10-Q 1 f10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarterly Period Ended September 30, 2002 Commission File No. 1-15729 PARAGON TECHNOLOGIES, INC. -------------------------------------------------------------------------------- (Exact Name Of Registrant As Specified In Its Charter) Delaware 22-1643428 --------------------------------------------------- --------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 600 Kuebler Road, Easton, PA 18040 --------------------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: 610-252-3205 --------------------- Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares of common stock, par value $1.00 per share, outstanding as of October 28, 2002: 4,244,916. PART I - FINANCIAL INFORMATION ------------------------------ Item 1. Financial Statements ------- -------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Balance Sheets September 30, 2002 and December 31, 2001 (In Thousands, Except Share Data)
(UNAUDITED) September 30, December 31, 2002 2001 ------------------- ------------------ Assets ------ Current assets: Cash and cash equivalents $ 6,748 6,114 Receivables: Trade (net of allowance for doubtful accounts of $283 as of September 30, 2002 and $54 as of December 31, 2001) 5,015 7,093 Notes and other receivables 1,359 630 ------ ------ Total receivables 6,374 7,723 ------ ------ Costs and estimated earnings in excess of billings 220 244 Inventories: Raw materials 981 1,731 Work-in-process 142 254 Finished goods 276 408 ------ ------ Total inventories 1,399 2,393 ------ ------ Deferred income tax benefits 1,780 2,077 Prepaid expenses and other current assets 740 649 ------ ------ Total current assets 17,261 19,200 ------ ------ Property, plant and equipment, at cost: Land 27 27 Buildings and improvements 3,727 3,727 Machinery and equipment 4,287 5,059 ------ ------ 8,041 8,813 Less: accumulated depreciation (5,705) (6,112) ------ ------ Net property, plant and equipment 2,336 2,701 ------ ------ Investment in joint venture 1,720 1,667 Excess of cost over fair value of net assets acquired, less amortization of $1,053 as of September 30, 2002 and December 31, 2001 17,657 17,657 Other assets, at cost less accumulated amortization of $126 as of September 30, 2002 and $94 as of December 31, 2001 86 118 ------ ------ Total assets $ 39,060 41,343 ====== ======
See accompanying notes to consolidated financial statements. 2 Item 1. Financial Statements (Continued) ------- -------------------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Balance Sheets September 30, 2002 and December 31, 2001 (In Thousands, Except Share Data)
(UNAUDITED) September 30, December 31, 2002 2001 ------------------- ------------------ Liabilities and Stokholders' Equity ----------------------------------- Current liabilities: Current installments of long-term debt $ 2,300 2,305 Accounts payable 2,969 3,319 Customers' deposits and billings in excess of costs and estimated earnings for completed and uncompleted contracts 2,331 3,345 Accrued salaries, wages, and commissions 544 676 Income taxes payable 2 46 Accrued royalties payable 108 92 Accrued product warranties 1,092 863 Accrued pension and retirement savings plan liabilities 1,160 1,122 Accrued restructuring expenses 222 494 Accrued other liabilities 1,371 1,126 ------ ------ Total current liabilities 12,099 13,388 ------ ------ Long-term liabilities: Long-term debt, excluding current installments: Term loan 5,175 6,900 Subordinated notes payable 3,000 3,000 ------ ------ Total long-term debt 8,175 9,900 Other long-term liability 431 412 Deferred income taxes payable 1,213 628 Deferred compensation 19 134 ------ ------ Total long-term liabilities 9,838 11,074 ------- ------ Stockholders' equity: Common stock, $1 par value; authorized 20,000,000 shares; issued and outstanding 4,244,916 shares as of September 30, 2002 and 4,221,635 shares as of December 31, 2001 4,245 4,222 Additional paid-in capital 7,231 7,071 Retained earnings 5,905 5,841 Accumulated other comprehensive loss (258) (253) ------ ------ Total stockholders' equity 17,123 16,881 ------ ------ Total liabilities and stockholders' equity $ 39,060 41,343 ====== ======
See accompanying notes to consolidated financial statements. 3 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Statements of Operations (Unaudited) For the Three and Nine Months Ended September 30, 2002 and September 30, 2001 (In Thousands, Except Share And Per Share Data)
