10QSB 1 form10qsb.txt FORM 10QSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-QSB [x] QUARTERLY REPORT UNDER SECTION 13 0R 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended May 31, 2001 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANCE ACT OF 1934 For the transition period from _____________ to ________________ Commission File Number 0-22969 Paladyne Corp. (Name of Small Business Issuer in its charter) Delaware 59-3562953 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1650A Gum Branch Road, Jacksonville, NC 28540 (Address of Principal Executive Offices) 910-478-0097 (Issuer's Telephone Number) N/A (Former name, former address and former fiscal year, if changed since last report) Checked whether the issuer (1) filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 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 --- --- APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. Class Outstanding as of June 10, 2001 Common Stock, $.001 PAR VALUE 8,459,351 Transitional Small Business Disclosure Format (check one): Yes No X --- --- 1 TABLE OF CONTENTS Page ---- PART I. CONSOLIDATED FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements 3 Condensed Consolidated Balance Sheets - May 31, 2001 and August 31, 2000 4 Condensed Consolidated Statements of Operations - three months ended May 31, 2001 and May 31, 2000 5 Condensed Consolidated Statements of Operations - nine months ended May 31, 2001 and May 31, 2000 6 Condensed Consolidated Statements of Cash Flows - nine months ended May 31, 2001 and May 31, 2000 7 Notes to Condensed Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II. OTHER INFORMATION Item 1. Legal Proceedings 15 Item 6. Exhibits and Reports on Form 8-K 15 SIGNATURES 16 2 PART I. ITEM 1. FINANCIAL STATEMENTS The following unaudited Condensed Consolidated Financial Statements for the three months and nine months ended May 31, 2001 and May 31, 2000 have been prepared by Paladyne Corp., a Delaware corporation. 3 PALADYNE CORP. CONDENSED CONSOLIDATED BALANCE SHEETS MAY 31, 2001 AUGUST 31, 2000 (UNAUDITED) --------------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 296,908 $ 635,612 Short term investments - 484,508 Accounts receivable, net of allowances of $607,999 and $12,555 1,376,576 1,037,544 Prepaid expenses and other current assets 86,200 867 ----------- ----------- Total Current Assets 1,759,684 2,158,531 Property and equipment, net 2,954,287 124,725 Goodwill, net 9,358,077 211,012 Capitalized software development costs, net 377,374 338,037 Other assets 31,674 51,461 ----------- ----------- Total Assets $14,481,096 $ 2,883,766 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable $ 1,850,000 Accounts payable 1,584,905 $ 680,214 Accrued expenses 980,463 131,375 Accrued preferred stock dividends 139,400 108,800 Current portion of capital lease obligations 652,531 Current portion of long-term debt 898,467 ----------- ----------- Total Current Liabilities 6,105,766 920,389 Capital lease obligations 852,175 Long-term debt 2,651,533 ----------- ----------- Total Liabilities 9,609,474 920,389 ----------- ----------- Stockholders' Equity Cumulative, convertible preferred stock; $.001 par value; 5,000,000 shares authorized, 137,143 issued and outstanding 137 137 Convertible preferred stock- Series B, $.001 par value, 5,000,000 shares authorized, 4,100,000 and -0- issued and outstanding 4,100 Common stock; $.001 par value; 25,000,000 shares authorized, 8,459,351 and 8,456,599 issued and outstanding 8,460 8,457 Additional paid-in capital 12,869,647 7,136,430 Accumulated deficit (8,010,722) (5,181,647) ----------- ----------- Total Stockholders' Equity 4,871,622 1,963,377 ----------- ----------- Total Liabilities and Stockholders' Equity $14,481,096 $ 2,883,766 =========== =========== See accompanying notes to condensed consolidated financial statements 4 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MAY 31, MAY 31, 2001 2000 (UNAUDITED) (UNAUDITED) ----------- ----------- Total Revenues $ 3,089,932 $ 1,581,445 Cost of Revenues 1,832,994 984,022 ----------- ----------- Gross Profit 1,256,938 597,423 Selling, general and administrative expenses 2,114,075 553,049 Depreciation and amortization 453,965 36,728 ----------- ----------- Income (loss) from operations (1,311,102) 7,646 Other income (expense): Interest income 7,536 - Interest expense (169,091) (4,950) ----------- ----------- Net income (loss) (1,472,657) 2,696 Cumulative Convertible Preferred Stock Dividend Requirement (10,200) (10,200) ----------- ----------- Net income (loss) attributable to common stockholders ($1,482,857) $ (7,504) =========== =========== Weighted