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, 2005
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, Pennsylvania 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|
The number of shares outstanding of the Registrant's Common Stock as of August
5, 2005 was 4,300,885.
[PARAGON TECHNOLOGIES, INC. LOGO]
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 Cash Flows (Unaudited).................. 4
Notes to Consolidated Financial Statements (Unaudited)............. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk............ 25
Item 4. Controls and Procedures............................................... 25
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........... 26
Item 3. Defaults Upon Senior Securities....................................... 26
Item 4. Submission of Matters to a Vote of Security Holders................... 26
Item 5. Other Information..................................................... 26
Item 6. Exhibits.............................................................. 27
SIGNATURES.............................................................................. 28
EXHIBIT INDEX........................................................................... 29
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2005 and December 31, 2004
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2005 2004
------------------- ------------------
Assets
------
Current assets:
Cash and cash equivalents...................... $ 4,626 3,602
Receivables:
Trade (net of allowance for doubtful
accounts of $445 as of June 30,
2005 and $231 as of December
31, 2004)................................... 11,510 5,756
Notes and other receivables................... 115 244
------ ------
Total receivables........................... 11,625 6,000
------ ------
Costs and estimated earnings in excess
of billings................................... 541 1,059
Inventories:
Raw materials................................. 1,809 1,175
Work-in-process............................... 648 246
Finished goods................................ 171 195
------ ------
Total inventories........................... 2,628 1,616
------ ------
Deferred income tax benefits.................... 840 889
Prepaid expenses and other current assets....... 611 636
------ ------
Total current assets........................ 20,871 13,802
------ ------
Property, plant and equipment, at cost:
Leasehold improvements.......................... 228 228
Machinery and equipment......................... 3,892 3,752
------ ------
4,120 3,980
Less: accumulated depreciation................. 2,798 2,744
------ ------
Net property, plant and equipment............. 1,322 1,236
------ ------
Goodwill........................................... 17,657 17,657
Other assets....................................... 10 10
------ ------
Total assets....................................... $ 39,860 32,705
====== ======
See accompanying notes to consolidated financial statements.
1
Item 1. Financial Statements (Continued)
------- --------------------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2005 and December 31, 2004
(In Thousands, Except Share Data)
(UNAUDITED)
June 30, December 31,
2005 2004
------------------- ------------------
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable................................ $ 5,316 3,000
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 4,995 1,560
Accrued salaries, wages, and
commissions................................... 593 428
Income taxes payable............................ 214 58
Accrued product warranty........................ 457 655
Deferred gain on sale-leaseback................. 165 165
Accrued other liabilities....................... 1,090 1,042
------ ------
Total current liabilities................... 12,830 6,908
------ ------
Long-term liabilities:
Deferred gain on sale-leaseback................. 275 358
Deferred income taxes payable................... 2,375 2,131
------ ------
Total long-term liabilities................. 2,650 2,489
------ ------
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 4,288,785 shares as
of June 30, 2005 and 4,265,310
shares as of December 31, 2004.............. 4,289 4,265
Additional paid-in capital.................... 8,141 7,996
Retained earnings............................. 11,950 11,047
------ ------
Total stockholders' equity.................. 24,380 23,308
------ ------
Total liabilities and stockholders' equity.. $ 39,860 32,705
====== ======
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 Six Months Ended June 30, 2005 and 2004
(In Thousands, Except Share and Per Share Data)
Three Months Ended Six Months Ended
--------------------------------- ----------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
Net sales................. $ 18,687 9,638 28,995 20,214
Cost of sales............. 14,378 7,304 22,074 15,250
--------- --------- --------- ---------
Gross profit on sales..... 4,309 2,334 6,921 4,964
--------- --------- --------- ---------
Selling, general and
administrative
expenses............... 2,766 2,074 5,095 4,117
Product development
costs.................. 41 133 84 205
Interest expense.......... - - 1 -
Interest income........... (61) (40) (74) (51)
Other expense
(income), net............. 465 (53) 410 (99)
--------- --------- --------- ---------
3,211 2,114 5,516 4,172
--------- --------- --------- ---------
Earnings before
income taxes........... 1,098 220 1,405 792
Income tax expense........ 389 91 502 322
--------- --------- --------- ---------
Net earnings.............. $ 709 129 903 470
========= ========= ========= =========
Basic earnings
per share.............. $ .17 .03 .21 .11
========= ========= ========= =========
Diluted earnings
per share.............. $ .16 .03 .21 .11
========= ========= ========= =========
Weighted average
shares outstanding..... 4,272,629 4,281,961 4,269,871 4,280,090
Dilutive effect of
stock options.......... 61,017 83,824 55,511 86,192
--------- --------- --------- ---------
Weighted average
shares outstanding
assuming dilution...... 4,333,646 4,365,785 4,325,382 4,366,282
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
3
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 2005 and 2004
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2005 2004
------------------- -------------------
Cash flows from operating activities:
Net earnings ....................................... $ 903 470
Adjustments to reconcile net earnings
to net cash provided (used) by operating
activities:
Depreciation of plant and equipment............. 234 214
Amortization of deferred gain on sale-
leaseback..................................... (83) (83)
Other non-cash items affecting
earnings...................................... 9 -
Change in operating assets and liabilities:
Receivables................................. (5,625) 157
Costs and estimated earnings in
excess of billings....................... 518 (15)
Inventories................................. (1,012) (520)
Deferred tax expenses....................... 293 808
Prepaid expenses and other
current assets........................... 25 155
Accounts payable............................ 2,316 1,054
Customers' deposits and billings
in excess of costs and estimated
earnings................................. 3,435 (907)
Accrued salaries, wages, and
commissions.............................. 165 354
Income taxes payable........................ 156 (894)
Accrued product warranty.................... (198) (114)
Accrued other liabilities................... 48 (1,249)
Deferred compensation....................... - 5
------ -----
Net cash provided (used) by
operating activities.............................. 1,184 (565)
------ -----
Cash flows from investing activities:
Additions to property, plant and equipment.......... (320) (150)
------ -----
Net cash used by investing activities............... (320) (150)
------ -----
See accompanying notes to consolidated financial statements.
