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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, 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
November 5, 2004: 4,260,360.
---------
Paragon Technologies, Inc.
TABLE OF CONTENTS
Page
Number
-----------
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets (Unaudited)............................ 1
Consolidated Statements of Operations (Unaudited).................. 3
Consolidated Statements of Comprehensive
Income (Unaudited).............................................. 4
Consolidated Statements of Cash Flows (Unaudited).................. 5
Notes to Consolidated Financial Statements (Unaudited)............. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk........................................................ 24
Item 4. Controls and Procedures............................................... 24
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 25
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds........................................................ 25
Item 3. Defaults Upon Senior Securities....................................... 25
Item 4. Submission of Matters to a Vote of Security Holders................... 25
Item 5. Other Information..................................................... 26
Item 6. Exhibits.............................................................. 26
SIGNATURES.............................................................................. 27
EXHIBIT INDEX........................................................................... 28
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
September 30, 2004 and December 31, 2003
(In Thousands, Except Share Data)
(UNAUDITED)
September 30, December 31,
2004 2003
------------------- ------------------
Assets
- ------
Current assets:
Cash and cash equivalents...................... $ 3,733 5,591
Receivables:
Trade (net of allowance for doubtful
accounts of $216 as of September 30,
2004 and $265 as of December
31, 2003)................................... 7,140 5,277
Notes and other receivables................... 236 38
------ ------
Total receivables........................... 7,376 5,315
------ ------
Costs and estimated earnings in excess
of billings................................... 258 521
Inventories:
Raw materials................................. 1,332 926
Work-in-process............................... 226 106
Finished goods................................ 261 159
------ ------
Total inventories........................... 1,819 1,191
------ ------
Deferred income tax benefits.................... 772 1,444
Prepaid expenses and other current assets....... 727 629
------ ------
Total current assets........................ 14,685 14,691
------ ------
Property, plant and equipment, at cost:
Leasehold improvements.......................... 228 228
Machinery and equipment......................... 3,856 3,643
------ ------
4,084 3,871
Less: accumulated depreciation................. 2,781 2,455
------ ------
Net property, plant and equipment............. 1,303 1,416
------ ------
Goodwill........................................... 17,657 17,657
Other assets....................................... 10 10
------ ------
Total assets....................................... $ 33,655 33,774
====== ======
See accompanying notes to consolidated financial statements.
1
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
September 30, 2004 and December 31, 2003
(In Thousands, Except Share Data)
(UNAUDITED)
September 30, December 31,
2004 2003
------------------- ------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable................................ $ 3,389 2,671
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 2,426 2,180
Accrued salaries, wages, and
commissions................................... 455 304
Income taxes payable............................ - 894
Accrued product warranty........................ 766 925
Deferred gain on sale-leaseback................. 165 165
Accrued other liabilities....................... 1,280 2,507
------ ------
Total current liabilities................... 8,481 9,646
------ ------
Long-term liabilities:
Deferred gain on sale-leaseback................. 399 523
Deferred income taxes payable................... 1,967 1,594
Deferred compensation........................... 47 42
------ ------
Total long-term liabilities................. 2,413 2,159
------ ------
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 4,276,060 shares as
of September 30, 2004 and 4,277,595
shares as of December 31, 2003.............. 4,276 4,278
Additional paid-in capital...................... 7,876 7,586
Retained earnings............................... 10,609 10,105
------ ------
Total stockholders' equity.................. 22,761 21,969
------ ------
Total liabilities and stockholders' equity.. $ 33,655 33,774
====== ======
See accompanying notes to consolidated financial statements.
