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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 June 30, 2004
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
August 5, 2004: 4,295,060.
---------
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2004 2003
------------------- ------------------
Assets
- ------
Current assets:
Cash and cash equivalents....................... $ 4,914 5,591
Receivables:
Trade (net of allowance for doubtful
accounts of $126 as of June 30,
2004 and $265 as of December
31, 2003)................................... 4,878 5,277
Notes and other receivables................... 280 38
------ ------
Total receivables........................... 5,158 5,315
------ ------
Costs and estimated earnings in excess
of billings................................... 536 521
Inventories:
Raw materials................................. 1,308 926
Work-in-process............................... 197 106
Finished goods................................ 206 159
------ ------
Total inventories........................... 1,711 1,191
------ ------
Deferred income tax benefits.................... 894 1,444
Prepaid expenses and other current assets....... 474 629
------ ------
Total current assets........................ 13,687 14,691
------ ------
Property, plant and equipment, at cost:
Leasehold improvements.......................... 228 228
Machinery and equipment......................... 3,793 3,643
------ ------
4,021 3,871
Less: accumulated depreciation................. 2,669 2,455
------ ------
Net property, plant and equipment............. 1,352 1,416
------ ------
Goodwill........................................... 17,657 17,657
Other assets....................................... 10 10
------ ------
Total assets....................................... $ 32,706 33,774
====== ======
See accompanying notes to consolidated financial statements.
2
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2004 2003
------------------- ------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable................................ $ 3,725 2,671
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 1,273 2,180
Accrued salaries, wages, and
commissions................................... 658 304
Income taxes payable............................ - 894
Accrued product warranty........................ 811 925
Deferred gain on sale-leaseback................. 165 165
Accrued other liabilities....................... 1,258 2,507
------ ------
Total current liabilities................... 7,890 9,646
------ ------
Long-term liabilities:
Deferred gain on sale-leaseback................. 440 523
Deferred income taxes payable................... 1,852 1,594
Deferred compensation........................... 47 42
------ ------
Total long-term liabilities................. 2,339 2,159
------ ------
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 4,295,060 shares as
of June 30, 2004 and 4,277,595
shares as of December 31, 2003.............. 4,295 4,278
Additional paid-in capital.................... 7,911 7,586
Retained earnings............................. 10,271 10,105
------ ------
Total stockholders' equity.................. 22,477 21,969
------ ------
Total liabilities and stockholders' equity.. $ 32,706 33,774
====== ======
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, 2004 and 2003
(In Thousands, Except Share And Per Share Data)
Three Months Ended Six Months Ended
---------------------------------- ----------------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
---------------- ---------------- ---------------- ----------------
Net sales................. $ 9,638 10,983 20,214 19,547
Cost of sales............. 7,304 8,059 15,250 14,419
--------- --------- --------- ---------
Gross profit on sales..... 2,334 2,924 4,964 5,128
--------- --------- --------- ---------
Selling, general and
administrative
expenses............... 2,074 1,874 4,117 3,871
Product development
costs.................. 133 139 205 302
Restructuring charges
(credit)............... - - - (170)
Interest expense.......... - 151 - 369
Interest income........... (40) (22) (51) (46)
Equity in income of
joint venture.......... - (89) - (251)
Loss (gain) on
disposition of
property, plant
and equipment.......... - 2 - (1,361)
Other income, net......... (53) (126) (99) (259)
--------- --------- --------- ---------
2,114 1,929 4,172 2,455
--------- --------- --------- ---------
Earnings before
income taxes........... 220 995 792 2,673
Income tax expense........ 91 378 322 1,045
--------- --------- --------- ---------
Net earnings.............. $ 129 617 470 1,628
========= ========= ========= =========
Basic earnings
per share.............. $ .03 .14 .11 .38
========= ========= ========= =========
Diluted earnings
per share.............. $ .03 .14 .11 .38
========= ========= ========= =========
Weighted average
shares outstanding..... 4,281,961 4,266,799 4,280,090 4,262,213
Dilutive effect of
stock options.......... 83,824 89,955 86,192 78,021
--------- --------- --------- ---------
Weighted average
shares outstanding
assuming dilution...... 4,365,785 4,356,754 4,366,282 4,340,234
========= ========= ========= =========
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, 2004 and 2003
(In Thousands)
Three Months Ended Six Months Ended
------------------------------ ------------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net earnings..................... $ 129 617 470 1,628
Other comprehensive
income (loss), net of tax:
Interest rate swap:
Change in fair value
of derivative, net
of tax.................. - - - (8)
------ ------ ------ ------
Total other
comprehensive
income (loss)........ - - - (8)
------ ------ ------ ------
Comprehensive
income............... $ 129 617 470 1,620
====== ====== ====== ======
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, 2004 and 2003
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2004 2003
------------------- -------------------
Cash flows from operating activities:
Net earnings ....................................... $ 470 1,628
Adjustments to reconcile net earnings
to net cash provided (used) by operating