4
Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Six Months Ended June 30, 2005 and 2004
(In Thousands, Except Share Data)
Six Months Ended
----------------------------------------
June 30, June 30,
2005 2004
------------------- -------------------
Cash flows from financing activities:
Sale of common shares in connection with
employee incentive stock option plan............. 160 38
------ -----
Net cash provided by
financing activities......................... 160 38
------ -----
Increase (decrease) in cash and
cash equivalents................................. 1,024 (677)
Cash and cash equivalents,
beginning of period.............................. 3,602 5,591
------ -----
Cash and cash equivalents,
end of period.................................... $ 4,626 $ 4,914
====== ======
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest..................................... $ 1 $ -
====== ======
Income taxes................................. $ 62 $ 611
====== ======
See accompanying notes to consolidated financial statements.
5
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, 2005 and 2004
(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 that was sold subsequent to the end of the
reporting period, 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, 2004 as filed with the Securities and Exchange Commission.
Refer to the Company's annual report on Form 10-K for the year ended
December 31, 2004 for more complete financial information. See Note 11 of
the Notes to Consolidated Financial Statements for further information
regarding the sale of substantially all of the assets and liabilities of
Ermanco.
Use of Estimates
----------------
The preparation of the financial statements, in conformity with U.S.
generally accepted accounting principles, requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. The judgments made in assessing the appropriateness of the
estimates and assumptions utilized by management in the preparation of the
financial statements are based on historical and empirical data and other
factors germane to the nature of the risk being analyzed. Materially
different results may occur if different assumptions or conditions were to
prevail. Estimates and assumptions are mainly utilized to establish the
appropriateness of the allowance for doubtful accounts, inventory reserve,
warranty reserve, revenue recognition, and impairment of long-lived assets.
(2) 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.
A roll-forward of warranty activities is as follows (in thousands):
Beginning Ending
Balance Balance
January 1 Charge/(Credit) Spending June 30
------------- ------------------ ----------------- ------------------
2005................. $ 655 (55) (143) 457
2004................. $ 925 73 (187) 811
6
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, 2005 and 2004
(3) Major Segments of Business
--------------------------
Company Overview
----------------
Paragon 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. The
Company's capabilities include horizontal transportation, rapid dispensing,
order fulfillment, computer software, sortation, integrating conveyors and
conveyor systems, and aftermarket services.
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, and products are sold
worldwide.
SI Systems
----------
The Company's Easton, Pennsylvania operation (hereafter referred to as "SI
Systems") is a specialized systems integrator supplying SI Systems branded
automated material handling systems to manufacturing, assembly, order
fulfillment, 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 sold its interests in Ermanco subsequent to the reporting
period. Ermanco, the Company's Spring Lake, Michigan operation (hereafter
referred to as "Ermanco") was a manufacturer of Ermanco branded light to
medium duty unit handling conveyor and sortation products, serving the
material handling industry through a worldwide network of approximately 100
experienced material handling equipment distributors and one licensee.
Ermanco also provided complete conveyor systems for a variety of
applications, including distribution centers and automated manufacturing,
utilizing primarily its own manufactured conveyor products, engineering
services by its own staff or subcontractors, and subcontracted installation
services. Ermanco supplied material handling systems and equipment to both
national and international markets. Ermanco offered 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 were to distributors who have non-exclusive agreements
with the Company.