2
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Operations (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
(In Thousands, Except Share And Per Share Data)
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
---------------- ----------------- ----------------- -----------------
Net sales................. $ 10,754 8,742 30,968 28,289
Cost of sales............. 7,738 6,508 22,988 20,927
--------- --------- --------- ---------
Gross profit on sales..... 3,016 2,234 7,980 7,362
--------- --------- --------- ---------
Selling, general and
administrative
expenses............... 2,228 2,992 6,345 6,863
Product development
costs.................. 69 60 274 363
Restructuring charges
(credit)............... - - - (170)
Interest expense.......... - 306 - 675
Interest income........... (10) (9) (61) (55)
Equity in income of
joint venture.......... - (5) - (256)
Gain on sale of
SI/BAKER joint
venture................ - (4,919) - (4,919)
Gain on disposition of
property, plant
and equipment.......... - - - (1,361)
Other income, net......... (46) (103) (145) (364)
--------- --------- --------- ---------
2,241 (1,678) 6,413 776
--------- --------- --------- ---------
Earnings before
income taxes........... 775 3,912 1,567 6,586
Income tax expense........ 310 1,500 632 2,545
--------- --------- --------- ---------
Net earnings.............. $ 465 2,412 935 4,041
========= ========= ========= =========
Basic earnings
per share.............. $ .11 .56 .22 .95
========= ========= ========= =========
Diluted earnings
per share.............. $ .11 .55 .21 .93
========= ========= ========= =========
Weighted average
shares outstanding..... 4,290,310 4,277,345 4,282,681 4,266,778
Dilutive effect of
stock options.......... 63,710 133,799 77,672 98,206
--------- --------- --------- ---------
Weighted average
shares outstanding
assuming dilution...... 4,354,020 4,411,144 4,360,353 4,364,984
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
3
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, 2004 and 2003
(In Thousands)
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
---------------- ----------------- ----------------- -----------------
Net earnings................ $ 465 2,412 935 4,041
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.......... $ 465 2,412 935 4,033
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
4
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2004 and 2003
(In Thousands, Except Share Data)
Nine Months Ended
----------------------------------------
September 30, September 30,
2004 2003
------------------- -------------------
Cash flows from operating activities:
Net earnings ....................................... $ 935 4,041
Adjustments to reconcile net earnings
to net cash provided (used) by operating
activities:
Depreciation of plant and equipment............. 326 415
Amortization of intangibles..................... - 57
Gain on disposition of property,
plant and equipment........................... - (1,361)
Gain on sale of SI/BAKER joint venture.......... - (4,919)
Amortization of deferred gain on sale-
leaseback..................................... (124) (96)
Cash dividend received from joint venture....... - 1,000
Equity in income of joint venture............... - (256)
Noncash interest charges associated
with settlement of interest rate
swap contract................................. - 188
Issuance of common shares as interest
payment on subordinated notes................. - 90
Change in operating assets and liabilities:
Receivables................................. (2,061) 586
Costs and estimated earnings in
excess of billings....................... 263 (145)
Inventories................................. (628) 302
Deferred tax expenses....................... 1,045 259
Prepaid expenses and other
current assets........................... (98) (31)
Other noncurrent assets..................... - 1
Accounts payable............................ 718 355
Customers' deposits and billings
in excess of costs and estimated
earnings................................. 246 (844)
Accrued salaries, wages, and
commissions.............................. 151 (81)
Income taxes payable........................ (894) 1,595
Accrued product warranty.................... (159) 25
Accrued other liabilities................... (1,227) 621
Deferred compensation....................... 5 10
------ ------
Net cash provided (used) by
operating activities.............................. (1,502) 1,812
------ ------
Cash flows from investing activities:
Proceeds from the disposition of
property, plant and equipment .................... - 2,734
Proceeds from the divestment of the SI/BAKER
joint venture, net of advisory fees............... - 5,500
Additions to property, plant and equipment.......... (213) (180)
------ ------
Net cash provided (used) by
investing activities.............................. (213) 8,054
------ ------
See accompanying notes to consolidated financial statements.
5
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Nine Months Ended September 30, 2004 and 2003
(In Thousands, Except Share Data)
Nine Months Ended
--------------------------------------------
September 30, September 30,
2004 2003
------------------------ ------------------
Cash flows from financing activities:
Sale of common shares in connection
with employee incentive stock
option plan.................................... 38 12
Repurchase and retirement of
common stock................................... (181) -
Decrease in restricted cash...................... - 865
Repayment of long-term debt...................... - (8,700)
Settlement of interest rate swap contract........ - (283)
------ ------
Net cash provided (used) by
financing activities....................... (143) (8,106)
------ ------
Increase (decrease) in cash and
cash equivalents............................... (1,858) 1,760
Cash and cash equivalents,
beginning of period............................ 5,591 5,385
------ ------
Cash and cash equivalents,
end of period.................................. $ 3,733 7,145
====== ======
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest................................... $ - 456
====== ======
Income taxes............................... $ 616 (118)
====== ======
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.