activities:
Depreciation of plant and equipment............. 214 283
Amortization of intangibles..................... - 40
Gain on disposition of property,
plant and equipment........................... - (1,361)
Amortization of deferred gain on sale-
leaseback..................................... (83) (56)
Cash dividend received from joint venture....... - 1,000
Equity in income of joint venture............... - (251)
Issuance of common shares as interest
payment on subordinated notes................. - 90
Change in operating assets and liabilities:
Receivables................................. 157 (760)
Costs and estimated earnings in
excess of billings....................... (15) (538)
Inventories................................. (520) (137)
Deferred tax expenses....................... 808 216
Prepaid expenses and other
current assets........................... 155 185
Accounts payable............................ 1,054 814
Customers' deposits and billings
in excess of costs and estimated
earnings................................. (907) (454)
Accrued salaries, wages, and
commissions.............................. 354 (81)
Income taxes payable........................ (894) 291
Accrued product warranty.................... (114) 52
Accrued other liabilities................... (1,249) (340)
Deferred compensation....................... 5 8
------ ------
Net cash provided (used) by
operating activities.............................. (565) 629
------ ------
Cash flows from investing activities:
Proceeds from the disposition of
property, plant and equipment .................... - 2,734
Additions to property, plant and equipment.......... (150) (145)
------ ------
Net cash provided (used) by
investing activities.............................. (150) 2,589
------ ------
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, 2004 and 2003
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2004 2003
------------------- -------------------
Cash flows from financing activities:
Sale of common shares in connection
with employee incentive stock
option plan...................................... 38 8
Decrease in restricted cash........................ - 865
Repayment of long-term debt........................ - (4,975)
------ ------
Net cash provided (used) by
financing activities......................... 38 (4,102)
------ ------
Decrease in cash and
cash equivalents................................. (677) (884)
Cash and cash equivalents,
beginning of period.............................. 5,591 5,385
------ ------
Cash and cash equivalents,
end of period.................................... $ 4,914 4,501
====== ======
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest..................................... $ - 293
====== ======
Income taxes................................. $ 611 (370)
====== ======
See accompanying notes to consolidated financial statements.
7
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
(1) In the opinion of the management of Paragon Technologies, Inc. ("Paragon"
or the "Company"), the unaudited 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 full 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, 2003 as filed with the Securities and Exchange
Commission. Refer to the Company's Form 10-K for the year ended December
31, 2003 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. 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 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 2003.
A roll-forward of restructuring activities is as follows (in thousands):
Beginning Ending
Balance Charge/ Cash Balance
January 1 (Credit) Spending Reclassification June 30
------------ ------------- ------------ ------------------- ------------------
2004............ $ 68 - (5) - 63
2003............ $ 216 (170) (34) 170 182
The $63,000 restructuring accrual at June 30, 2004 relates to professional
fees for the 2001 restructuring that are still expected to be paid and is
included in accrued other liabilities.
The amount reclassified out of the restructuring accrual was previously
included in accrued pension and retirement savings plan liabilities.
(3) Accrued Product Warranty
------------------------
The Company's products are warranted against defects in materials and
workmanship for varying periods of time depending on customer requirements
and the type of system sold, with a typical warranty period of one year.
The Company provides an accrual for estimated future warranty costs and
potential product liability claims based upon a percentage of cost of
sales, ranging from one to two percent depending on the type of system
sold, and a detailed review of products still in the warranty period.
8
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
A roll-forward of warranty activities is as follows (in thousands):
Beginning Ending
Balance Balance
January 1 Additions Deductions June 30
------------- ------------------ ----------------- -------------------
2004.................. $ 925 73 (187) 811
2003.................. $ 894 168 (116) 946
(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 operation (hereafter referred to as "SI
Systems") is a specialized systems integrator supplying branded automated
material handling systems to manufacturing, assembly, order selection, and
distribution operations customers located primarily in North America,
including the U.S. government. The automated material handling systems are
marketed, designed, sold, installed, and serviced by its own staff or
subcontractors as labor-saving devices to improve productivity, quality,
and reduce costs. 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. The
engineering staff develops and designs computer control programs required
for the efficient operation of the systems and for optimizing
manufacturing, assembly, and fulfillment operations.
Ermanco
-------
The Company's Spring Lake, Michigan operation (hereafter referred to as
"Ermanco") is a manufacturer of Ermanco branded light to medium duty unit
handling conveyor 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
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.