The Company's systems vary in configuration and capacity. Historically,
system prices across the Company's product lines have ranged from $100,000
to several million dollars per system. Systems and aftermarket sales by
brand during the three and six months ended June 30, 2005 and 2004 are as
follows (in thousands):
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, 2005 and 2004
For the three months ended June 30, 2005:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 2,979 14,441 17,420 93.2%
Aftermarket sales............. 750 517 1,267 6.8%
------ ------ ------ -----
Total sales................... $ 3,729 14,958 18,687 100.0%
====== ====== ====== =====
As a % of total sales......... 20.0% 80.0% 100.0%
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 six months ended June 30, 2005:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Systems sales................. $ 6,016 20,428 26,444 91.2%
Aftermarket sales............. 1,579 972 2,551 8.8%
------ ------ ------ -----
Total sales................... $ 7,595 21,400 28,995 100.0%
====== ====== ====== =====
As a % of total sales......... 26.2% 73.8% 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%
The Company's products are sold worldwide through its own sales personnel,
along with a network of independent distributors and one licensee. Domestic
and international sales by brand during the three and six months ended June
30, 2005 and 2004 are as follows (in thousands):
For the three months ended June 30, 2005:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 3,679 14,629 18,308 98.0%
International sales........... 50 329 379 2.0%
------ ------ ------ -----
Total sales................... $ 3,729 14,958 18,687 100.0%
====== ====== ====== =====
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%
====== ====== ====== =====
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, 2005 and 2004
For the six months ended June 30, 2005:
% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------
Domestic sales................ $ 7,052 20,636 27,688 95.5%
International sales........... 543 764 1,307 4.5%
------ ------ ------ -----
Total sales................... $ 7,595 21,400 28,995 100.0%
====== ====== ====== =====
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%
====== ====== ====== =====
The Company operates in two major market segments, and products are sold
worldwide as follows:
For the Three Months Ended
June 30, 2005 (In Thousands): SI Systems Ermanco Total
------------------------------------------------ ------------- -------------- --------------
Sales.......................................... $ 3,729 14,958 18,687
Earnings (loss) before interest
expense, interest income, and
income taxes................................. (768) 1,805 1,037
Total assets................................... 7,653 32,207 39,860
Capital expenditures........................... 45 126 171
Depreciation and amortization expense.......... 20 101 121
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 Six Months Ended
June 30, 2005 (In Thousands): SI Systems Ermanco Total
------------------------------------------------ ------------- -------------- --------------
Sales.......................................... $ 7,595 21,400 28,995
Earnings (loss) before interest
expense, interest income, and
income taxes................................. (676) 2,008 1,332
Total assets................................... 7,653 32,207 39,860
Capital expenditures........................... 77 243 320
Depreciation and amortization expense.......... 42 192 234
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, 2005 and 2004
For the Six Months Ended
June 30, 2004 (In Thousands): SI Systems Ermanco Total
------------------------------------------------ ------------- -------------- --------------
SSales.......................................... $ 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
All of the Company's sales originate in the United States, and there are no
long lived assets existing outside the United States.
The Company's business is largely dependent upon a limited number of large
contracts with a limited number of customers. This dependence can cause
unexpected fluctuations in sales volume. Various external factors affect
the customers' decision-making process on expanding or upgrading their
current production or distribution sites. The customers' timing and
placement of new orders is often affected by factors such as the current
economy, current interest rates, and future expectations. The Company
believes that its business is not subject to seasonality, although the rate
of new orders can vary substantially from month to month. Since the Company
recognizes sales on a percentage of completion basis for its systems
contracts, fluctuations in the Company's sales and earnings occur with
increases or decreases in major installations.
(4) Recently Issued Accounting Pronouncements
-----------------------------------------
In November 2004, the Financial Accounting Standards Board issued SFAS No.
151, "Inventory Costs an Amendment of ARB No. 43, Chapter 4" ("FAS 151").
FAS 151 provides for certain fixed production overhead cost to be reflected
as a period cost and not capitalized as inventory. FAS 151 is effective for
the beginning of 2006. The adoption of FAS 151 is not expected to have a
material impact on the Company's financial statements.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised) "Share-Based Payment" ("FAS 123R"). FAS 123R addresses all
forms of share-based payment awards, including shares issued under employee
stock purchase plans, stock options, restricted stock, and stock
appreciation rights. It will require companies to recognize in the
statement of operations the grant-date fair value of stock options and
other equity-based compensation issued to employees, but expresses no
preference for a type of valuation model. The statement eliminates the
intrinsic value-based method prescribed by APB Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations, that the
Company currently uses. The Company is required to adopt FAS 123R beginning
in 2006. The adoption of FAS 123R is not expected to have a material impact
on the Company's financial statements.
In May 2005, the Financial Accounting Standard Board issued SFAS No. 154,
"Accounting Changes and Error Corrections - A Replacement of APB Opinion
No. 20 and FASB Statement No. 3" ("FAS 154"). FAS 154 requires
retrospective application to prior periods' financial statements for
changes in accounting principle, unless it is impracticable to determine
either the period-specific effects or the cumulative effect
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, 2005 and 2004
of the change. This statement also requires that retrospective application
of a change in accounting principle be limited to the direct effects of the
change. Indirect effects of a change in accounting principle, such as a
change in non-discretionary profit-sharing payments resulting from an
accounting change, should be recognized in the period of the accounting
change. FAS 154 also requires that a change in depreciation, amortization,
or depletion method for long-lived non-financial assets be accounted for as
a change in accounting estimate affected by a change in accounting
principle. This statement is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15,
2005. Early adoption is permitted for accounting changes and corrections of
errors made in fiscal years beginning after the date this statement was
issued. The Company is required to adopt the provisions of this statement,
as applicable, beginning in 2006.
(5) Sale-Leaseback
--------------
SI Systems' principal office is located in a 173,000 square foot, concrete,
brick, and steel facility in Easton, Pennsylvania. 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 $18,234 (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. In accordance
with SFAS 13 and SFAS 28, the leaseback does not meet the criteria for
classification as a capital lease; hence, it is classified as an operating
lease. The sale-leaseback resulted in a total gain of $2,189,000, of which
$1,363,000 was recorded as a gain in 2003. The seller-lessee (Company)
retained more than a minor part (25,000 square feet) but less than
substantially all of the use of the property (173,000 square feet) through
the leaseback and realized a profit on the sale in excess of the present
value of the minimum lease payments over the lease term. The present value
of the stream of lease payments utilizing the Company's incremental
borrowing rate of 10.0% was $826,000. The $826,000 of deferred profit is
amortized in equal amounts as a reduction in rent expense over the
five-year term of the lease. During the three months ended June 30, 2005
and 2004, $41,000 and $42,000, respectively, of the deferred gain was
recognized. During the six months ended June 30, 2005 and 2004, $83,000 and
$83,000, respectively, of the deferred gain was recognized.