Three Months Ended Nine Months Ended ------------------------------------ ----------------------------------- September 30, September 30, September 30, September 30, 2002 2001 2002 2001 ----------------- ----------------- ----------------- ----------------- Net sales $ 9,010 12,796 29,670 38,947 Cost of sales 7,119 9,499 22,404 28,994 --------- --------- --------- --------- Gross profit on sales 1,891 3,297 7,266 9,953 --------- --------- --------- --------- Selling, general and administrative expenses 2,251 2,213 6,774 7,899 Product development costs 94 86 253 402 Amortization of goodwill - 117 - 351 Restructuring expenses - - - 1,538 Interest expense 265 310 803 1,001 Interest income (35) (35) (88) (215) Equity in income of joint ventures (11) (148) (53) (373) Other income, net (4) (81) (528) (283) --------- --------- --------- --------- 2,560 2,462 7,161 10,320 --------- --------- --------- --------- Earnings (loss) before income taxes (669) 835 105 (367) Income tax expense (benefit) (267) 366 41 (155) --------- --------- --------- --------- Net earnings (loss) $ (402) 469 64 (212) ========= ========= ========= ========= Basic earnings (loss) per share $ (.09) .11 .02 (.05) ========= ========= ========= ========= Diluted earnings (loss) per share $ (.09) .11 .01 (.05) ========= ========= ========= ========= Weighted average shares outstanding 4,235,887 4,214,191 4,227,911 4,207,575 Dilutive effect of stock options - 26,375 65,696 33,474 Dilutive effect of phantom stock units - 15,617 4,692 17,381 --------- --------- --------- --------- Weighted average shares outstanding assuming dilution 4,235,887 4,256,183 4,298,299 4,258,430 ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 4 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Statements of Comprehensive Income (Unaudited) For the Three and Nine Months Ended September 30, 2002 and September 30, 2001 (In Thousands)
Three Months Ended Nine Months Ended ------------------------------------ ----------------------------------- September 30, September 30, September 30, September 30, 2002 2001 2002 2001 ----------------- ----------------- ----------------- ----------------- Net earnings (loss) $ (402) 469 64 (212) Other comprehensive income (loss), net of tax: Cash flow hedge: Cumulative effect of adoption of FAS 133 - - - (96) Change in fair value during the period (49) (132) (5) (182) ----- ----- ----- ----- Total other comprehensive income (loss) (49) (132) (5) (278) ----- ----- ----- ----- Comprehensive income (loss) $ (451) 337 59 (490) ===== ===== ===== =====
See accompanying notes to consolidated financial statements. 5 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Statements of Cash Flows (Unaudited) For the Nine Months Ended September 30, 2002 and September 30, 2001 (In Thousands, Except Share Data)
Nine Months Ended ---------------------------------------- September 30, September 30, 2002 2001 ------------------- ------------------- Cash flows from operating activities: Net earnings (loss) $ 64 (212) Adjustments to reconcile net earnings to net cash provided (used) by operating activities: Depreciation of plant and equipment 488 547 Amortization of intangibles 32 383 Gain on disposition of equipment (94) - Equity in income of joint ventures (53) (373) Issuance of 18,281 and 9,926 common shares, respectively, as noncash interest payments on subordinated notes 150 75 Issuance of 12,390 common shares as payment of employee's bonus - 111 Change in operating assets and liabilities: Receivables 1,224 (2,641) Costs and estimated earnings in excess of billings 24 442 Inventories 994 199 Prepaid expenses and other current assets (91) 73 Other noncurrent assets - 1 Accounts payable (350) (68) Customers' deposits and billings in excess of costs and estimated earnings for completed and uncompleted contracts (1,014) (333) Accrued salaries, wages, and commissions (132) (1,274) Income taxes payable (44) (369) Accrued royalties payable 16 (166) Accrued product warranties 229 (102) Accrued pension and retirement savings plan liabilities 38 481 Accrued restructuring expenses (272) 709 Accrued other liabilities 245 397 Deferred income taxes 896 11 Deferred compensation (115) (36) ------ ----- Net cash provided (used) by operating activities 2,235 (2,145) ------ ----- Cash flows from investing activities: Proceeds from the disposition of equipment 200 - Proceeds from the divestment of a joint venture 125 - Additions to property, plant and equipment (229) (530) ------ ----- Net cash provided (used) by investing activities 96 (530) ------ -----
See accompanying notes to consolidated financial statements. 6 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Consolidated Statements of Cash Flows (Unaudited) (Continued) For the Nine Months Ended September 30, 2002 and September 30, 2001 (In Thousands, Except Share Data)
Nine Months Ended ---------------------------------------- September 30, September 30, 2002 2001 ------------------- ------------------- Cash flows from financing activities: Sale of common shares in connection with employee incentive stock option plan 33 30 Repayment of long-term debt (1,730) (1,519) ------ ----- Net cash used by financing activities (1,697) (1,489) ------ ----- Increase (decrease) in cash and cash equivalents 634 (4,164) Cash and cash equivalents, beginning of period 6,114 7,925 ------ ----- Cash and cash equivalents, end of period $ 6,748 3,761 ====== ====== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 618 809 ====== ===== Income taxes $ 51 471 ====== =====