6
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 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 September 30
------------ ------------- ------------ ------------------- ------------------
2004............ $ 68 - (5) - 63
2003............ $ 216 (170) (48) 170 168
The $63,000 restructuring accrual at September 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.
7
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
A roll-forward of warranty activities is as follows (in thousands):
Beginning Ending
Balance Balance
January 1 Additions Deductions September 30
------------- ------------------ ----------------- -------------------
2004.................. $ 925 70 (229) 766
2003.................. $ 894 159 (134) 919
(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.
8
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 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 nine months ended September 30, 2004 and 2003
are as follows (in thousands):
For the three months ended September 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 2,191 7,103 9,294 86.4%
Aftermarket sales............. 920 540 1,460 13.6%
------ ------ ------ -----
Total sales................... $ 3,111 7,643 10,754 100.0%
====== ====== ====== =====
As a % of total sales......... 28.9% 71.1% 100.0%
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 nine months ended September 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 6,020 20,891 26,911 86.9%
Aftermarket sales............. 2,500 1,557 4,057 13.1%
------ ------ ------ -----
Total sales................... $ 8,520 22,448 30,968 100.0%
====== ====== ====== =====
As a % of total sales......... 27.5% 72.5% 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%
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, 2004 and 2003 are as follows (in thousands):
For the three months ended September 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 2,852 7,370 10,222 95.1%
International sales........... 259 273 532 4.9%
------ ------ ------ -----
Total sales................... $ 3,111 7,643 10,754 100.0%
====== ====== ====== =====
9
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
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 nine months ended September 30, 2004:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 7,282 21,912 29,194 94.3%
International sales........... 1,238 536 1,774 5.7%
------ ------ ------ -----
Total sales................... $ 8,520 22,448 30,968 100.0%
====== ====== ====== =====
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%
====== ====== ====== =====
The Company identifies operating segments based on the types of products
offered for sale as follows:
For the Three Months Ended
September 30, 2004 (In Thousands): SI Systems Ermanco Total
- -------------------------------- ------------ ------------ ------------
Sales..................................... $ 3,111 7,643 10,754
Earnings (loss) before interest
expense, interest income, and
income taxes............................ 74 691 765
Total assets.............................. 5,764 27,891 33,655
Capital expenditures...................... 4 59 63
Depreciation and amortization
expense................................. 26 86 112
For the Three Months Ended
September 30, 2003 (In Thousands): SI Systems Ermanco Total
- -------------------------------- ------------ ------------ ------------
Sales..................................... $ 2,809 5,933 8,742
Earnings before interest expense,
interest income, equity in income of
joint venture, gain on sale of SI/BAKER
joint venture, gain on disposition of
property, plant and equipment, and
income taxes............................ 54 (769) (715)
Gain on sale of SI/BAKER joint
venture................................. 4,919 - 4,919
Gain on disposition of property,
plant and equipment..................... - - -
Total assets.............................. 6,487 27,741 34,228
Capital expenditures...................... 4 31 35
Depreciation and amortization
expense................................. 32 100 132
10
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
For the Nine Months Ended
September 30, 2004 (In Thousands): SI Systems Ermanco Total
- -------------------------------- ------------ ------------ ------------
Sales..................................... $ 8,520 22,448 30,968
Earnings (loss) before interest
expense, interest income, and
income taxes............................ (159) 1,665 1,506
Total assets.............................. 5,764 27,891 33,655
Capital expenditures...................... 56 157 213
Depreciation and amortization
expense................................. 79 247 326
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, restructuring
credits, equity in income of joint
venture, gain on sale of SI/BAKER
joint venture, gain (loss) on
disposition of property, plant
and equipment, and income taxes......... 290 210 500
Restructuring credits..................... 170 - 170
Gain on sale of SI/BAKER joint
venture................................. 4,919 - 4,919
Gain (loss) on disposition of property,
plant and equipment..................... 1,363 (2) 1,361
Total assets.............................. 6,487 27,741 34,228
Capital expenditures...................... 38 142 180
Depreciation and amortization
expense................................. 114 301 415
(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.