(6) 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%. Effective August 5, 2005, due to the issuance of a
$2,000,000 letter of credit in connection with the sale of Ermanco, the
amount of available line of credit was reduced to $2,800,000.
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, 2005. As of June 30, 2005, the
Company did not have any borrowings under the line of credit facility, and
the line of credit facility expires effective June 30, 2006.
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, 2005 and 2004
(7) 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
------------------------------------------
The Company uses the projected unit credit actuarial method to compute
pension expense, which includes amortization of past service costs over the
average remaining service lives of the employees expected to receive
benefits. The net periodic pension expense for the three and six months
ended June 30, 2005 and 2004 includes the following components (in
thousands):
Three Months Ended Six Months Ended
---------------------------- --------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Service cost-benefits earned
during the period.................. $ 28 24 53 47
Interest cost on projected
benefit obligation................ 14 11 27 22
Expected return on plan
assets - increase................. (20) (15) (38) (29)
Recognized net actuarial
loss.............................. 1 1 3 2
----- ----- ----- -----
Net periodic pension expense......... 23 21 45 42
===== ===== ===== =====
Contributions
-------------
The Company did not make any contributions to its defined benefit plan
during the three and six months ended June 30, 2005. The Company expects
total pension plan contributions to its defined benefit plan to approximate
$90,000 for the year ended December 31, 2005.
(8) 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 June 30,
2005, the Company had repurchased 34,700 shares of common stock at a
weighted average cost, including brokerage commissions, of $9.38 per share.
Cash expenditures for the stock repurchases were $325,632. As of June 30,
2005, $674,368 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. There were no repurchases in
the three and six months ended June 30, 2005.
In August 2005, the Company's Board of Directors amended its existing stock
repurchase program by increasing the amount it has authorized management to
repurchase from up to $1,000,000 of the Company's common stock to up to
$5,000,000, of which approximately $4,675,000 remains available for
repurchases under the stock repurchase program.
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, 2005 and 2004
(9) 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.
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, 2005 and 2004, would have been as
follows:
Three Months Ended Six Months Ended
---------------------------- --------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net earnings, as reported............ $ 709 129 903 470
Deduct: total stock-based
employee compensation
determined under fair value
method, net of related tax
effects........................... (11) (29) (22) (63)
--- --- --- ---
Pro forma net earnings............... $ 698 100 881 407
=== === === ===
Earnings per share:
Basic -- as reported............... $ .17 .03 .21 .11
=== === === ===
Basic -- pro forma................. $ .16 .02 .21 .10
=== === === ===
Diluted -- as reported............. $ .16 .03 .21 .11
=== === === ===
Diluted -- pro forma............... $ .16 .02 .20 .09
=== === === ===
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, 2005
and the year ended December 31, 2004.
(10) Legal Proceedings
-----------------
The Company is involved in various 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.
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, 2005 and 2004
(11) Sale of Ermanco
---------------
On May 20, 2005, the Company and Ermanco entered into an Asset Purchase
Agreement (the "Asset Purchase Agreement") with TGW Transportgerate GmbH,
an Austrian corporation ("Buyer Parent"), and Malibu Acquisition, Inc., a
Michigan corporation and wholly owned subsidiary of Buyer Parent ("Buyer"),
pursuant to which Paragon agreed to sell to Buyer substantially all of the
assets and liabilities of Ermanco, Paragon's conveyor and sortation
subsidiary located in Spring Lake, Michigan. The terms of the Asset
Purchase Agreement provided that Buyer pay cash in the amount of $23
million (subject to a working capital adjustment) and assume certain
liabilities of Ermanco, as more fully described in the Asset Purchase
Agreement, a copy of which was filed with the Securities and Exchange
Commission on July 1, 2005. In approving the sale of the assets and
liabilities of Ermanco, Paragon's Board of Directors received an opinion
from its financial advisor, Boenning & Scattergood, Inc., that the
consideration received by Paragon in the transaction was fair from a
financial point of view to the stockholders of Paragon. Upon receiving
approval from Paragon's stockholders at a Special Meeting of Stockholders
held on August 3, 2005, the closing of the sale of the assets and
liabilities of Ermanco occurred on August 5, 2005. The Company received
cash consideration of approximately $23,055,000 (subject to a working
capital adjustment) in connection with the sale of the assets and
liabilities of Ermanco. Due to the fact that there is a final working
capital adjustment, the final gain or loss on the transaction has not yet
been determined. Ermanco's contribution to the Company's consolidated
sales, net earnings, and basic earnings per share were $21,400,000,
$1,316,000, and $.31, respectively, for the six months ended June 30, 2005.