See accompanying notes to consolidated financial statements. 7 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 (1) The information contained in this Form 10-Q report is unaudited. In the opinion of the management of Paragon Technologies, Inc. ("Paragon" or the "Company"), the interim financial statements furnished reflect all adjustments and accruals that are necessary to present a fair statement of results for the interim periods. The financial statements include the accounts of the Company and Ermanco Incorporated ("Ermanco"), a wholly owned subsidiary company, after elimination of intercompany balances and transactions. Results for interim periods are not necessarily indicative of results expected for the fiscal year. This quarterly report should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements of the Company and the related Notes thereto appearing in our annual report on Form 10-K, as amended, for the year ended December 31, 2001, as filed with the Securities and Exchange Commission. Refer to the Company's Form 10-K, as amended, for the year ended December 31, 2001 for more complete financial information. (2) Restructuring ------------- During the second quarter of 2001, the Company restructured its business operations and recorded a charge of $1,538,000 for restructuring costs. In conjunction with the restructuring plan, the Company reduced the number of office associates by 14 and discontinued production operations at its Easton, Pennsylvania facility. All production employees working in the Easton, Pennsylvania manufacturing plant were laid off by the end of November 2001. Prior to the restructuring, the Company employed approximately 20 production employees, with an additional 27 individuals on an extended layoff. The restructuring charges included costs of $678,000 for severance and other personnel costs, $562,000 for pension expense associated with the curtailment of the Company's defined benefit plan for the Company's Easton, Pennsylvania production employees, and $298,000 for plant closure and professional service fees related to the restructuring. The restructuring charges were determined based on formal plans approved by the Company's management and the Board of Directors. The liability related to the curtailment of the defined benefit plan is recorded as accrued pension and retirement savings plan liabilities on the consolidated balance sheets. The major components of the restructuring charge and remaining accruals are as follows:
Balance at Cash Balance at December 31, 2001 Payments September 30, 2002 ---------------------- -------------- ------------------------- Severances $ 274,000 (178,000) 96,000 Other 220,000 (94,000) 126,000 ------- -------- ------- $ 494,000 (272,000) 222,000 ======= ======= =======
(3) Major Segments of Business -------------------------- Operating segments are defined as components of an enterprise in which separate financial information is available and evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company identified such segments based on both management responsibility and types and products offered for sale. The Company operates in two major market segments. 8 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 The Company's Easton, Pennsylvania operations (hereafter referred to as "SI Systems") is a specialized systems integrator supplying SI Systems' branded automated material handling systems to manufacturing, order selection, and distribution operations. The systems are marketed, designed, sold, installed, and serviced by its own staff or agents, generally as labor-saving devices to improve productivity, quality, and reduce costs. SI Systems also operates as a project manager in connection with the installation, integration, and service of its products, generally utilizing subcontractors. SI Systems' branded products are utilized to automate the movement or selection of products and are often integrated with other automated equipment such as conveyors and robots. SI Systems' branded integrated material handling solutions involve both standard and specially designed components and include integration of non-proprietary automated handling technologies so as to provide turnkey solutions for its customers' unique material handling needs. SI Systems' staff develops and designs computer control programs required for the efficient operation of the systems. SI Systems' branded products are sold to customers located in North America, including the U.S. government. The Company's Spring Lake, Michigan operations (hereafter referred to as "Ermanco") is a manufacturer of Ermanco branded light to medium duty unit handling conveyor products, serving the material handling industry through a worldwide network of approximately 100 experienced material handling equipment distributors and licensees. Ermanco also provides complete conveyor systems for a variety of applications, including distribution and manufacture of computers and electronic products, utilizing primarily its own manufactured conveyor products, engineering services by its own staff or subcontractors, and subcontracted installation services. Ermanco supplies material handling systems and equipment to both national and international markets. Ermanco offers services ranging from the delivery of basic transportation conveyors to turnkey installations of complex, fully automated work-in-process production lines and distribution centers, utilizing sophisticated, custom-designed controls software. Many of Ermanco's sales are to distributors who have non-exclusive agreements with the Company. The Company's systems vary in configuration and capacity. Historically, system prices across the Company's product lines have ranged from $100,000 to several million dollars per system. Systems and aftermarket sales by brand during the three and nine months ended September 30, 2002 and September 30, 2001 are as follows (in thousands): For the three months ended September 30, 2002:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Systems sales $ 2,706 5,363 8,069 89.5% Aftermarket sales 630 311 941 10.5% ------ ------ ------ ----- Total sales $ 3,336 5,674 9,010 100.0% ====== ====== ====== ===== As a % of total sales 37.0% 63.0% 100.0%