9
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
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, 2004 and 2003 are as
follows (in thousands):
For the three months ended June 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 1,748 6,646 8,394 87.1%
Aftermarket sales............. 748 496 1,244 12.9%
------ ------ ------ -----
Total sales................... $ 2,496 7,142 9,638 100.0%
====== ====== ====== =====
As a % of total sales......... 25.9% 74.1% 100.0%
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 six months ended June 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 3,829 13,788 17,617 87.2%
Aftermarket sales............. 1,580 1,017 2,597 12.8%
------ ------ ------ -----
Total sales................... $ 5,409 14,805 20,214 100.0%
====== ====== ====== =====
As a % of total sales......... 26.8% 73.2% 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%
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, 2004 and 2003 are as follows (in thousands):
For the three months ended June 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 2,204 7,011 9,215 95.6%
International sales........... 292 131 423 4.4%
------ ------ ------ -----
Total sales................... $ 2,496 7,142 9,638 100.0%
====== ====== ====== =====
10
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
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 six months ended June 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 4,429 14,542 18,971 93.9%
International sales........... 980 263 1,243 6.1%
------ ------ ------ -----
Total sales................... $ 5,409 14,805 20,214 100.0%
====== ====== ====== =====
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%
====== ====== ====== =====
The Company identifies operating segments based on the types of products
offered for sale as follows:
For the Three Months Ended
June 30, 2004 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------- ---------------- ---------------- ----------------
Sales..................................... $ 2,496 7,142 9,638
Earnings (loss) before interest
expense, interest income, and
income taxes............................ (204) 384 180
Total assets.............................. 3,538 29,168 32,706
Capital expenditures...................... 27 57 84
Depreciation and amortization
expense................................. 29 75 104
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, gain (loss) on
disposition of property, plant and
equipment, and income taxes............. 183 854 1,037
Gain (loss) on disposition of property,
plant and equipment..................... - (2) (2)
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 (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
For the Six Months Ended
June 30, 2004 (In Thousands): SI Systems Ermanco Total
- ------------------------------------------- ---------------- ---------------- ----------------
Sales..................................... $ 5,409 14,805 20,214
Earnings (loss) before interest
expense, interest income, and
income taxes............................ (241) 982 741
Total assets.............................. 3,538 29,168 32,706
Capital expenditures...................... 52 98 150
Depreciation and amortization
expense................................. 53 161 214
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, restructuring
credits, equity in income of
joint venture, gain (loss) on
disposition of property, plant and
equipment, and income taxes............. 236 978 1,214
Restructuring credits..................... 170 - 170
Gain (loss) on disposition of property,
plant and equipment..................... 1,363 (2) 1,361
Total assets.............................. 5,214 29,155 34,369
Capital expenditures...................... 34 111 145
Depreciation and amortization
expense................................. 82 201 283
(5) Recently Issued Accounting Pronouncements
-----------------------------------------
In December 2003, the Company adopted SFAS No. 132 (revised), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("FAS 132")
as amended. This standard retains the existing disclosures and requires
additional disclosures to provide details about pension plan assets,
benefit obligations, cash flows, benefit costs, and related information.
The disclosure requirements are included in the Company's financial
statements.
In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities" ("FIN 46R"), which
addresses how a business enterprise should evaluate whether it has a
controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
was issued in January 2003. The Company is required to apply FIN 46R to
variable interest entities ("VIE") created after December 31, 2003. For
variable interests in VIE's created before January 1, 2004, FIN 46R will be
applied beginning January 1, 2005. The application of FIN 46R is not
expected to have a material effect on the Company's financial statements.
12
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
(6) Sale-Leaseback
--------------
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 for five years. The leasing agreement
requires fixed monthly rentals of $17,703 (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 sale-leaseback resulted in a gain of $2,189,000, of which $1,363,000
was recorded as a gain during the three months ended March 31, 2003. The
remaining gain of $826,000 was deferred and is being recognized as a
reduction in rent expense over the term of the lease. During the three
months ended June 30, 2004 and June 30, 2003, $42,000 and $40,000,
respectively, of the deferred gain was recognized. During the six months
ended June 30, 2004 and June 30, 2003, $83,000 and $56,000, respectively,
of the deferred gain was recognized.
(7) Investment in SI/BAKER Joint Venture
------------------------------------
On March 1, 1993, the Company and Automated Prescription Systems, Inc.
formed a 50/50 joint venture, SI/BAKER, INC. ("SI/BAKER"). In 1998,
Automated Prescription Systems, Inc. was renamed McKesson Automation
Systems Inc. ("McKesson"). On September 19, 2003, the Company sold its
entire ownership interest in SI/BAKER to McKesson and received cash
proceeds of $5,600,000. Prior to the sale, the Company received royalty
income from SI/BAKER at a rate of 2% of SI/BAKER's gross sales for
marketing and sales efforts on behalf of SI/BAKER. The Company accounted
for its investment in the joint venture on the equity basis by recognizing
its proportionate share (50%) of SI/BAKER's net earnings. The sale resulted
in a gain of $4,901,000 in 2003.
(8) Line of Credit
--------------
The Company has a line of credit facility which may not exceed $5,000,000,
$4,800,000 available, as amended, and is to be used primarily for working
capital purposes. Interest on the line of credit facility is at the LIBOR
Market Index Rate plus 1.4%.
The line of credit facility contains various non-financial covenants and is
secured by all accounts receivables and inventory. The Company was in
compliance with all covenants as of June 30, 2004. As of June 30, 2004, the
Company did not have any borrowings under the line of credit facility, and
the line of credit facility expires effective June 30, 2005.
(9) Long-Term Debt
--------------
The Company received $14,000,000 in the form of a seven-year term loan from
its principal bank to finance the acquisition of Ermanco on September 30,
1999. The interest rate on the term loan was variable at a rate equal to
the three-month LIBOR Market Index Rate plus 2.65%.
13
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
Also in connection with the acquisition of Ermanco, on September 30, 1999,
the Company issued promissory notes to the stockholders of Ermanco,
including notes in the amounts of $1,382,861 and $1,001,382 to Steven
Shulman and Leon C. Kirschner, respectively. Mr. Shulman is a director of
the Company, and Mr. Kirschner serves as the President of Ermanco and Chief
Operating Officer of the Company. The notes, with an original term of seven
years, bore interest at an annual rate of 10% through September 30, 2002,
and 12% from October 1, 2002 through the prepayment date. 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.