11
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 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 September 30, 2004 and September 30, 2003, $41,000 and
$40,000, respectively, of the deferred gain was recognized. During the nine
months ended September 30, 2004 and September 30, 2003, $124,000 and
$96,000, 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 is available, 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 September 30, 2004. As of September 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%.
12
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 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 nine months ended September 30, 2004 and 2003
includes the following components (in thousands):
Three Months Ended Nine Months Ended
--------------------------------------- -------------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------------- ------------------ ------------------ ------------------
Service cost-benefits
earned during the period..... $ 23 22 70 66
Interest cost on projected
benefit obligation.......... 11 10 33 50
Expected return on plan
assets - increase........... (15) (13) (44) (78)
Recognized net actuarial
loss (gain)................. 1 1 3 (3)
----- ----- ----- -----
Net periodic pension
expense..................... 20 20 62 35
Curtailment cost
(settlement credit)......... - - - (144)
----- ----- ----- -----
Total pension expense
(benefit)................... $ 20 20 62 (109)
===== ===== ===== =====
Contributions
-------------
The Company made $45,000 of contributions to its defined benefit plan
during the three and nine months ended September 30, 2004. The Company
expects total pension plan contributions to its defined benefit plan to
approximate $90,000 for the year ended December 31, 2004.
13
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
(11) Stock Repurchase Program
------------------------
In August 2004, the Company's Board of Directors approved a program to
repurchase up to $1,000,000 of its outstanding common stock. As of
September 30, 2004, the Company had repurchased 19,000 shares of common
stock at a weighted average cost, including brokerage commissions, of $9.55
per share. Cash expenditures for the stock repurchases approximated
$181,424. As of September 30, 2004, approximately $818,576 remained
available for repurchases under the stock repurchase program. Based on
market conditions and other factors, additional repurchases may be made
from time to time, in compliance with SEC regulations, in the open market
or through privately negotiated transactions at the discretion of the
Company. There is no expiration date with regards to the stock repurchase
program.
(12) 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 nine months ended September 30, 2004 and 2003,
would have been as follows:
Three Months Ended Nine Months Ended
--------------------------------------- ----------------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------------ ------------------ ------------------ ------------------
Net earnings, as
reported................. $ 465 2,412 935 4,041
Deduct: total stock-
based employee
compensation
determined under
fair value method,
net of related tax
effects.................. (29) (56) (92) (188)
----- ----- ----- -----
Pro forma net
earnings................. $ 436 2,356 843 3,853
===== ===== ===== =====
Earnings per share:
Basic - as reported...... $ .11 .56 .22 .95
===== ===== ===== =====
Basic - pro forma........ $ .10 .55 .20 .90
===== ===== ===== =====
Diluted - as reported.... $ .11 .55 .21 .93
===== ===== ===== =====
Diluted - pro forma...... $ .10 .53 .19 .88
===== ===== ===== =====
14
Item 1. Financial Statements (Continued)
- ------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three and Nine Months Ended September 30, 2004 and 2003
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 nine months ended September 30,
2004 and the year ended December 31, 2003.
(13) 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. 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.
-------------------------------
15
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 September 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 nine
months ended September 30, 2004, and for the years ended December 31, 2003,
2002, 2001, and 2000.
Nine Months
Ended Year Ended December 31,
September 30, ----------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
------------- ------- ------- ------- -------
Backlog of orders - Beginning............ $ 10,525 6,924 13,342 22,913 23,685
Add: orders........................... 32,343 40,896 31,806 41,181 63,534
Less: sales........................... 30,968 37,295 38,224 50,752 64,306
------ ------ ------ ------ ------
Backlog of orders - Ending............... $ 11,900 10,525 6,924 13,342 22,913
====== ====== ====== ====== ======
Capacity Utilization(1).................. 76.8% 74.8% 75.6% 77.7% 82.6%
16
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 September 30, 2004 and as of December 31, 2003, 2002, 2001,
and 2000:
As of As of December 31,
September 30, ----------------------------------------
(Dollars in Thousands) 2004 2003 2002 2001 2000
------------- ------- ------- ------- -------
Current assets........................... $ 14,685 14,691 15,444 19,200 22,850
------ ------ ------ ------ ------
Current liabilities...................... 8,481 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 September 30,
2004, and as of December 31, 2003, 2002, 2001, and 2000:
As of As of December 31,
September 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............. $ 22,761 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.