average common shares outstanding: Basic 8,459,351 8,404,334 Diluted 8,459,351 8,404,334 Earnings (loss) per share: Basic $ (.18) $ - Diluted $ (.18) $ - See accompanying notes to condensed consolidated financial statements 5 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED MAY 31, MAY 31, 2001 2000 (UNAUDITED) (UNAUDITED) ----------- ----------- Total Revenues $ 5,366,350 $ 3,828,405 Cost of Revenues 3,120,428 2,202,820 ----------- ----------- Gross Profit 2,245,922 1,625,585 Selling, general and administrative expenses 4,190,755 1,438,331 Depreciation and amortization 686,510 75,553 ----------- ----------- Income (loss) from operations (2,631,343) 111,701 Other income (expense): Interest income 28,584 -- Interest expense (226,316) (24,418) ----------- ----------- Net income (loss) (2,829,075) 87,283 Cumulative Convertible Preferred Stock Dividend Requirement (30,600) (30,600) ----------- ----------- Net income (loss) attributable to common stockholders $(2,859,675) $ 56,683 =========== =========== Weighted average common shares outstanding: Basic 8,459,351 7,499,172 Diluted 8,459,351 9,446,679 Earnings (loss) per share: Basic $ (.34) $ .01 Diluted $ (.34) $ .01 See accompanying notes to condensed consolidated financial statements 6 PALADYNE CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED MAY 31, MAY 31, 2001 2000 (UNAUDITED) (UNAUDITED) ----------- ----------- Cash flows used in operating activities $ (426,585) $ (138,606) Cash flows used in investing activities (97,146) (572,626) Cash flows provided by financing activities 185,027 1,375,218 ---------- ---------- Net increase (decrease) in cash and cash equivalents (338,704) 663,986 Cash and cash equivalents at beginning of period 635,612 - ---------- ---------- Cash and cash equivalents at end of period $ 296,908 $ 663,986 ========== ========== Supplemental Cash Flow Information: Cash paid for interest $ - $ 24,418 Non cash investing and financing activities: Issuance of common shares as payment of debt 99,400 Accrual of preferred stock dividend 40,800 108,800 Assets acquired in merger 4,234,636 - Debt assumed in merger 5,000,000 - Liabilities assumed in merger 2,375,579 - Issuance of preferred stock in merger 5,765,420 - See accompanying notes to condensed consolidated financial statements 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS UNAUDITED NOTE 1. BASIS OF PRESENTATION The consolidated financial information included herein includes the information for Paladyne Corp. and its wholly owned subsidiary. All significant inter-company transactions and balances have been eliminated. The consolidated financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that, in the opinion of management, are necessary for a fair statement of results for this interim period. The accompanying financial statements include estimated amounts and disclosures based on management's assumptions about future events. Actual results may differ from those estimates. The results of operations and cash flows for the interim periods are not necessarily indicative of the results to be expected for the full year. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements included in the Company's Form 10-KSB for the fiscal year ended August 31, 2000 as filed with the Securities and Exchange Commission. The Company's consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As with any new venture, concerns must be considered in light of the normal problems, expenses and complications encountered by entrance into established markets and the competitive environment in which the Company operates. The consolidated financial statements do not include, nor does management feel it necessary, any adjustments to reflect any possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern NOTE 2. MERGER On February 1, 2001, Paladyne Corp. ("Paladyne") through a wholly-owned subsidiary E-com Acquisition Corp. ("Acquisition Sub"), merged (the "Merger") with e-commerce support centers, inc., a North Carolina corporation ("e-com"), pursuant to an Agreement and Plan of Merger, dated as of December 21, 2000, as amended (collectively, the "Merger Agreement"). Upon the Merger, e-com became a wholly-owned subsidiary of Paladyne. e-com is a provider of electronic Customer Relationship Management (CRM) solutions as an outsourcing option to e-commerce companies from its call center in Jacksonville, NC. The merger consideration (the "Merger Consideration") to the e-com shareholders consisted of shares of newly-created Series B Convertible Preferred Stock, $.001 par value (the "Series B Preferred Stock"), Anti-Dilution Warrants and Performance