In 2003, the Company prepaid all of its outstanding term and subordinated
debt.
(10) Pension Benefits
----------------
The Company maintains a defined benefit plan for employees covered by its
collective bargaining agreement. Retirement benefits are based on the
employee's years of service multiplied by the appropriate monthly benefit
amount. Employee compensation does not impact pension benefits. The
Company's policy is to fund retirement plans in compliance with applicable
laws and regulations. Assets of the Company's defined benefit plan are
primarily invested in publicly traded common stocks, corporate and
government debt securities, mutual funds, and cash or cash equivalents.
Components of Net Periodic Pension Expense (Benefit)
---------------------------------------------------
The Company uses the projected unit credit actuarial method to compute
pension expense, which includes amortization of past service costs over 30
years. The net periodic pension expense (benefit) and total pension expense
(benefit) for the three and six months ended June 30, 2004 and 2003
includes the following components (in thousands):
Three Months Ended Six Months Ended
---------------------------- --------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Service cost-benefits earned $ 24 22 47 44
during the period..................
Interest cost on projected
benefit obligation................ 11 10 22 40
Expected return on plan
assets - increase................. (15) (13) (29) (65)
Recognized net actuarial
loss (gain)....................... 1 1 2 (4)
------ ------ ------ ------
Net periodic pension expense......... 21 20 42 15
Curtailment cost (settlement
credit)........................... - - - (144)
------ ------ ------ ------
Total pension expense (benefit)...... $ 21 20 $ 42 (129)
====== ====== ====== ======
Contributions
-------------
The Company did not make any contributions to its defined benefit plan
during the three and six months ended June 30, 2004. The Company expects
total pension plan contributions to its defined benefit plan to approximate
$41,000 for the year ended December 31, 2004.
14
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
(11) Stock-Based Compensation
------------------------
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"), as amended
by FAS 148, 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, 2004 and 2003, would have
been as follows:
Three Months Ended Six Months Ended
---------------------------- ----------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net earnings, as reported............ $ 129 617 470 1,628
Deduct: total stock-based
employee compensation
determined under fair value
method, net of related tax
effects........................... (29) (60) (63) (132)
----- ----- ----- -----
Pro forma net earnings............... $ 100 557 407 1,496
===== ===== ===== =====
Earnings per share:
Basic-- as reported................ $ .03 .14 .11 .38
===== ===== ===== =====
Basic-- pro forma.................. $ .02 .13 .10 .35
===== ===== ===== =====
Diluted-- as reported.............. $ .03 .14 .11 .38
===== ===== ===== =====
Diluted-- pro forma................ $ .02 .13 .09 .34
===== ===== ===== =====
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, 2004
and the year ended December 31, 2003.
(12) Legal Proceedings
-----------------
In July 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 infringed 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 was
seeking monetary damages and injunctive relief against the Company.
15
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Six Months Ended June 30, 2004 and 2003
In February 2004, a settlement was reached between the Company and the
competitor. Under the settlement, the competitor dismissed the action and
agreed that the Company's products involved in the litigation are immune
from suit for infringement of any of the competitor's intellectual property
rights. In exchange, Paragon agreed to dismiss its counterclaims and paid
the competitor $1,125,000. Total costs associated with the litigation
recognized during 2003, inclusive of settlement costs and legal costs, were
$1,375,000.
The Company is involved in various other claims and legal actions arising
in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's consolidated financial position, results of
operations, or liquidity.
----------------------------------------
16
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations
---------------------
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the unaudited
consolidated financial statements for the period ended June 30, 2004, and the
cautionary statements and consolidated financial statements and related notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2003. The discussion and analysis contains "forward-looking
statements" based on management's current expectations, assumptions, estimates,
and projections. These forward-looking statements involve risks and
uncertainties. The Company's actual results could differ materially from those
included in these "forward-looking statements" 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.
----------------------------------------
Business Overview
- -----------------
Paragon Technologies, Inc. provides a variety of material handling
solutions, including systems, technologies, products, and services for material
flow applications. The Company has gone to market with a multiple brand,
multiple channel strategy under the SI Systems and Ermanco brands.
Founded in 1958, SI Systems material handling solutions are based on core
technologies in horizontal transportation and order fulfillment and are aimed at
improving productivity for manufacturing, assembly, and distribution center
operations. Since 1964, Ermanco conveyor technologies and integrated conveyor
systems have been based on core technologies in transportation, accumulation,
and sortation and continue to address the needs of the distribution, assembly,
and manufacturing marketplace. Ermanco is known as the originator of the
line-shaft-driven, live-roller conveyor.
----------------------------------------
Key Performance Metrics Relevant to the Company
- -----------------------------------------------
Capacity Utilization
--------------------
Capacity Utilization, as documented in the Federal Reserve Statistical
Release(1), is a key economic indicator that the Company follows as a barometer
that may lead to capital spending for material handling systems. Capacity
Utilization attempts to measure what percent of available capacity is actually
being utilized. Management believes that when Capacity Utilization rises above
80%, as occurred in fiscal 2000, the Company may see an increase in rate of new
orders, and therefore, an increase in backlog and sales may also occur. The
backlog of orders represents the uncompleted portion of systems contracts along
with the value of parts and services from customer purchase orders related to
goods that have not been shipped or services that have not been rendered.