Ermanco and Paragon indemnified the Buyer and Buyer Parent for, among other
things, a breach of any representation, warranty, covenant, or agreement
set forth under the terms of the Asset Purchase Agreement. Paragon and
Ermanco will have no liability to Buyer or Buyer Parent with respect to
claims for breaches of representations and/or warranties until the
aggregate amount of loss relating to such breaches exceeds $230,000, and
then only for such amount that exceeds $230,000. The overall aggregate
indemnification liability of Paragon and Ermanco shall not exceed
$5,750,000. At the closing of the asset sale, Paragon delivered to the
Buyer an irrevocable letter of credit issued by Wachovia Bank, National
Association in the amount of $2 million as security for its indemnification
obligations. The letter of credit shall remain in place for a period of one
year following the closing of the asset sale or longer in the event of any
pending dispute thereunder; provided, however, that if a dispute remains
pending longer than the one year period following the closing of the asset
sale, the amount of the letter of credit shall be reduced to an amount not
less than an amount sufficient to resolve such dispute. If applicable, the
reduced letter of credit shall remain in place following the one year
anniversary of the closing of the asset sale until any pending dispute has
been resolved.
Ermanco and Paragon agreed that for a period of 3 years following the
closing of the transaction, each will not solicit any employee, customer,
or supplier of Buyer to leave Buyer's employment or alter its business
dealings with the Buyer.
-----------------------------
14
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, 2005, 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, 2004. 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 are 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.
Subsequent to the reporting period, the Company completed the sale of
substantially all of the assets and liabilities of Ermanco. The Company received
cash consideration of approximately $23,055,000 (subject to a working capital
adjustment) in connection with the sale of the assets and liabilities of
Ermanco. Due to the fact that there is a final working capital adjustment, the
final gain or loss on the transaction has not yet been determined. Ermanco's
contribution to the Company's consolidated sales, net earnings, and basic
earnings per share were $21,400,000, $1,316,000, and $.31, respectively, for the
six months ended June 30, 2005. Following the sale of Ermanco, the Company will
no longer sell Ermanco branded products and as such, the Company's future
financial statements may be impacted.
-----------------------------
15
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
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, the
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, 2005, and for the years ended December 31, 2004, 2003,
2002, 2001, and 2000:
Six Months
Ended Year Ended December 31,
June 30, ------------------------------------------
(Dollars in Thousands) 2005 2004 2003 2002 2001 2000
---- ---- ---- ---- ---- ----
Backlog of orders - Beginning.......... $ 11,206 10,525 6,924 13,342 22,913 23,685
Add: orders.......................... 42,361 42,936 40,896 31,806 41,181 63,534
Less: sales.......................... 28,995 42,255 37,295 38,224 50,752 64,306
------ ------ ------ ------ ------ ------
Backlog of orders - Ending............. $ 24,572 11,206 10,525 6,924 13,342 22,913
====== ====== ====== ====== ====== ======
Capacity Utilization(1).................. 79.4% 78.0% 74.9% 75.6% 77.4% 82.6%
The Company's backlog of orders as of June 30, 2005 associated with Ermanco
and SI Systems was $16,799,000 and $7,773,000, respectively.
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, 2005 and as of December 31, 2004, 2003, 2002, 2001,
and 2000:
As of As of December 31,
June 30, -----------------------------------------------------
(Dollars in Thousands) 2005 2004 2003 2002 2001 2000
---- ---- ---- ---- ---- ----
Current assets................ $ 20,871 13,802 14,691 15,444 19,200 22,850
------ ------ ------ ------ ------ ------
Current liabilities........... 12,830 6,908 9,554 9,416 13,357 15,193
Current ratio................. 1.63 2.00 1.54 1.64 1.44 1.50
16
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
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 stockholders 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, 2005 and
as of December 31, 2004, 2003, 2002, 2001, and 2000:
As of As of December 31,
June 30, -----------------------------------------------------
(Dollars in Thousands) 2005 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............... $ 24,380 23,308 22,061 17,885 16,912 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 U.S. 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
impairment 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.
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, 2005, there are no contracts that are anticipated to result in a loss.
17
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
Revenue Recognition on Systems Sales (Continued)
------------------------------------
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, 2005.
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, 2005 was $457,000.
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 Impairment
----------------
During 2004, 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 its reporting
units. If these estimates or their related assumptions change, the Company may
be required to record impairment charges in the future. The book value of
goodwill as of June 30, 2005 was $17,657,000, all of which is attributable to
Ermanco. See Note 11 of the Notes to Consolidated Financial Statements for
further information regarding the sale of substantially all of the assets and
liabilities of Ermanco.
-----------------------------
18
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
(a) Results of Operations - Six Months Ended June 30, 2005 Compared
---------------------------------------------------------------
to the Six Months Ended June 30, 2004
-------------------------------------
Earnings Summary
----------------
The Company had net earnings of $903,000 (or $0.21 basic earnings per
share) for the six months ended June 30, 2005, compared to net earnings of
$470,000 (or $0.11 basic earnings per share) for the six months ended June 30,
2004. The increase in net earnings was primarily due to an increase in sales and
gross profit on sales related to sales to customers in the technology sector,
partially offset by an increase in selling, general and administrative expenses
and Ermanco subsidiary divestiture costs as mentioned below.