Warrants (as discussed below) and the right to receive additional shares of Paladyne Common Stock in conjunction with future placements by Paladyne. Terrence J. Leifheit, the principal shareholder of e-com, and another e-com shareholder, delivered into escrow securities representing approximately 25% of the aggregate Merger Consideration as security for indemnification claims Paladyne may have under the Merger Agreement. Upon the Merger, Paladyne issued 4,100,000 shares of Series B Preferred Stock. Each share of Series B Preferred Stock votes on a two-for-one basis with the Common Stock on all matters, but with a separate vote on matters directly affecting such Series, mandatorily converts into two shares of Paladyne Common Stock immediately following stockholder approval of an increase in the number of authorized shares of Common Stock, will receive any dividends declared on an as-converted basis with the Common Stock and will have a liquidation preference of $5.00 per share. The stockholder approval was obtained during a July 10, 2001 stockholders meeting, accordingly, the shares are deemed converted as of that date. 8 To protect against dilution to the former e-com shareholders upon exercise of outstanding pre-Merger Paladyne options and warrants (the "Present Options/Warrants"), Paladyne granted to them Anti-Dilution Warrants to purchase 4,000,000 shares of Paladyne Common Stock at an exercise price of $1.146 per share (subject to adjustment), vesting as to 0.6 of a share of Common Stock for each share of Common Stock issued upon the exercise of Present Options/Warrants, and expiring 30 days after the later of (i) termination or exercise of all Present Options/Warrants or (ii) notice from Paladyne as to the aggregate number of Present Options/Warrants that were exercised. To give the former e-com shareholders the opportunity to participate more directly in the future performance of Paladyne resulting from the acquired e-com business, Paladyne granted to them Performance Warrants to purchase 500,000 shares of Paladyne Common Stock at an exercise price of $1.146 per share (subject to adjustment), exercisable for five years and vesting in 100,000 share tranches for each $20 million of net revenue increases, above $50 million annually, achieved in either year or both of the two (2) year periods ending January 31, 2002 and 2003. For the purpose of these awards, the measurement will be on a trailing 12-month basis, and with an acceptable gross margin (20% or greater) for each tranche to qualify. In addition, ending upon the earlier to occur of December 20, 2002 or Paladyne's completion of $6,500,000 in cash from sales of Common Stock or Common Stock equivalents (the "New Securities"), e-com shareholders will receive, one share (the "Deferred Shares") of Common Stock for each $1.00 in gross proceeds received upon the sale of New Securities or issuable upon conversion, exercise or exchange of New Securities. The Merger Agreement provided that Paladyne would grant options, at market value, to e-com employees for the purchase of an aggregate of 500,000 shares of Paladyne Common Stock under its 1999 Stock Option Plan. The Compensation Committee of the Board of Directors was authorized to grant such options upon receipt from former e-com management of a proposal of the-ecom employees to whom the options should be granted. Immediately prior to the Merger, e-com purchased from Gibralter Publishing, Inc., a North Carolina corporation, all of the tangible and intangible assets used in e-com's call center operations, subject to related liabilities, pursuant to an Option Agreement. Prior to the Merger, Gibralter had been operating the call center on behalf of ecom. The purchase price for these assets was $5 million which is payable by e-com pursuant to two amended promissory notes issued to Gibralter and guaranteed by Paladyne, one note for $1,500,000, repayable in two installments of $750,000, the first being due after completion of a $3,000,000 equity or convertible debt offering and the remaining payment due no sooner than six months after the first payment and after three consecutive months of positive cash flow from operations. The second note for $3,500,000, is repayable in equal quarterly principal and interest payments of $377,000 beginning in October 2001 and continuing through July 2004. Both notes bear interest at 10% per annum and are secured by the purchased assets. A portion of these assets used by e-com in its call center operations consists of equipment that is leased by Gibraltar pursuant to various equipment leases. Pending the receipt by Gibralter of lessor