Backlog is generally indicative of customer demand for the Company's products.
As the demand for the Company's products increases, the backlog of orders, rate
of new orders, and sales also typically increases. The following table depicts
the Company's backlog, orders, sales, and Capacity Utilization for the six
months ended June 30, 2004, and for the years ended December 31, 2003, 2002,
2001, and 2000.
Six Months Year Ended December 31,
Ended --------------------------------------
(Dollars in Thousands) June 30, 2004 2003 2002 2001 2000
-------------------- -------- -------- -------- --------
Backlog of orders - Beginning.... $ 10,525 6,924 13,342 22,913 23,685
Add: orders................... 19,514 40,896 31,806 41,181 63,534
Less: sales................... 20,214 37,295 38,224 50,752 64,306
------ ------ ------ ------ ------
Backlog of orders - Ending....... $ 9,825 10,525 6,924 13,342 22,913
======= ====== ====== ====== ======
Capacity Utilization (1).......... 76.7% 74.8% 75.6% 77.7% 82.6%
17
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
Current Ratio
-------------
The Company's current ratio, which is the ratio of current assets to
current liabilities, has been relatively consistent. Management of the Company
monitors the current ratio as a measure of determining liquidity and believes
the current ratio illustrates that the Company's financial resources are
adequate to satisfy its future cash requirements through the next year. The
following table depicts the Company's current assets, current liabilities, and
current ratio as of June 30, 2004 and as of December 31, 2003, 2002, 2001, and
2000:
As of As of December 31,
June 30, --------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
------------ -------- -------- -------- --------
Current assets........................... $ 13,687 14,691 15,444 19,200 22,850
------ ------ ------ ------ ------
Current liabilities...................... 7,890 9,646 9,472 13,388 15,193
Current ratio............................ 1.73 1.52 1.63 1.43 1.50
Debt to Equity Ratio
--------------------
With an emphasis over the past several years on generating cash flows to
eliminate the Company's senior and subordinated debt, the Company has eliminated
its financial leverage as evidenced by its debt to equity ratio, which is the
ratio of total debt to stockholders' equity. Management believes the absence of
debt provides greater protection for its shareholders and enhances the Company's
ability to obtain additional financing, if required. The following table
illustrates the calculation of the debt to equity ratio as of June 30, 2004, and
as of December 31, 2003, 2002, 2001, and 2000:
As of As of December 31,
June 30, --------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
------------ -------- -------- -------- --------
Current installments of
long-term debt........................ $ - 1,437 2,305 1,521
Long-term debt........................... - - 7,263 9,900 12,780
------ ------ ------ ------ ------
Total debt............................... - - 8,700 12,205 14,301
------ ------ ------ ------ ------
Total stockholders' equity............... $ 22,477 21,969 17,829 16,881 16,980
====== ====== ====== ====== ======
Debt to equity ratio..................... - - .49 .72 .84
----------------------------------------
Critical Accounting Policies and Estimates
- ------------------------------------------
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with United States Generally Accepted Accounting
Principles. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and other financial information, including
the related disclosure of commitments and contingencies at the date of our
financial statements. Actual results may, under different assumptions and
conditions, differ significantly from our estimates.
We believe that our accounting policies related to revenue recognition on
system sales, warranty, inventories, allowance for doubtful accounts, and asset
impairments as described below, are our "critical accounting policies." These
policies have been reviewed with the Audit Committee of the Board of Directors
and are discussed in greater detail below.
18
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
Revenue Recognition on Systems Sales
------------------------------------
Revenues on systems contracts, accounted for in accordance with SOP 81-1 of
the American Institute of Certified Public Accountants, are recorded on the
basis of the Company's estimates of the percentage of completion of individual
contracts. Gross margin is recognized on the basis of the ratio of aggregate
costs incurred to date to the most recent estimate of total costs. As contracts
may extend over one or more years, revisions in cost and profit estimates during
the course of the work are reflected in the accounting periods in which the
facts requiring revisions become known. At the time a loss on a contract becomes
known, the entire amount of the estimated ultimate loss is accrued. As of June
30, 2004, there were no contracts that are anticipated to result in a loss.
The Company believes that it has the ability to reasonably estimate the
total costs and applicable gross profit margins at the inception of the contract
for all of its systems contracts. However, where cost estimates change, there
could be a significant impact on the amount of revenue recognized. The Company's
failure to estimate accurately can result in cost overruns which will result in
the loss of profits if the Company determines that it has significantly
underestimated the costs involved in completing contracts. The Company has not
had any significant cost overruns resulting in loss of profits during the three
and six months ended June 30, 2004.
Accrued Product Warranty
------------------------
The Company's products are warranted against defects in materials and
workmanship for varying periods of time depending on customer requirements and
the type of system sold, with a typical warranty period of one year. The Company
provides an accrual for estimated future warranty costs and potential product
liability claims based upon a percentage of cost of sales, ranging from one to
two percent depending on the type of system sold, and a detailed review of
products still in the warranty period. Historically, the level of warranty
reserve has been appropriate based on management's assessment of estimated
future warranty claims. However, if unanticipated warranty issues arise in the
future, there could be a significant impact on the recorded warranty reserve.