For the three months ended September 30, 2001:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Systems sales $ 2,583 8,338 10,921 85.3% Aftermarket sales 1,373 502 1,875 14.7% ------ ------ ------ ----- Total sales $ 3,956 8,840 12,796 100.0% ====== ====== ====== ===== As a % of total sales 30.9% 69.1% 100.0%
9 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 For the nine months ended September 30, 2002:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Systems sales $ 8,411 17,560 25,971 87.5% Aftermarket sales 2,345 1,354 3,699 12.5% ------ ------ ------ ----- Total sales $ 10,756 18,914 29,670 100.0% ====== ====== ====== ===== As a % of total sales 36.3% 63.7% 100.0%
For the nine months ended September 30, 2001:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Systems sales $ 11,004 22,691 33,695 86.5% Aftermarket sales 3,746 1,506 5,252 13.5% ------ ------ ------ ----- Total sales $ 14,750 24,197 38,947 100.0% ====== ====== ====== ===== As a % of total sales 37.9% 62.1% 100.0%
The Company's products are sold through its own sales personnel, along with a network of distributors and licensees. Domestic and international sales by brand during the three and nine months ended September 30, 2002 and September 30, 2001 are as follows (in thousands): For the three months ended September 30, 2002:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Domestic sales $ 3,299 5,308 8,607 95.5% International sales 37 366 403 4.5% ------ ------ ------ ----- Total sales $ 3,336 5,674 9,010 100.0% ====== ====== ====== =====
For the three months ended September 30, 2001:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Domestic sales $ 3,878 7,790 11,668 91.2% International sales 78 1,050 1,128 8.8% ------ ------ ------ ----- Total sales $ 3,956 8,840 12,796 100.0% ====== ====== ====== =====
For the nine months ended September 30, 2002:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Domestic sales $ 10,567 17,484 28,051 94.5% International sales 189 1,430 1,619 5.5% ------ ------ ------ ----- Total sales $ 10,756 18,914 29,670 100.0% ====== ====== ====== =====
For the nine months ended September 30, 2001:
% of Total SI Systems Ermanco Total Sales --------------- -------------- -------------- -------------- Domestic sales $ 14,050 20,562 34,612 88.9% International sales 700 3,635 4,335 11.1% ------ ------ ------ ----- Total sales $ 14,750 24,197 38,947 100.0% ====== ====== ====== =====
10 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 The Company also engages in sales with the U.S. government, which is one of the Company's major customers. Sales to the U.S. government during the three and nine months ended September 30, 2002 and September 30, 2001 are as follows (in thousands):
As a % of Total Sales ----------------- For the three months ended September 30, 2002 $ 376 4.2% For the three months ended September 30, 2001 1,412 11.0%
As a % of Total Sales ----------------- For the nine months ended September 30, 2002 $ 3,102 10.5% For the nine months ended September 30, 2001 5,806 14.9%
The Company identifies operating segments based on the types of products offered for sale as follows:
For the Three Months Ended September 30, 2002 (In Thousands): SI Systems Ermanco Total ------------------------------------------- ------------------- ----------------- ----------- Sales $ 3,336 5,674 9,010 Earnings (loss) before interest expense, interest income, equity in income of joint ventures, and income taxes (43) (407) (450) Total assets 8,809 30,251 39,060 Capital expenditures 34 21 55 Depreciation and amortization expense 68 112 180
For the Three Months Ended September 30, 2001 (In Thousands): SI Systems Ermanco Total ------------------------------------------- ------------------- ----------------- ----------- Sales $ 3,956 8,840 12,796 Earnings before interest expense, interest income, equity in income of joint ventures, and income taxes 376 586 962 Total assets 12,438 31,214 43,652 Capital expenditures 57 280 337 Depreciation and amortization expense 104 229 333
11 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001
For the Nine Months Ended September 30, 2002 (In Thousands): SI Systems Ermanco Total ------------------------------------------- ------------------- ----------------- ----------- Sales $ 10,756 18,914 29,670 Earnings (loss) before interest expense, interest income, equity in income of joint ventures, and income taxes 1,075 (308) 767 Total assets 8,809 30,251 39,060 Capital expenditures 55 174 229 Depreciation and amortization expense 208 312 520