17
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
September 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 nine months ended September 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 September 30, 2004 was $766,000.
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
18
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 September 30, 2004 was $17,657,000.
-------------------------------
(a) Results of Operations -- Nine Months Ended September 30, 2004 Compared
------------------------------------------ ---------------------------
to the Nine Months Ended September 30, 2003
-------------------------------------------
Earnings Summary
- ----------------
The Company had net earnings of $935,000 (or $0.22 basic earnings per
share) for the nine months ended September 30, 2004, compared to net earnings of
$4,041,000 (or $0.95 basic earnings per share) for the nine months ended
September 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 of the Company's ownership interest in the
SI/BAKER joint venture of $4,919,000;
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
$256,000; and
o royalty income from the Company's former SI/BAKER joint venture of
$226,000.
Partially offsetting the above decrease in net earnings for the nine months
ended September 30, 2004 was a reduction of (1) $675,000 in interest expense as
a result of the elimination of the Company's senior and subordinated debt in
September 2003, and (2) the prior year comparable period containing an accrual
of $1,020,000 associated with potential defense costs to defend charges asserted
against the Company by a competitor relating to the Company's intellectual
property.
Net Sales and Gross Profit on Sales
- -----------------------------------
2004 2003
--------------------- --------------------
Net sales............................................. $30,968,000 28,289,000
Cost of sales......................................... 22,988,000 20,927,000
---------- ----------
Gross profit on sales................................. $ 7,980,000 7,362,000
========== ==========
Gross profit as a percentage of sales................. 25.8% 26.0%
==== ====
The net sales increase was primarily attributable to an increase in Ermanco
branded sales of $3,367,000, partially offset by a decline of approximately
$688,000 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 nine months ended September
30, 2004, when compared to the nine months ended September 30, 2003, was
favorably impacted by approximately 0.4% due to product mix, and unfavorably
impacted by approximately 0.6% due primarily to costs related to enhancing the
Company's operations.
19
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(a) Results of Operations -- Nine Months Ended September 30, 2004 Compared
-----------------------------------------------------------------------
to the Nine Months Ended September 30, 2003 (Continued)
--------------------------------------------
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $6,345,000 were lower by
$518,000 for the nine months ended September 30, 2004 than for the nine months
ended September 30, 2003. The decrease was attributable to the prior year
comparable period being impacted by the accrual of $1,020,000 associated with
potential defense costs to defend charges asserted against the Company by a
competitor relating to the Company's intellectual property that was settled in
2004 and collections of $172,000 during the second quarter of 2004 on accounts
receivable previously recognized as uncollectible. Partially offsetting these
decreases were the addition of resources aimed at expanding the customer base
and an increase in salaries and fringe benefits totaling $377,000, an increase
in consulting and marketing expenses primarily associated with product promotion
and marketing research totaling $184,000, and severance costs of $115,000.
Product Development Costs
- -------------------------
Product development costs, including patent expense, of $274,000 was lower
by $89,000 for the nine months ended September 30, 2004 than for the nine months
ended September 30, 2003. Development programs in the nine months ended
September 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
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 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 nine months ended
September 30, 2004, as compared to $675,000 of interest expense for the nine
months ended September 30, 2003.
Equity in Income of Joint Venture
- ---------------------------------
In September 2003, the Company sold its entire ownership interest in
SI/BAKER, INC. During the nine months ended September 30, 2003, equity in income
of the SI/BAKER joint venture was $256,000.
Gain on Sale of SI/BAKER Joint Venture
- --------------------------------------
In September 2003, the Company sold its entire ownership interest in
SI/BAKER, INC. The sale resulted in a gain of $4,919,000 in the third quarter of
2003.