The recorded warranty reserve as of June 30, 2004 was $811,000.
Inventories
-----------
Inventories are valued at the lower of average cost or market. The Company
provides an inventory reserve determined by a specific identification of
individual slow moving items and other inventory items based on historical
experience. The reserve is considered to be a write-down of inventory to a new
cost basis. Upon disposal of inventory, the cost and related inventory reserve
are removed from the accounts. Historically, the level of inventory reserve has
been appropriate based on management's assessment of estimated future inventory
disposals.
Allowance for Doubtful Accounts
-------------------------------
The Company provides an allowance for doubtful accounts determined by a
specific identification of individual accounts and other accounts based on
historical experience. The Company writes off receivables upon determination
that no further collections are probable. Historically, receivable write offs
have not had a material impact on the Company's financial statements.
Asset Impairments
-----------------
On January 1, 2002, the Company adopted SFAS No. 142, analyzed its goodwill
for impairment, and makes similar evaluations on a periodic basis. During 2003,
the Company performed the required impairment test of goodwill and determined
that there was no impairment. In assessing the recoverability of the Company's
goodwill, the Company must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of the respective asset. If
these estimates or their
19
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
Asset Impairments (Continued)
-----------------
related assumptions change the fair value of the asset in the future, the
Company may be required to record impairment charges. The book value of goodwill
as of June 30, 2004 was $17,657,000.
----------------------------------------
(a) Results of Operations-- Six Months Ended June 30, 2004 Compared to the
----------------------------------------------------------------------
Six Months Ended June 30, 2003
------------------------------
Earnings Summary
- ----------------
The Company had net earnings of $470,000 (or $0.11 basic earnings per
share) for the six months ended June 30, 2004, compared to net earnings of
$1,628,000 (or $0.38 basic earnings per share) for the six months ended June 30,
2003. The decrease in net earnings was primarily due to the prior year
comparable period containing:
o a pre-tax gain on the sale-leaseback of the Company's Easton,
Pennsylvania facility of $1,363,000;
o a restructuring credit of $170,000 pertaining to the final settlement
of the remaining pension obligations associated with the Company's
terminated pension plan;
o equity in income of the Company's former SI/BAKER joint venture of
$251,000; and
o royalty income from the Company's former SI/BAKER joint
venture of $168,000.
Offsetting the above decrease in net earnings for the six months ended June
30, 2004 was a reduction of $369,000 in interest expense as a result of the
elimination of the Company's senior and subordinated debt in September 2003.
Net Sales and Gross Profit on Sales
- -----------------------------------
2004 2003
-------------- --------------
Net sales............................................. $ 20,214,000 19,547,000
Cost of sales......................................... 15,250,000 14,419,000
---------- ----------
Gross profit on sales................................. $ 4,964,000 5,128,000
========== ==========
Gross profit as a percentage of sales................. 24.6% 26.2%
==== ====
The net sales increase was primarily attributable to an increase in Ermanco
branded sales of $1,656,000, partially offset by a decline of approximately
$989,000 in SI Systems branded sales. The increase in Ermanco branded sales was
primarily attributable to a larger backlog of Ermanco branded orders entering
fiscal 2004 when compared to the backlog of Ermanco branded orders entering
fiscal 2003. The decline in SI Systems branded sales was associated with delays
in customer buying decisions and competitive pressures.
Gross profit, as a percentage of sales, for the six months ended June 30,
2004, when compared to the six months ended June 30, 2003, was unfavorably
impacted by approximately 0.6% due to competitive pricing pressures and product
mix, and by approximately 1.0% due primarily to the lower sales volume
experienced during the second quarter of 2004 to cover fixed overhead costs.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(a) Results of Operations -- Six Months Ended June 30, 2004 Compared to the
- --- ---------- ------------------------------------------------------------
Six Months Ended June 30, 2003 (Continued)
------------------------------
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $4,117,000 were higher by
$246,000 for the six months ended June 30, 2004 than for the six months ended
June 30, 2003. The increase was comprised of the addition of resources aimed at
expanding the customer base and an increase in salaries and fringe benefits
totaling $283,000, an increase in marketing expenses primarily associated with
product promotion and marketing research totaling $42,000, and severance costs
of $115,000. Partially offsetting these increases were collections of $172,000
during the second quarter of 2004 on accounts receivable previously recognized
as uncollectible.
Product Development Costs
- -------------------------
Product development costs, including patent expense, of $205,000 was lower
by $97,000 for the six months ended June 30, 2004 than for the six months ended
June 30, 2003. Development programs in the six months ended June 30, 2004 were
aimed at enhancements to the Company's sortation and accumulation conveyor
technologies, and improvements to the Company's Order Picking, Fulfillment, and
Replenishment systems. 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 systems.
Restructuring Charges (Credits)
- -------------------------------
In 2001, the Company restructured its business operations, including
curtailment of a defined benefit plan. In February 2003, the Company settled its
remaining pension obligations by purchasing annuities and correspondingly
recorded a restructuring credit of $170,000.