For the Nine Months Ended September 30, 2001 (In Thousands): SI Systems Ermanco Total ------------------------------------------- ------------------- ----------------- ----------- Sales $ 14,750 24,197 38,947 Earnings before interest expense, interest income, equity in income of joint ventures, and income taxes (before restructuring expenses) 559 1,025 1,584 Restructuring expenses 1,538 - 1,538 Total assets 12,438 31,214 43,652 Capital expenditures 121 409 530 Depreciation and amortization expense 311 619 930
(4) New Accounting Pronouncements ----------------------------- Effective January 1, 2002, the Company adopted Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Impairment losses, if any, will be measured as of January 1, 2002 and recognized as the cumulative effect of a change in accounting principle in 2002. FAS 142 also requires that intangible assets with determinable useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with Statement No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-Lived Assets to Be Disposed Of." As of January 1, 2002, the Company had unamortized goodwill of $17,657,000, all of which was attributable to Ermanco. FAS 142 requires that the Company completes a first phase of the impairment review for goodwill by June 30, 2002. The required review was completed during the second quarter of 2002 and did not indicate any impairment. 12 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 (4) New Accounting Pronouncements (Continued) ----------------------------- Comparison to Prior Year "As Adjusted" -------------------------------------- The following table presents prior year reported amounts adjusted to eliminate the effect of goodwill amortization in accordance with FAS 142.
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- --------------------------- 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Reported net earnings (loss) $(402,000) 469,000 64,000 (212,000) Add back: goodwill amortization, net of tax - 66,000 - 203,000 ------- ------- ------- ------- Adjusted net earnings (loss) $(402,000) 535,000 64,000 (9,000) ======= ======= ======= ======= Basic net earnings (loss) per share: Reported net earnings (loss) per share $ (.09) .11 .02 (.05) Add back: goodwill amortization, net of tax - .02 - .05 ------- ------- ------- ------- Adjusted net earnings (loss) per share $ (.09) .13 .02 - ======= ======= ======= ======= Diluted net earnings (loss) per share: Reported net earnings (loss) per share $ (.09) .11 .01 (.05) Add back: goodwill amortization, net of tax - .02 - .05 ------- ------- ------- ------- Adjusted net earnings (loss) per share $ (.09) .13 .01 - ======= ======= ======= =======
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The Statement also supersedes APB No. 30 provisions related to the accounting and reporting for the disposal of a segment of a business. This Statement establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The Statement retains most of the requirements in SFAS No. 121 related to the recognition of impairment of long-lived assets to be held and used. This Statement was adopted by the Company on January 1, 2002 and did not have any impact on the Company's financial statements. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146) which addresses financial accounting and reporting for costs associated with exit or disposal activities. This statement nullifies Emerging Issues Task Force Issue 94-3. "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and establishes that fair value is the objective for initial measurement of the liability. The Statement is effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. 13 Item 1. Financial Statements (Continued) ------- -------------------- Paragon Technologies, Inc. and Subsidiary Notes To Consolidated Financial Statements Nine Months Ended September 30, 2002 and September 30, 2001 (5) Other Comprehensive Loss ------------------------ The Company is exposed to market risk from changes in interest rates, and uses an interest rate swap to hedge this risk. The seven-year interest rate swap has a notional amount of $4,600,000 and is classified as a cash flow hedge of forecasted variable rate interest payments on a portion of the Company's term loan. Gains and losses on the interest rate swap are deferred in accumulated other comprehensive loss. The fair value of the interest rate swap at September 30, 2002 was a liability of approximately $431,000. The separate components of other comprehensive loss are as follows (in thousands):
Gross Tax Effect Net ----- ---------- --- Accumulated other comprehensive loss at December 31, 2001 $ 412 159 253 Other comprehensive loss 19 14 5 --- --- --- Accumulated other comprehensive loss at September 30, 2002 $ 431 173 258 === === ===