Gain on Disposition of Property, Plant and Equipment
- ----------------------------------------------------
The gain on the disposition of property, plant and equipment of $1,361,000
for the nine months ended September 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.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(a) Results of Operations -- Nine Months Ended September 30, 2004 Compared
-----------------------------------------------------------------------
to the Nine Months Ended September 30, 2003 (Continued)
--------------------------------------------
Other Income, Net
- -----------------
In September 2003, the Company sold its entire ownership interest in
SI/BAKER, INC. The unfavorable variance of $219,000 in other income, net for the
nine months ended September 30, 2004 as compared to the nine months ended
September 30, 2003 was primarily attributable to revenue-based royalty income
from the Company's SI/BAKER joint venture recognized during the first nine
months of 2003.
Income Tax Expense
- ------------------
The Company recognized income tax expense of $632,000 during the nine
months ended September 30, 2004 compared to income tax expense of $2,545,000
during the nine months ended September 30, 2003. Income tax expense was
generally recorded at statutory federal and state tax rates.
(b) Results of Operations - Three Months Ended September 30, 2004 Compared to
-------------------------------------------------------------------------
the Three Months Ended September 30, 2003
-----------------------------------------
Earnings Summary
- ----------------
The Company had net earnings of $465,000 (or $0.11 basic earnings per
share) for the three months ended September 30, 2004, compared to net earnings
of $2,412,000 (or $0.56 basic earnings per share) for the three months ended
September 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 of the Company's ownership interest in the
SI/BAKER joint venture of $4,919,000; and
o royalty income from the Company's former SI/BAKER joint venture of
$58,000.
Partially offsetting the above decrease in net earnings for the three
months ended September 30, 2004 was:
o a reduction of $306,000 in interest expense as a result of the
elimination of the Company's senior and subordinated debt
in September 2003;
o higher revenues and gross profit of $2,012,000 and $782,000,
respectively, as described below; and
o lower selling, general and administrative expenses by $764,000 as
described below.
With the exception of the following Statement of Operations captions,
changes in the third quarter of 2004 compared to the prior year were consistent
with those previously noted above for the nine-month period.
Net Sales and Gross Profit on Sales
- -----------------------------------
2004 2003
--------------------- --------------------
Net sales............................................. $10,754,000 8,742,000
Cost of sales......................................... 7,738,000 6,508,000
---------- ---------
Gross profit on sales................................. $ 3,016,000 2,234,000
========== =========
Gross profit as a percentage of sales................. 28.0% 25.6%
==== ====
The net sales increase was primarily attributable to an increase in Ermanco
branded sales of $1,710,000 and an increase of $302,000 in SI Systems branded
sales. Based on contract completion requirements, the increase in sales across
both brands was primarily attributable to a larger backlog of orders entering
the third quarter of 2004 when compared to the backlog of orders entering the
third quarter of 2003.
21
Item 2. Management's Discussion and Analysis of Financial Condition and
- ------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------
(b) Results of Operations - Three Months Ended September 30, 2004 Compared
----------------------------------------------------------------------
to the Three Months Ended September 30, 2003 (Continued)
--------------------------------------------
Net Sales and Gross Profit on Sales (Continued)
- -----------------------------------
Gross profit, as a percentage of sales, for the three months ended
September 30, 2004 was favorably impacted by approximately 2.2% due to the
favorable performance on several contracts initiated in prior periods that were
completed during the third quarter of 2004 and product mix.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $2,228,000 were lower by
$764,000 for the three months ended September 30, 2004 than for the three months
ended September 30, 2003. The decrease was attributable to the prior year
comparable period being impacted by the accrual of $1,020,000 associated with
potential defense costs to defend charges asserted against the Company by a
competitor relating to the Company's intellectual property that was settled in
2004. Partially offsetting this decrease was the addition of resources aimed at
expanding the customer base and an increase in salaries and fringe benefits
totaling $94,000, and an increase in consulting and marketing expenses primarily
associated with product promotion and marketing research totaling $114,000.
-------------------------------
Liquidity and Capital Resources
- -------------------------------
The Company's cash and cash equivalents decreased to $3,733,000 at
September 30, 2004 from $5,591,000 at December 31, 2003. The decrease resulted
primarily from:
o cash used by operating activities totaling $1,502,000;
o purchases of capital equipment of $213,000; and
o repurchase and retirement of common stock of $181,000.
Cash used by operating activities of $1,502,000 during the nine months
ended September 30, 2004 as compared to cash provided by operating activities of
$1,812,000 during the nine months ended September 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 nine months ended September 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
is available, 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 September 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.