Net Sales and Gross Profit on Sales
-----------------------------------
2005 2004
------------------ ------------------
Net sales............................................ $ 28,995,000 20,214,000
Cost of sales........................................ 22,074,000 15,250,000
---------- ----------
Gross profit on sales................................ $ 6,921,000 4,964,000
========== ==========
Gross profit as a percentage of sales................ 23.9% 24.6%
==== ====
The net sales increase was attributable to an increase in Ermanco branded
sales of $6,595,000, complemented by an increase of $2,186,000 in SI Systems
branded sales. The increase in Ermanco branded sales was primarily attributable
to progress made on contracts received during the second quarter of 2005 from
customers in the technology sector. The increase in SI Systems branded sales was
associated with a larger backlog of SI Systems branded orders entering fiscal
2005 when compared to the backlog of SI Systems branded orders entering fiscal
2004. Contributing to the increase in SI Systems branded sales was progress made
on contracts received prior to the start of the year and during the first half
of 2005 in accordance with contract completion requirements.
Gross profit, as a percentage of sales, for the six months ended June 30,
2005, when compared to the six months ended June 30, 2004, was unfavorably
impacted by approximately 5.3% due to product mix and competitive pricing
pressures, partially offset by approximately 4.6% due to a reduction in overhead
costs.
Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses of $5,095,000 were higher by
$978,000 for the six months ended June 30, 2005 than for the six months ended
June 30, 2004. The increase was attributable to the addition of resources aimed
at expanding the customer base and an increase in salaries and fringe benefits
totaling $275,000, an increase in expenses related to revenue and profit
performance totaling $345,000, and bad debt expense of $217,000 for accounts
receivable recognized as potentially uncollectible. Also contributing to lower
selling, general and administrative expenses in the prior year were collections
of $172,000 during the second quarter of 2004 on accounts receivables previously
recognized as potentially uncollectible.
Product Development Costs
-------------------------
Product development costs, including patent expense, of $84,000 were lower
by $121,000 for the six months ended June 30, 2005 than for the six months ended
June 30, 2004. Development programs in the six months ended June 30, 2005 were
aimed at enhancements to the Company's sortation and accumulation conveyor
technologies. 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 Fulfillment systems
technologies.
19
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
(a) Results of Operations - Six Months Ended June 30, 2005 Compared
---------------------------------------------------------------
to the Six Months Ended June 30, 2004 (Continued)
-------------------------------------
Other Expense (Income), Net
---------------------------
The unfavorable variance of $509,000 in other expense (income), net for the
six months ended June 30, 2005 as compared to the six months ended June 30, 2004
was primarily attributable to Ermanco subsidiary divestiture costs of $527,000
which represented transaction expenses associated with professional fees
incurred in connection with the sale of substantially all of the assets and
liabilities of Ermanco.
Income Tax Expense
------------------
The Company recognized income tax expense of $502,000 during the six months
ended June 30, 2005 compared to income tax expense of $322,000 during the six
months ended June 30, 2004. Income tax expense was generally recorded at
statutory federal and state tax rates.
(b) Results of Operations - Three Months Ended June 30, 2005 Compared to the
-------------------------------------------------------------------------
Three Months Ended June 30, 2004
--------------------------------
Earnings Summary
----------------
The Company had net earnings of $709,000 (or $0.17 basic earnings per
share) for the three months ended June 30, 2005, compared to net earnings of
$129,000 (or $0.03 basic earnings per share) for the three months ended June 30,
2004. The increase in net earnings was primarily due to an increase in sales and
gross profit on sales related to sales to customers in the technology sector,
partially offset by an increase in selling, general and administrative expenses
and Ermanco subsidiary divestiture costs as mentioned below.
Net Sales and Gross Profit on Sales
-----------------------------------
2005 2004
------------------ ------------------
Net sales............................................ $ 18,687,000 9,638,000
Cost of sales........................................ 14,378,000 7,304,000
---------- ---------
Gross profit on sales................................ $ 4,309,000 2,334,000
========== =========
Gross profit as a percentage of sales................ 23.1% 24.2%
==== ====
The net sales increase was primarily attributable to an increase in Ermanco
branded sales of $7,816,000, complemented by an increase of $1,233,000 in SI
Systems branded sales. The increase in Ermanco branded sales was primarily
attributable to progress made on contracts received during the second quarter of
2005 from customers in the technology sector. The increase in SI Systems branded
sales was associated with a larger backlog of SI Systems branded orders entering
the second quarter of 2005, when compared to the backlog of SI Systems branded
orders entering the second quarter of 2004. Contributing to the increase in SI
Systems branded sales was progress made on contracts received prior to the start
of the second quarter of 2005 in accordance with contract completion
requirements.
Gross profit, as a percentage of sales, for the three months ended June 30,
2005, when compared to the three months ended June 30, 2004, was unfavorably
impacted by approximately 9.0% due to product mix and competitive pricing
pressures, partially offset by approximately 7.9% due to a reduction in overhead
costs.