The Company uses derivative financial instruments as risk management tools and not for speculative purposes. (6) Long-Term Debt --- -------------- The Company was in violation of the covenant related to its Funds Flow Coverage Ratio and received waivers from its principal bank for the covenant violation for the quarters ended June 30, 2002 and September 30, 2002. During August 2002, the Company entered into an arrangement to amend its credit agreements with its principal bank relative to future covenant requirements and the maintenance of a minimum cash balance covenant. In August 2002, the line of credit agreement was amended to extend the expiration date of the facility to June 30, 2003 and decrease the amount available under the facility. During November 2002, the Company prepaid, without penalty, $1,200,000 of the term loan reducing the balance of the term loan to $5,987,500 and placed $1,150,000 in escrow with the Company's principal bank. Beginning with the quarter ended December 31, 2002, the escrow amount will be reduced by $287,500 every quarter and applied to the principal portion of the term loan until the escrow amount reaches zero at September 30, 2003. The Company will resume making equal quarterly payments of $575,000 plus accrued interest beginning with the quarter ended December 31, 2003. The Company also amended its credit agreements relative to future covenant requirements, the minimum cash balance covenant was reduced to $4,000,000, and certain conditions were added regarding the sale of the Company's Easton facility. In November 2002, the line of credit agreement was also amended to decrease the amount available under the facility to $1,000,000. The Company remains prohibited from making any cash payments of subordinated debt and interest through the quarter ended September 30, 2003, and beginning with the quarter ended December 31, 2003 interest payments on the subordinated debt may be made in the form of cash if the Company is in full compliance with all the financial covenants set forth in the Loan Agreement, as amended, with the Company's principal bank. The Company intends to satisfy its quarterly interest obligations on subordinated debt with the issuance of the Company's common stock in the event the Company's principal bank does not grant waivers regarding the making of cash payments of interest on subordinated debt. 14 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Liquidity and Capital Resources ------------------------------- The Company's cash and cash equivalents increased to $6,748,000 at September 30, 2002 from $6,114,000 at December 31, 2001. The increase resulted from cash provided by operating activities totaling $2,235,000, proceeds of $200,000 from the disposition of equipment, and proceeds of $125,000 from the divestment of a joint venture. Partially offsetting the increase in cash and cash equivalents from these sources was the repayment of long-term debt of $1,730,000 and purchases of capital equipment of $229,000. Funds used by operating activities during the nine months ended September 30, 2001 were $2,145,000. Acquisition of Ermanco Incorporated ----------------------------------- On September 30, 1999, the Company acquired all of the outstanding common stock of Ermanco. Under the terms of the Stock Purchase Agreement, the Company acquired all of the outstanding common stock of Ermanco for a purchase price of $22,801,000 consisting of $15,301,000 in cash, $3,000,000 in promissory notes payable to the fourteen stockholders of Ermanco, and 481,284 shares of the Company's common stock with a value of $4,500,000 based on the average closing price of $9.35 of the Company's common stock for the five trading days immediately preceding the date of the Stock Purchase Agreement, August 6, 1999. In order to complete the Ermanco acquisition, the Company obtained financing from its principal bank. The Company entered into a line of credit facility which may not exceed the lesser of $1,000,000, as amended, or an amount based on a borrowing base formula tied principally to accounts receivable, inventory, fair market value of the Company's property and plant, and liquidation value of equipment. This amount will be reduced by the unpaid principal balance of the term loan described below. The line of credit facility is to be used primarily for working capital purposes. As of September 30, 2002, the Company did not have any borrowings under the line of credit facility, and the facility expires effective June 30, 2003. The Company financed $14,000,000 of the acquisition through a seven-year term loan from its bank. During the first two years of the term loan, the Company was obligated to repay equal quarterly payments of $312,500 plus accrued interest. After September 30, 2001, the Company commenced making equal quarterly payments of $575,000 plus interest, continuing until the loan is fully repaid. In connection with the most recent amendment, the Company prepaid, without penalty, $1,200,000 of the term loan reducing the balance of the term loan to $5,987,500 and placed $1,150,000 in escrow with the Company's principal bank. Beginning with the quarter ended December 31, 2002, the escrow amount will be reduced by $287,500 every quarter and applied to the principal portion of the term loan until the escrow amount reaches zero at September 30, 2003. The Company will resume making equal quarterly payments of $575,000 plus accrued interest beginning with the quarter ended December 31, 2003. The interest rate on the term loan is variable at a rate equal to the three-month LIBOR Market Index Rate plus three percent, which was 