decreased 3.0% compared to net sales of $9,010,000 for the three months ended
September 30, 2002. The sales decrease of $268,000 was comprised of a decrease
in SI Systems' branded sales of $527,000 and an increase in Ermanco branded
sales of $259,000 for the three months ended September 30, 2003 when compared to
the three months ended September 30, 2002. The decline in SI Systems' branded
sales of $527,000 was primarily due to the prior year comparable period
containing a greater amount of sales related to the LO-TOW(R) and Order Picking,
Fulfillment, and Replenishment product lines. The improvement in Ermanco branded
sales of $259,000 was primarily attributable to a significant amount of progress
made on orders received during the first half of 2003.
Gross profit, as a percentage of sales, was 25.6% for the three months
ended September 30, 2003 compared to 21.0% for the three months ended September
30, 2002. Gross profit, as a percentage of sales, for the three months ended
September 30, 2003 was favorably impacted by approximately 3.4% due to the
favorable performance on the Company's contracts and product mix, and
approximately 1.2% due to a reduction in overhead costs during the three months
ended September 30, 2003 as compared to the three months ended September 30,
2002.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $2,992,000 were higher by
$741,000 for the three months ended September 30, 2003 than in the three months
ended September 30, 2002. The increase of $741,000 was comprised of the accrual
of $1,020,000 for potential defense costs to vigorously defend the charges
asserted against the Company by a competitor relating to the Company's
intellectual property. Partially offsetting the aforementioned unfavorable
variance and contributing to the amount of selling, general and administrative
expenses in the three months ended September 30, 2002 were approximately
$150,000 of provision related to increasing the allowance for doubtful accounts
associated with possible uncollectible receivables, and approximately $170,000
of expenses pertaining to a reduction of office associates.
Product Development Costs
- -------------------------
Product development costs, including patent expense, of $60,000 were lower
by $34,000 for the three months ended September 30, 2003 than in the three
months ended September 30, 2002. Development programs in the three months ended
September 30, 2003 included computer software for warehousing and distribution
center operations, and improvements to the narrow belt sorter and the Company's
Order Picking, Fulfillment, and Replenishment product line. Development programs
in the three months ended September 30, 2002 were aimed at improvements to the
Company's accumulation conveyor technologies and the Order Picking, Fulfillment,
and Replenishment product line.
Interest Expense and Interest Income
- ------------------------------------
Interest expense of $306,000 was higher by $41,000 for the three months
ended September 30, 2003 than for the three months ended September 30, 2002.
During the three months ended September 30, 2003, interest expense was impacted
by non-cash interest charges of $306,000 associated with the settlement of the
interest rate swap contract. Also impacting interest expense during the
three months ended September 30,
24
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Results Of Operations
- ---------------------
(b) Three Months Ended September 30, 2003 Versus Three Months Ended September
-------------------------------------------------------------------------
30, 2002
--------
Interest Expense and Interest Income (Continued)
- ------------------------------------
2003 was the reduced level of long-term debt due to principal payments and lower
interest rates and the reversal of approximately $126,000 of previously accrued
interest on subordinated notes payable and the impact of the change in the fair
value of the interest rate swap agreement.
Interest income of $9,000 for the three months ended September 30, 2003
decreased by $26,000, when compared to the three months ended September 30,
2002. The decrease in interest income was attributable to a reduction in the
level of funds available for short-term investments and lower interest rates.
Other Income, Net
- -----------------
The favorable variance of $5,018,000 in other income, net for the three
months ended September 30, 2003 as compared to the three months ended September
30, 2002 was primarily attributable to the gain on the sale of the Company's
ownership interest in the SI/BAKER joint venture of $4,919,000, and an increase
of $66,000 in revenue-based royalty income from the Company's SI/BAKER joint
venture and license agreements related to material handling systems sales.
------------------------------------
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) the amount of defense costs and the results of
pending litigation related to the Company's intellectual property; (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; or (4) 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 from September
30, 1999 through September 19, 2003, 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
25
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
Quantitative and Qualitative Disclosures (Continued)
- ----------------------------------------
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 was the Company's principal bank. On September 19, 2003, the Company
settled the liability associated with the fair value of its interest rate swap
with its 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 are material
to its results of operations.
Critical Accounting Policies
- ----------------------------
Refer to the Company's Form 10-K for the year ended December 31, 2002 for
information regarding the Company's Critical Accounting Policies.
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 September 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 changes in the Company's internal control over financial
reporting identified in connection with the evaluation of such controls
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.
26
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 that
certain of the Company's products infringe patents held by the competitor and
also asserting claims for breach of contract, unjust enrichment, unfair
competition, tortious interference with prospective economic advantage and
violation of New Jersey's consumer fraud act as a result of alleged improper use
of the competitor's trade secrets, technology and other proprietary information.
Based on these allegations, the competitor is seeking monetary damages and
injunctive relief against the Company.
In September 2003, the Company filed an answer denying the material
allegations of the complaint and asserting counterclaims against the competitor.
Discovery has commenced and all fact discovery is to be completed by June 30,
2004. A status conference with the court has been scheduled for July 14, 2004 at
which point the schedule for the remainder of the case will be addressed.
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.
27
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) Exhibits:
2.2 Stock Purchase Agreement by and among McKesson
Automation Systems, Inc., Paragon
Technologies, Inc., and SI/BAKER, INC. dated
September 19, 2003 (incorporated by
reference to Exhibit 2.2 on Form 8-K, filed on
October 1, 2003).
10.37 First Amendment to Term Loan A and B Agreement
dated August 4, 2003 by and between Paragon
Technologies, Inc. and Wachovia Bank, National
Association (filed herewith).
10.38 Ninth Amendment to Line of Credit Note and Loan
Agreement dated August 4, 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 Leonard S. Yurkovic, 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 Leonard S.
Yurkovic, 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 September 30, 2003:
A Form 8-K was furnished on August 14, 2003 announcing
financial results for the second quarter and six months
ended June 30, 2003.
28
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/ Leonard S. Yurkovic
------------------------------
Leonard S. Yurkovic
President & CEO
/s/ Ronald J. Semanick
------------------------------
Ronald J. Semanick
Chief Financial Officer
Dated: November 13, 2003
-----------------------
29