20
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
b) Results of Operations - Three Months Ended June 30, 2005 Compared to the
-------------------------------------------------------------------------
Three Months Ended June 30, 2004 (Continued)
--------------------------------
Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses of $2,766,000 were higher by
$692,000 for the three months ended June 30, 2005 than for the three months
ended June 30, 2004. The increase was attributable to the addition of resources
aimed at expanding the customer base and an increase in salaries and fringe
benefits totaling $258,000, an increase in expenses related to revenue and
profit performance totaling $315,000, and bad debt expense of $117,000 for
accounts receivable recognized as potentially uncollectible. Partially
offsetting the aforementioned unfavorable variance was a decrease in marketing
and public relations expenses primarily associated with trade shows, product
promotion, and marketing research totaling $113,000. Also contributing to lower
selling, general and administrative expenses in the prior year were collections
of $172,000 during the second quarter of 2004 on accounts receivables previously
recognized as potentially uncollectible.
Product Development Costs
-------------------------
Product development costs, including patent expense, of $41,000 were lower
by $92,000 for the three months ended June 30, 2005 than for the three months
ended June 30, 2004. Development programs in the three months ended June 30,
2005 were aimed at enhancements to the Company's sortation and accumulation
conveyor technologies. Development programs in the three months ended June 30,
2004 were aimed at enhancements to conveyor technologies, and improvements to
the Company's Order Fulfillment systems technologies.
Income Tax Expense
------------------
The Company recognized income tax expense of $389,000 during the three
months ended June 30, 2005 compared to income tax expense of $91,000 during the
three months ended June 30, 2004. Income tax expense was generally recorded at
statutory federal and state tax rates.
-----------------------------
Liquidity and Capital Resources
-------------------------------
The Company's cash and cash equivalents increased to $4,626,000 at June 30,
2005 from $3,602,000 at December 31, 2004. The increase resulted from cash
provided by operating activities totaling $1,184,000 and proceeds of $160,000
from the sale of common stock in connection with the Company's Equity
Compensation Plan, partially offset by purchases of capital equipment of
$320,000.
Cash provided by operating activities during the six months ended June 30,
2005 was $1,184,000 as compared to cash used by operating activities during the
six months ended June 30, 2004 of $565,000. Contributing to cash provided by
operating activities during the six months ended June 30, 2005 primarily were
net earnings of $903,000, an increase of $3,435,000 in customers' deposits and
billings in excess of costs and estimated earnings, and an increase of
$2,316,000 in accounts payable, partially offset by an increase of $5,625,000 in
accounts receivable. Contributing to cash used by operating activities during
the six months ended June 30, 2004 was 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, and the payment of $611,000 in
income taxes, partially offset by an increase of $1,054,000 in accounts payable.
21
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
Liquidity and Capital Resources (Continued)
-------------------------------
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. Effective
August 5, 2005, due to the issuance of a $2,000,000 letter of credit in
connection with the sale of Ermanco, the amount of available line of credit was
reduced to $2,800,000. The line of credit facility contains various
non-financial covenants and is secured by all accounts receivables and
inventory. As of June 30, 2005, the Company did not have any borrowings under
the line of credit facility, and the line of credit facility expires effective
June 30, 2006.
Subsequent to the reporting period, the Company received cash consideration
of approximately $23,055,000 in connection with the sale of the assets and
liabilities of Ermanco. The Company anticipates that its financial resources,
consisting of cash generated from operations, its line of credit, and the
subsequent sale of Ermanco 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,
the subsequent sale of Ermanco, and the dependence upon a limited number of
large contracts with a limited number of customers.
The Company is currently exploring various business strategies designed to
enhance the value of the Company's assets for its stockholders. The Company has
retained the investment banking firm, Boenning & Scattergood, Inc., to advise
the Company in evaluating its strategic options. The Company is continuing to
evaluate and actively explore a range of possible options, including
transactions intended to provide liquidity and maximize stockholder value, and
consider the acquisition of complementary assets and/or businesses. The Company
may not be able to effect any of these strategic options on favorable terms or
at all.
-----------------------------
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, as amended,
requires fixed monthly rentals of $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.
SI Systems' principal office is located in a 173,000 square foot, concrete,
brick, and steel facility in Easton, Pennsylvania. 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 $18,234
(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 June 30, 2005
as noted above are as follows:
Payments Due by Period
-------------------------------------------------------------------------------
Total 2005 2006 2007 2008 2009
----- ---- ---- ---- ---- ----
Contractual
obligations:
Operating
leases........ $ 1,804,000 289,000 591,000 606,000 318,000 -
--------- ------- ------- ------- ------- -------
Total......... $ 1,804,000 289,000 591,000 606,000 318,000 -
========= ======= ======= ======= ======= =======
22
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
Contractual Obligations (Continued)
Amount of Commitment
Expiration Per Period
Total Amount ------------------------------------------------------------
Committed 2005 2006 2007 2008 2009
------------ ---- ---- ---- ---- ----
Other
commercial
commitments:
Letters of
credit........ $ 200,000 - 200,000 - - -
Effective August 5, 2005, due to the issuance of a $2,000,000 letter of
credit in connection with the sale of Ermanco, the amount of available line of
credit was reduced to $2,800,000.
In addition to the obligations noted above, the Company also has an
employment agreement with Leon C. Kirschner, Chief Operating Officer of the
Company and President of Ermanco Incorporated. Terms of the employment agreement
include a base salary of $272,328 per year. Mr. Kirschner has the right to
terminate the employment agreement voluntarily by giving the Company written
notice of such termination no less than 180 days prior to the effective date of
the termination. Under certain circumstances, the employment agreement provides
for post termination severance payments.