-------------------------------
22
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 office equipment, computer equipment, and
software under various operating leases with terms extending through September
2007.
Future contractual obligations and commercial commitments at September 30,
2004 as noted above are as follows:
Payments Due by Period
---------------------------------------------------------------------------------
Total 2004 2005 2006 2007 2008
----- ---- ---- ---- ---- ----
Contractual
obligations:
Operating
leases........ $ 2,318,000 168,000 636,000 590,000 606,000 318,000
--------- --------- --------- --------- --------- ---------
Total......... $ 2,318,000 168,000 636,000 590,000 606,000 318,000
========= ========= ========= ========= ========= =========
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 September 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.
23
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) did not have a material impacton
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.
Item 3. 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) Evaluation of Disclosure Controls and Procedures
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, 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) Change in Internal Control Over Financial Reporting
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
24
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 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table represents the periodic repurchases of equity
securities made by the Company during the three months ended September 30, 2004:
- -------------------------------------------------------------------------------------------------------
Total Number Appropriate
Average of Shares Appropriate Dollar Value
Price Paid Repurchased Dollar Value of Shares
Total Per Share as Part of a of Shares That May Yet
Number (Including Publicly Purchased Be Purchased
Fiscal of Shares Brokerage Announced Under the Under the
Period Repurchased Commissions) Program Program Program
- -------------------------------------------------------------------------------------------------------
7/1/04 - 7/31/04 - $ - - $ - $ -
8/1/04 - 8/31/04 - $ - - $ - $ 1,000,000
9/1/04 - 9/30/04 19,000 $ 9.55 19,000 $ 181,424 $ 818,576
- -------------------------------------------------------------------------------------------------------
In August 2004, the Company's Board of Directors approved a program to
repurchase up to $1,000,000 of its outstanding common stock. As of September 30,
2004, the Company had repurchased 19,000 shares of common stock at a weighted
average cost, including brokerage commissions, of $9.55 per share. Cash
expenditures for the stock repurchases approximated $181,424. As of September
30, 2004, approximately $818,576 remained available for repurchases under the
stock repurchase program. Based on market conditions and other factors,
additional repurchases may be made from time to time, in compliance with SEC
regulations, in the open market or through privately negotiated transactions at
the discretion of the Company. There is no expiration date with regards to the
stock repurchase program.
Item 3. Defaults Upon Senior Securities
- ------- -------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
Not applicable.
25
Item 5. Other Information
- ------- -----------------
Not applicable.
Item 6. Exhibits
- ------- --------
Exhibits:
10.28 Loan Agreement related to the Line of Credit
entered into August 6, 2004 by and
between Paragon Technologies, Inc., Ermanco
Incorporated, Wachovia Bank, National
Association (filed herewith).
10.29 Promissory Note related to the Line of Credit Loan
Agreement entered into August 6, 2004 by and
between Paragon Technologies, Inc., Ermanco
Incorporated, and Wachovia Bank, National
Association (filed herewith).
10.30 Security Agreement related to the Line of Credit
dated August 6, 2004 by and between
Paragon Technologies, Inc., Ermanco
Incorporated, 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 (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).
26
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PARAGON TECHNOLOGIES, INC.
/s/ Leonard S. Yurkovic
-----------------------------------------------
Leonard S. Yurkovic
President & CEO
/s/ Ronald J. Semanick
-----------------------------------------------
Ronald J. Semanick
Chief Financial Officer
Dated: November 12, 2004
-----------------
27
EXHIBIT INDEX
-------------
Exhibits
- --------
10.28 Loan Agreement related to the Line of Credit entered into
August 6, 2004 by and between Paragon Technologies, Inc., Ermanco
Incorporated, Wachovia Bank, National Association (filed herewith).
10.29 Promissory Note related to the Line of Credit Loan Agreement
entered into August 6, 2004 by and between Paragon Technologies,
Inc., Ermanco Incorporated, and Wachovia Bank, National
Association (filed herewith).
10.30 Security Agreement related to the Line of Credit dated August 6,
2004 by and between Paragon Technologies, Inc., Ermanco
Incorporated, 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 (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).
28