consents to the assignments of these leases to e-com, and in accordance with an Equipment Use Agreement entered into by Gibralter and e-com, Gibralter has granted to e-com the right to possess and use the equipment and e-com has agreed to assume and pay to the lessors the payments to be made by Gibralter pursuant to the leases. The acquisition was accounted for using the purchase method of accounting effective February 1, 2001, and accordingly, the assets and liabilities as of this date are included in the accompanying consolidated financial statements as of May 31, 2001. As of July 20, 2001 the Company has performed a purchase price allocation based upon information available as of this date. The purchase price has been allocated to the net assets acquired and net liabilities assumed based upon their estimated fair values. Included in this preliminary allocation were acquired assets of approximately $4,235,000, assumed debt of $5,000,000 and other liabilities of approximately $2,376,000. The 4,100,000 shares of Series B Preferred Stock issued in the merger was valued based upon the underlying 8,200,000 shares of common stock at a price of $.7031 (average fair value a few days before and after the date of the merger agreement) for a total consideration of $5,765,000. Total consideration of $5,765,000 and acquisition costs of approximately $467,000 results in an excess of purchase price over the fair value of the net assets acquired of $9,373,000 that has been assigned to goodwill that will be amortized on a straight-line basis over 15 years. The results of the acquired business have been included in the consolidated financial statements since the date of acquisition. 9 The following unaudited pro forma information presents the condensed consolidated statement of operations of the Company as if the acquisition had taken place on September 1, 1999. e-com had a December 31 year end and therefore, e-com's results for the three and six months ended December 31, 2000 have been consolidated with Paladyne's results for the three and nine months ended May 31, 2001. e-com's results for the three and nine months ended June 30, 2000 have been consolidated with Paladyne's results for the three and nine months ended May 31, 2000. For the three months ended For the nine months ended May 31, May 31, May 31, May 31, 2001 2000 2001 2000 ---- ---- ---- ---- Actual Pro Forma Pro Forma Pro Forma Revenues $ 3,089,932 $ 2,775,778 $ 7,823,551 $ 5,861,140 Net loss attributable to common stockholders $(1,482,857) $ (978,640) $(4,282,671) $ (3,197,361) Weighted average common shares outstanding: Basic and diluted 8,459,351 8,404,334 8,458,956 7,499,172 Earnings (loss) per share: Basic and diluted $ (.18) $ (.12) $ (.50) $ (.43) These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as additional amortization expense as a result of the goodwill and increased interest expense on acquisition related debt. They do not purport to be indicative of the results of operations that actually would have resulted on the date indicated, or which may result in the future. NOTE 3. CAPITAL STOCK The holders of the Company's cumulative convertible preferred stock are entitled to receive, out of the net profits of the Company, annual dividends at the rate of $.2975 per share. If the net profits of the Company are not sufficient to pay the preferred dividend, then any unpaid portion of the dividend will be included in accrued expenses. The Company had accrued cumulative preferred stock dividends of $139,400 as of May 31, 2001. NOTE 4. CAPITALIZED SOFTWARE DEVELOPMENT COSTS Costs incurred to establish the technological feasibility of computer software products are charged to expense as incurred. Costs of producing product masters subsequent to establishing technological feasibility, including coding and testing, are capitalized. Capitalization of computer software costs ceases when the product is available for general release to customers. Capitalized costs as of May 31, 2001 for the development of the Datagration product, release 1.0 and release 2.0, was $486,729. Datagration 1.0 was released in March 2000 and Datagration 2.0 was released in November 2000. Accumulated amortization of software development costs as of May 31, 2001 was $109,354. These capitalized software development costs are amortized using either the straight-line method over the estimated economic life of the product (which is estimated to be three years) or the ratio of current revenues to current and anticipated revenues for the product whichever results in the greater amount of amortization. Unamortized capitalized costs of a computer software product in excess of its estimated net realizable value are expensed. NOTE 5. INCOME TAXES The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. The Company recorded a valuation allowance to state deferred tax assets at estimated realizable value. The Company does not consider the realization of such amounts to be more likely than not, due to uncertainty related to realization of those assets through future taxable income. 