Off-Balance Sheet Arrangements
------------------------------
As of June 30, 2005, 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.
Recently Issued Accounting Pronouncements
-----------------------------------------
In November 2004, the Financial Accounting Standards Board issued SFAS No.
151, "Inventory Costs an Amendment of ARB No. 43, Chapter 4" ("FAS 151"). FAS
151 provides for certain fixed production overhead cost to be reflected as a
period cost and not capitalized as inventory. FAS 151 is effective for the
beginning of 2006. The adoption of FAS 151 is not expected to have a material
impact on the Company's financial statements.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised) "Share-Based Payment" ("FAS 123R"). FAS 123R addresses all forms
of share-based payment awards, including shares issued under employee stock
purchase plans, stock options, restricted stock, and stock appreciation rights.
It will require companies to recognize in the statement of operations the
grant-date fair value of stock options and other equity-based compensation
issued to employees, but expresses no preference for a type of valuation model.
The statement eliminates the intrinsic value-based method prescribed by APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations, that the Company currently uses. The Company is required to
adopt FAS 123R beginning in 2006. The adoption of FAS 123R is not expected to
have a material impact on the Company's financial statements.
In May 2005, the Financial Accounting Standard Board issued SFAS No. 154,
"Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20
and FASB Statement No. 3" ("FAS 154"). FAS 154 requires retrospective
application to prior periods' financial statements for changes in accounting
principle, unless it is
23
Item 2. Management's Discussion and Analysis of Financial Condition
------- -----------------------------------------------------------
and Results of Operations (Continued)
-------------------------
Recently Issued Accounting Pronouncements (Continued)
-----------------------------------------
impracticable to determine either the period-specific effects or the cumulative
effect of the change. This statement also requires that retrospective
application of a change in accounting principle be limited to the direct effects
of the change. Indirect effects of a change in accounting principle, such as a
change in non-discretionary profit-sharing payments resulting from an accounting
change, should be recognized in the period of the accounting change. FAS 154
also requires that a change in depreciation, amortization, or depletion method
for long-lived non-financial assets be accounted for as a change in accounting
estimate affected by a change in accounting principle. This statement is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Early adoption is permitted for accounting
changes and corrections of errors made in fiscal years beginning after the date
this statement was issued. The Company is required to adopt the provisions of
this statement, as applicable, beginning in 2006.
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.
-----------------------------
24
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 June 30, 2005. 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 accumulated and
communicated to the Company's management, including the Company's CEO and
CFO, to allow timely decisions regarding required disclosure, and 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.
25
PART II -- OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings
------- -----------------
The Company is involved in various 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 June 30, 2005:
-------------------------------------------------------------------------------------------------------
Total Number Approximate
Average of Shares Approximate 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
-------------------------------------------------------------------------------------------------------
4/1/05 - 4/30/05 - $ - - $ - $ 674,368
5/1/05 - 5/31/05 - $ - - $ - $ 674,368
6/1/05 - 6/30/05 - $ - - $ - $ 674,368
-------------------------------------------------------------------------------------------------------
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 June 30,
2005, the Company had repurchased 34,700 shares of common stock at a weighted
average cost, including brokerage commissions, of $9.38 per share. Cash
expenditures for the stock repurchases were $325,632. As of June 30, 2005,
$674,368 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. There
were no repurchases in the three and six months ended June 30, 2005.
In August 2005, the Company's Board of Directors amended its existing stock
repurchase program by increasing the amount it has authorized management to
repurchase from up to $1,000,000 of the Company's common stock to up to
$5,000,000, of which approximately $4,675,000 remains available for repurchases
under 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.
Item 5. Other Information
------- -----------------
Not applicable.
26
Item 6. Exhibits and Reports on Form 8-K
------- --------------------------------
10.31 Loan Agreement (Line of Credit) entered into
June 20, 2005 by and between Paragon
Technologies, Inc., Ermanco Incorporated,
and Wachovia Bank, National Association
(filed herewith).
10.32 Promissory Note related to the Line of Credit
entered into June 20, 2005 by and
between Paragon Technologies, Inc., Ermanco
Incorporated, and Wachovia Bank,
National Association (filed herewith).
10.33 Asset Purchase Agreement by and among TGW
Transportgerate GmbH, Malibu Acquisition,
Inc., Ermanco Incorporated, and Paragon
Technologies, Inc. dated May 20, 2005
(incorporated by reference to Exhibit 10.1 to
Form 8-K, filed on May 23, 2005).
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).
27
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: August 12, 2005
-----------------------
28
EXHIBIT INDEX
-------------
Exhibits
--------
10.31 Loan Agreement (Line of Credit) entered into June 20, 2005
by and between Paragon Technologies, Inc., Ermanco
Incorporated, and Wachovia Bank, National Association
(filed herewith).
10.32 Promissory Note related to the Line of Credit entered into
June 20, 2005 by and between Paragon Technologies, Inc.,
Ermanco Incorporated, and Wachovia Bank, National
Association (filed herewith).
10.33 Asset Purchase Agreementby and among TGW Transportgerate
GmbH, Malibu Acquisition, Inc., Ermanco Incorporated,
and Paragon Technologies, Inc. dated May 20, 2005
(incorporated by reference to Exhibit 10.1 to Form 8-K,
filed on May 23, 2005).
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).
29