Interest Expense
- ----------------
In September 2003, the Company repaid all of its outstanding senior and
subordinated debt. The Company had no interest expense in the six months ended
June 30, 2004, as compared to $369,000 of interest expense for the six months
ended June 30, 2003.
Equity in Income of Joint Venture
- ---------------------------------
In September 2003, the Company sold its entire ownership interest in
SI/BAKER, INC. During the six months ended June 30, 2003, equity in income of
the SI/BAKER joint venture was $251,000.
Gain on Disposition of Property, Plant and Equipment
- ----------------------------------------------------
The gain on the disposition of property, plant and equipment of $1,361,000
for the six months ended June 30, 2003 was primarily attributable to the
sale-leaseback of the Company's Easton, Pennsylvania facility in February 2003.
The sale-leaseback resulted in a total gain of $2,189,000, of which $1,363,000
was recorded in 2003. The remaining gain of $826,000 was deferred and is being
recognized as a reduction in rent expense over the five-year term of the lease.
Other Income, Net
- -----------------
In September 2003, the Company sold its entire ownership interest in
SI/BAKER, INC. The unfavorable variance of $160,000 in other income, net for the
six months ended June 30, 2004 as compared to the six months ended June 30, 2003
was primarily attributable to revenue-based royalty income from the Company's
SI/BAKER recognized during the first half of 2003.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(a) Results of Operations -- Six Months Ended June 30, 2004 Compared to the
- --- ---------- ------------------------------------------------------------
Six Months Ended June 30, 2003 (Continued)
------------------------------
Income Tax Expense
- ------------------
The Company recognized income tax expense of $322,000 during the six months
ended June 30, 2004 compared to income tax expense of $1,045,000 during the six
months ended June 30, 2003. Income tax expense was generally recorded at
statutory federal and state tax rates.
(b) Results of Operations - Three Months Ended June 30, 2004 Compared to the
- --- ------------------------------------------------------------------------
Three Months Ended June 30, 2003
--------------------------------
Earnings Summary
- ----------------
The Company had net earnings of $129,000 (or $0.03 basic earnings per
share) for the three months ended June 30, 2004, compared to net earnings of
$617,000 (or $0.14 basic earnings per share) for the three months ended June 30,
2003. The decrease in net earnings was primarily due to the prior year
comparable period containing:
o higher revenues and gross profit of $1,345,000 and $590,000,
respectively, as described below;
o lower selling, general and administrative expenses by $200,000 as
described below;
o equity in income of the Company's former SI/BAKER joint venture of
$89,000; and
o royalty income from the Company's former SI/BAKER joint venture of
$85,000.
Offsetting the above decrease in net earnings for the three months ended
June 30, 2004 was a reduction of $151,000 in interest expense as a result of the
elimination of the Company's senior and subordinated debt in September 2003.
With the exception of the following Statement of Operations captions, changes in
the second quarter of 2004 compared to the prior year were consistent with those
previously noted above for the six-month period.
Net Sales and Gross Profit on Sales
- -----------------------------------
2004 2003
---------------- ----------------
Net sales............................................. $ 9,638,000 10,983,000
Cost of sales......................................... 7,304,000 8,059,000
--------- ----------
Gross profit on sales................................. $ 2,334,000 2,924,000
========= ==========
Gross profit as a percentage of sales................. 24.2% 26.6%
==== ====
The net sales decrease was primarily attributable to a decrease in Ermanco
branded sales of $815,000 and a decline of $530,000 in SI Systems branded sales.
The decrease in Ermanco branded sales was primarily attributable to the prior
year comparable period containing a greater amount of sales due to progress made
on orders received during the first half of 2003 based on contract completion
requirements. The decline in SI Systems branded sales was associated with delays
in customer buying decisions and competitive pressures.
Gross profit, as a percentage of sales, for the three months ended June 30,
2004 was unfavorably impacted by approximately 3.3% due to the lower sales
volume to cover fixed overhead costs for the three months ended June 30, 2004.
Partially offsetting the aforementioned unfavorable variance by approximately
1.0% was the favorable performance on several contracts initiated in the prior
year that were completed during the second quarter of 2004 and product mix.
22
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(b) Results of Operations - Three Months Ended June 30, 2004 Compared to the
- --- ------------------------------------------------------------------------
Three Months Ended June 30, 2003 (Continued)
--------------------------------
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $2,074,000 were higher by
$200,000 for the three months ended June 30, 2004 than for the three months
ended June 30, 2003. The increase was comprised of the addition of resources
aimed at expanding the customer base and an increase in salaries and fringe
benefits totaling $120,000, an increase in marketing expenses primarily
associated with product promotion and marketing research totaling $107,000, and
severance costs of $115,000. Partially offsetting these increases were
collections of $172,000 during the second quarter of 2004 on accounts receivable
previously recognized as uncollectible.
----------------------------------------
Liquidity and Capital Resources
- -------------------------------
The Company's cash and cash equivalents decreased to $4,914,000 at June 30,
2004 from $5,591,000 at December 31, 2003. The decrease resulted primarily from:
o cash used by operating activities totaling $565,000; and
o purchases of capital equipment of $150,000.