10 NOTE 6. DEBT AND CAPITAL LEASE OBLIGATIONS: In conjunction with the e-com acquisition on February 1, 2001, the Company assumed debt related to the purchase of fixed assets and capital lease obligations totaling approximately $6,743,000. Notes payable to Gibralter Publishing, Inc., a related party, represents $5,000,000 of this total. The remaining balance relates to capitalized leases for equipment and software. Total debt and capital lease obligations obligations as of May 31, 2001 are summarized as follows: Notes payable to Gibralter Publishing, Inc., 10% interest, $5,000,000 Line of credit with a bank, interest at prime plus 1% 350,000 Convertible subordinated debentures, 8% interest due March 2002 50,000 Capital leases, principal and interest payable in installments through 2004, interest rates range from 8% to 13% collateralized by specific computer and telephone equipment and software 1,504,706 ---------- Total 6,904,706 Less - current portion (3,400,998) ---------- Total long term portion $3,503,708 NOTE 7. CONTINGENCY The Company has been named in a lawsuit filed by a former employee claiming additional compensation is due. The Company's position is that the lawsuit has no merit and intends to vigorously defend its position. No amounts have been accrued relating to this lawsuit as of May 31, 2001. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview -------- Since the February merger with e-commerce support centers, inc. ("ecom"), Paladyne Corp. (the "Company") has provded CRM-based customer and tech support, and outbound telemarketing for business-to-business to customer needs, see Note 2 to the notes to the financial statements. In addition, the Company's proprietary Datagrationa product integrates customer data from diverse sources, including legacy systems, to form the single customer view critical for data mining and the practice of CRM. Marketing efforts for Datagration have been significantly curtailed during the three months ended May 31, 2001. The Company's consolidated financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As with any new venture, concerns must be considered in light of the normal problems, expenses and complications encountered by entrance into established markets and the competitive environment in which the Company operates. The consolidated financial statements do not include, nor does management feel it necessary, any adjustments to reflect any possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern During the three months ended May 31, 2001, the Company has continued to reduce or eliminate non-critical expenses and operations. The Virginia and Florida offices of the Company were closed and non-essential personnel were terminated and certain other personnel continue to defer all or a portion of their compensation. RESULTS OF OPERATIONS --------------------- The following table sets forth the percentage relationship to the total revenues of principal items contained in the Company's Condensed Consolidated Statements of Operations for the three and nine months ended May 31, 2001 and May 31, 2000, respectively. The percentages discussed throughout this analysis are stated on an approximate basis. Three months Ended Nine months Ended May 31, May 31, May 31, May 31, 2001 2000 2001 2000 ------------------ ----------------- (UNAUDITED) (UNAUDITED) Total revenues 100% 100% 100% 100% Cost of revenues 59% 62% 58% 58% ---- ---- ---- ---- Gross profit 41% 38% 42% 42% Operating expenses 83% 38% 91% 40% ---- ---- ---- ---- Operating income (loss) (42%) 0% (49%) 2% Interest expense 6% 0% 4% 1% Interest income - - - - ---- ---- ---- ---- Net income (loss) (48%) 0% (52%) 1% ---- ---- ---- ---- ---- ---- ---- ---- 12 COMPARISON OF THE NINE MONTHS ENDED MAY 31, 2001 TO NINE MONTHS ENDED --------------------------------------------------------------------- MAY 31, 2000 ------------ Revenues for the nine months ended May 31, 2001 increased $1,537,945 (40%) to $5,366,350 from the corresponding nine-month period in the prior year. This increase is due to the acquisition that was effective February 1, 2001 that resulted in $3,822,581 of revenue during the four-months since the acquisition date. The Company's traditional