4.80% as of September 30, 2002. The Company also entered into an interest rate swap agreement for a portion of the term loan to hedge the floating interest rate. At September 30, 2002, the notional amount of the seven-year interest rate swap was $4,600,000, and it fixes interest at a rate of 9.38%. As of September 30, 2002, the liability associated with the fair value of the cash flow hedge was approximately $431,000. To obtain the line of credit and term loan, the Company granted the bank a security interest in all personal property, including, without limitation, all accounts, deposits, documents, equipment, fixtures, general intangibles, goods, instruments, inventory, letters of credit, money, securities, and a first mortgage on all real estate. The line of credit facility and term loan contain various restrictive covenants relating to additional indebtedness, asset acquisitions or dispositions, investments, guarantees, payment of dividends, maintenance of certain financial ratios, and as amended, maintenance of a minimum cash balance covenant of $4,000,000. The Company was in compliance with all covenants or obtained appropriate waivers as of September 30, 2002 (See Note 6). 15 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Acquisition of Ermanco Incorporated (Continued) ----------------------------------- On September 30, 1999, the Company also issued promissory notes to fourteen stockholders of Ermanco, two of which are directors of the Company (Messrs. Shulman and Kirschner), in the aggregate principal amount of $3,000,000. The notes have a term of seven years and bear interest at an annual rate of ten percent through September 30, 2002, twelve percent from October 1, 2002 through September 30, 2004, and fourteen percent from October 1, 2004 through September 30, 2006. The weighted average interest rate on the promissory notes is 11.714% over the term of the notes. Interest shall be payable quarterly, in cash or under certain conditions, in the Company's common stock upon approval of the Company's Board of Directors. The promissory notes may be prepaid prior to the end of the seven-year term provided that there is no debt outstanding under the Company's line of credit facility and term loan. From July 1, 2001 through September 30, 2003, the Company has been and will be prohibited from making any cash payments on subordinated debt and interest. However, the bank waived the restriction from paying interest on the subordinated debt in the form of cash for the quarter ended December 31, 2001 and the quarter ended March 31, 2002. Beginning with the quarter ended December 31, 2003 interest payments on the subordinated debt may be made in the form of cash if the Company is in full compliance with all the financial covenants set forth in the Loan Agreement, as amended, with the Company's principal bank. The Company intends to satisfy its quarterly interest obligations on subordinated debt with the issuance of the Company's common stock in the event the Company's principal bank does not grant waivers regarding the making of cash payments of interest on subordinated debt. The Company was in violation of the covenant related to its Funds Flow Coverage Ratio and received waivers from its principal bank for the covenant violation for the quarters ended June 30, 2002 and September 30, 2002. During August 2002, the Company entered into an arrangement to amend its credit agreements with its principal bank relative to future covenant requirements and the maintenance of a minimum cash balance covenant. In August 2002, the line of credit agreement was amended to extend the expiration date of the facility to June 30, 2003 and decrease the amount available under the facility. During November 2002, the Company prepaid, without penalty, $1,200,000 of the term loan reducing the balance of the term loan to $5,987,500 and placed $1,150,000 in escrow with the Company's principal bank. Beginning with the quarter ended December 31, 2002, the escrow amount will be reduced by $287,500 every quarter and applied to the principal portion of the term loan until the escrow amount reaches zero at September 30, 2003. The Company will resume making equal quarterly payments of $575,000 plus accrued interest beginning with the quarter ended December 31, 2003. The Company also amended its credit agreements relative to future covenant requirements, the minimum cash balance covenant was reduced to $4,000,000, and certain conditions were added regarding the sale of the Company's Easton facility. In November 2002, the line of credit agreement was also amended to decrease the amount available under the facility to $1,000,000. Commitments and Contingencies ----------------------------- Ermanco's operations are located in a 94,000 square foot steel building in Spring Lake, Michigan. The building is leased from an organization that is affiliated with the Company through a common director and officer of the Company, Messrs. Shulman and Kirschner. The leasing agreement requires fixed monthly rentals of $32,858 (with annual increases of 2.5%), which includes a variable portion based on the lessor's borrowing rate and the unpaid mortgage balance. The terms of the lease require the payment of all taxes, insurance, and other ownership related costs of the property. The lease expires on September 30, 2004. The Company also leases certain automobiles and office equipment, office space, computer equipment, and software under various operating leases with terms extending through September 2007. 