Cash used by operating activities of $565,000 during the six months ended
June 30, 2004 as compared to cash provided by operating activities of $629,000
during the six months ended June 30, 2003 decreased primarily due to the payment
of settlement and legal costs of $1,197,000 associated with an action against
the Company by a competitor relating to the Company's intellectual property.
Also contributing to cash provided by operating activities during the six months
ended June 30, 2003 was the receipt of a federal income tax refund of $1,093,000
and the receipt of a $1,000,000 cash dividend from the SI/BAKER joint venture.
In 2003, the Company repaid all of its outstanding term debt and
subordinated debt.
The Company's line of credit facility may not exceed $5,000,000, $4,800,000
available, as amended, and is to be used primarily for working capital purposes.
The line of credit facility contains various non-financial covenants and is
secured by all accounts receivables and inventory. As of June 30, 2004, the
Company did not have any borrowings under the line of credit facility, and the
line of credit facility expires effective June 30, 2005.
The Company anticipates that its financial resources, consisting of cash
generated from operations and its line of credit, 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 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.
----------------------------------------
23
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
Contractual Obligations
- -----------------------
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 $33,283 through September 30, 2004. Thereafter, monthly
rentals are $29,310 (with annual increases of 2.5%). The terms of the lease
require the payment by Ermanco of all taxes, insurance, and other ownership
related costs of the property. The lease, as amended on April 1, 2004, expires
on September 30, 2008.
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 for five years. The leasing agreement
requires fixed monthly rentals of $17,703 (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, computer
equipment, and software under various operating leases with terms extending
through September 2007.
Future contractual obligations and commercial commitments at June 30, 2004
as noted above are as follows:
Payments Due by Period
---------------------------------------------------------------------------------
Total 2004 2005 2006 2007 2008
----- ---- ---- ---- ---- ----
Contractual
obligations:
Operating
leases........ $ 2,498,000 348,000 636,000 590,000 606,000 318,000
--------- --------- --------- --------- ---------- ---------
Total......... $ 2,498,000 348,000 636,000 590,000 606,000 318,000
========= ========= ========= ========= ========== =========
Amount of Commitment
Expiration Per Period
-----------------------------------------------------------------
Total Amounts
Committed 2004 2005 2006 2007 2008
------------- ---- ---- ---- ---- ----
Other
commercial
commitments:
Letters of
credit........ $200,000 - 200,000 - - -
Line of
credit........ - - - - - -
Off-Balance Sheet Arrangements
- ------------------------------
As of June 30, 2004, the Company had no off-balance sheet arrangements in
the nature of guarantee contracts, retained or contingent interests in assets
transferred to unconsolidated entities (or similar arrangements serving as
credit, liquidity, or market risk support to unconsolidated entities for any
such assets), or obligations (including contingent obligations) arising out of
variable interests in unconsolidated entities providing financing, liquidity,
market risk, or credit risk support to the Company, or that engage in leasing,
hedging, or research and development services with the Company.
----------------------------------------
24
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
Recently Issued Accounting Pronouncements
- -----------------------------------------
The adoption of SFAS No. 132 (revised) and FASB Interpretation No. 46 did
not have a material impact on the Company's financial statements.
----------------------------------------
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 earnings, liquidity, financial condition, review of
strategic alternatives, and other 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 factors over which the Company
has no control, including the strength of domestic and foreign economies, sales
growth, competition, and certain costs increases; or (3) if the factors on which
the Company's conclusions are based do not conform to the Company's
expectations.
Quantitative and Qualitative Disclosures about Market Risk
- ----------------------------------------------------------
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.
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, 2004. 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.
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PART II -- OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings
- ------- -----------------
In July 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 infringed 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 was seeking monetary
damages and injunctive relief against the Company.
In February 2004, a settlement was reached between the Company and the
competitor. Under the settlement, the competitor dismissed the action and agreed
that the Company's products involved in the litigation are immune from suit for
infringement of any of the competitor's intellectual property rights. In
exchange, Paragon agreed to dismiss its counterclaims and paid the competitor
$1,125,000.
The Company is involved in various other claims and legal actions arising
in the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
Item 4. Submission of Matter to a Vote of Security Holders
- ------- --------------------------------------------------
The Company's Annual Meeting of Stockholders was held on June 23, 2004 with
the following item being submitted to a vote of stockholders:
1. The election of five 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 18, 2004,
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 3,389,436 478,721 409,438
Theodore W. Myers 3,626,995 241,162 409,438
Anthony W. Schweiger 3,630,869 237,288 409,438
Steven Shulman 3,394,582 473,575 409,438
Leonard S. Yurkovic 3,409,035 459,122 409,438
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Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) Exhibits:
10.27 Amendment to Lease Agreement by and between Spring
Lake Properties Holdings, L.C.
and Ermanco Incorporated dated April 1, 2004
(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 (filed herewith).
32.2 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 signed by Ronald J.
Semanick, Chief Financial Officer and Vice
President - Finance and Treasurer (filed herewith).
(b) The following reports on Form 8-K were filed during the
quarter ended June 30, 2004:
A Current Report on Form 8-K was furnished on May 12, 2004
announcing the Company's financial results for the first
quarter ended March 31, 2004.
27
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: August 12, 2004
-------------------
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