revenue sources declined $2,277,412 during the nine months. This decrease is due to the termination of the US West MDU project which concluded in June 2000 and the significant reduction of the Qwest database project in December 2000. The US West project was providing approximately $110,000 of monthly revenue while the Qwest database project was generating about $250,000 of monthly revenue. Gross profit increased by $620,337 (38%) for the nine-month period ended May 31, 2001 from $1,625,585 for the corresponding nine-month period in the prior year to $2,245,922. As a percentage of sales, gross profit remained essentially unchanged at 42% during the nine-month period ended May 31, 2001 and 2000. Operating expenses, including depreciation and amortization, have increased as percentage of revenue from 40% for the nine months ended May 31, 2000 to 91% for the nine months ended May 31, 2001. This increase is due in part to a sharp decline in the Company's traditional revenue stream that did not affect normal operating costs. The inclusion of the operations of e-com, which was acquired on February 1, 2001, also accounted for a large portion of this increase. Depreciation and amortization increased from $75,553 to $686,510 for the nine months ended May 31, 2000 compared to May 31, 2001. This is due primarily to the amortization of goodwill related to the acquisition of e-com and the depreciation of the acquired assets. The allowance for bad debts was increased $500,000 in the nine months ended May 31, 2001, this results in a charge to bad debt expense during the same period compared to no expense in the nine months ended May 31, 2000. This bad debt increase is attributable to overall economic conditions, the demise of many technology companies who were customers and disputes with the Company's traditional customer relating to services. Interest expense, as percentage of revenue, increased to 4% from less than 1% during the nine months ended May 31, 2001 as compared to the nine months ended May 31, 2000. This increase from $24,418 to $226,316 is attributable to the debt assumed relating to the acquisition of e-com on February 1, 2001. COMPARISON OF THE THREE MONTHS ENDED MAY 31, 2001 TO THREE MONTHS ENDED ----------------------------------------------------------------------- MAY 31, 2000 ------------ Revenues for the three months ended May 31, 2001 increased $1,508,487 (95%) to $3,089,932 from the corresponding three-month period in the prior year. This increase is due entirely to the acquisition that was effective February 1, 2001 that resulted in $2,925,499 of revenue during the three months ended May 31, 2001. The Company's traditional revenue sources declined $1,402,326 during the three months ended May 31, 2001. This decrease is due to the termination of the US West MDU project which concluded in June 2000 and the significant reduction of the Qwest database project in December 2000. The US West project was providing approximately $110,000 of monthly revenue while the Qwest database project was generating about $250,000 of monthly revenue. Gross profit increased by $659,515 (110%) for the three-month period ended May 31, 2001 from $597,423 for the corresponding three-month period in the prior year to $1,256,938. As a percentage of sales, gross profit increased 3% to 41% during the three-month period ended May 31, 2001 from 38% for the same period in the prior year. Operating expenses, including depreciation and amortization, have increased as percentage of revenue from 38% for the three months ended May 31, 2000 to 83% for the three months ended May 31, 2001. This increase of $1,978,263 from the three month period ended May 31, 2001 from May 31, 2000 is due to several factors. A sharp decline in the Company's traditional revenue stream that did not affect normal operating costs together with the inclusion of the operations for e-com that was acquired on February 1, 2001 accounted for a large portion of this increase. Depreciation and amortization increased from $36,728 to $453,965 for the three months ended May 31, 2000 compared to May 31, 2001. This is due 13 primarily to the amortization of goodwill related to the acquisition of e-com and the depreciation of the acquired assets. The allowance for bad debts was increased $500,000 in the three months ended May 31, 2001, this results in a charge to bad debt expense during the same period compared to no expense in the three months ended May 31, 2000. This bad debt increase is attributable to overall economic conditions, the demise of many technology companies who were customers and disputes with the Company's traditional customer relating to services. Interest expense, as percentage of revenue, increased to 6% from less than 1% during the three months ended May 31, 2001 as compared to the three months ended May 31, 2000. This increase from $4,950 to $169,091 is attributable to the debt assumed relating to the acquisition of e-com on February 1, 2001. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company's principal cash requirements are for operating expenses, including employee costs, funding of accounts receivable, capital expenditures and funding of the operations. The Company's primary sources of cash have been from private placements of the Company's common stock, a bank line of credit, and cash derived from operations. The Company has continued to aggressively seek additional financing or additional equity infusion to fund the acquisition and growth of e-com. A private placement of between $3,000,000 - $6,000,000 would be optimum to implement the most aggressive growth plans of the Company and it is likely that this will be dilutive to stockholders. The Company is engaged in cost cutting moves including closing the Florida and Virginia offices and certain employee reductions. If a private placement of smaller amount is necessary, then certain growth plans of the Company would have to be modified and reduced. The Company has been unsuccessful in raising any significant capital since the ecom purchase on February 1, 2001. Conventional bank financing has not been expanded but efforts there and with the private placement are continuing. The Company must obtain additional capital, primarily to enable payment of the merger related costs from the February 2001 merger with ecom. These merger costs, additional borrowing related to the merger, and the loss of the traditional revenue source have strained liquidity significantly. In order to maintain its operations at the current levels, the Company must obtain additional capital. Cash used in operating activities increased from $138,606 to $426,585 for the nine months ended May 31, 2000 to the corresponding nine months in 2001. This cash decrease is primarily the result of increased operating losses, caused by the loss of the Company's traditional revenue source and increased operating costs since the ecom acquisition in February 2001, for the nine months ended May 31, 2001 compared to the comparable period from the prior year. INFLATION --------- In the opinion of management, inflation has not had a material effect on the operations of the Company. RISK FACTORS AND CAUTIONARY STATEMENTS -------------------------------------- Forward-looking statements in this report are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The Company wishes to advise readers that actual results may differ substantially from such forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those expressed in or implied by the statements, including, but not limited to, the following: the ability of the Company to provide for its debt obligations and to provide for working capital needs from operating revenue, and other risks detailed in the Company's periodic report filings with the Securities and Exchange Commission. 14 PART II ITEM 1. LEGAL PROCEEDINGS In November 1999, the Company terminated the employment with its Vice President of Sales. Subsequent to this termination, the former employee filed a lawsuit claiming additional compensation was warranted in the Superior Court of Fulton County, in the State of Georgia and is seeking payment of $178,750. The Court issued a summary judgment order on default in June 2000 to the plaintiff in the amount of $137,500. The Company appealed the decision and in July 2000 submitted to the Court a Motion to Open Default. A hearing was held on August 4, 2000 and the Court ordered the summary judgment to be reopened and the Company may present its defense in this matter. A mediation conference on April 27, 2001 did not result in a settlement. The Company is defending itself vigorously against this claim. As such, no provision has been accrued in these financial statements as the Company believes there is no merit to the claim. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 3.1 Certificate of Amendment of the Certificate of Incorporation of Paladyne Corp., as filed with the Delaware Secretary of State on July 17, 2001. (b) Reports on Form 8-K - none. 15 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PALADYNE CORP. Date: July 23, 2001 By /s/ Terrence Leifheit ---------------------- Terrence Leifheit President Date: July 23, 2001 By /s/ Clifford Clark ------------------- Clifford Clark Chief Financial Officer 16