16 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Commitments and Contingencies (Continued) ----------------------------- On March 4, 1996, SI/BAKER established a $3,000,000 line of credit facility (the "Facility") with its principal bank (the "bank"). Under the terms of the Facility, SI/BAKER's parent companies, Paragon Technologies, Inc. and McKesson Automation Systems Inc., have each provided a limited guarantee and surety in an amount not to exceed $1,000,000 for a combined guarantee of $2,000,000 to the bank for the payment and performance of the related note, including any further renewals or modifications of the facility. As of September 30, 2002, SI/BAKER did not have any borrowings under the Facility, and the Facility expires effective June 30, 2003. Other Liquidity and Capital Resource Matters -------------------------------------------- The Company anticipates that its financial resources, consisting of cash generated from operations and borrowings available under its credit facility will be adequate to satisfy its future cash requirements through the next year. If the Company is unable to meet the terms of its financial covenants relating to its outstanding indebtedness and is unable to receive a waiver from its lender, a default could result under the Company's borrowing agreements. A default may result in the acceleration of the Company's indebtedness and cause the Company's debt to become immediately due and payable. If acceleration occurs, the Company may not be able to repay its debt, and the Company may not be able to borrow sufficient additional funds to refinance such debt. Sales volume, as well as cash liquidity, may experience fluctuations due to the unpredictability of future contract sales and the dependence upon a limited number of large contracts with a limited number of customers. For these reasons, cash liquidity beyond a twelve-month period is difficult for the Company to forecast with reasonable accuracy. The Company plans to consider all strategic alternatives to increase stockholder value, including expansion opportunities as they arise, although the ongoing operating results of the Company, the restrictive covenants associated with the financing obtained from the Company's principal bank, the economics of the expansion, and the circumstances justifying the expansion will be key factors in determining the amount of resources the Company will devote to further expansion. Results Of Operations --------------------- (a) Nine Months Ended September 30, 2002 Versus Nine Months Ended September 30, --------------------------------------------------------------------------- 2001 ---- The Company's net earnings for the nine months ended September 30, 2002 was $64,000 compared to a net loss of $212,000 for the nine months ended September 30, 2001. Contributing to the net earnings for the nine months ended September 30, 2002 was other income from the short-term licensing of certain real property of $300,000 and a gain on the sale of excess fixed assets of $94,000, and the application of the non-amortization provision of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," whereby goodwill is no longer amortized thereby resulting in an increase to pre-tax income of $351,000. Contributing to the net loss for the nine months ended September 30, 2001 were restructuring charges of $1,538,000. Net Sales and Gross Profit on Sales ----------------------------------- Net sales of $29,670,000 for the nine months ended September 30, 2002 decreased 23.8% compared to net sales of $38,947,000 for the nine months ended September 30, 2001. The sales decrease of $9,277,000 was primarily attributable to a lower volume of orders associated with the current economic slowdown and competitive pricing pressures. The net sales decrease was comprised of a decrease in Ermanco's branded sales of approximately $5,283,000 and a decrease in SI Systems' branded sales of approximately $3,994,000 for the nine months ended September 30, 2002 when compared to the nine months ended September 30, 2001. The decline in Ermanco branded sales was primarily due to the prior year comparable period containing a greater 17 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Results Of Operations --------------------- (a) Nine Months Ended September 30, 2002 Versus Nine Months Ended September 30, --------------------------------------------------------------------------- 2001 ---- Net Sales and Gross Profit on Sales (Continued) ----------------------------------- amount of sales related to distributors and companies in the technology sector. The decline in SI Systems' branded sales was primarily due to the prior year comparable period containing a greater amount of sales related to the LO-TOW(R) product line. Contributing to the reduction of approximately $2,640,000 in LO-TOW(R) sales for the nine months ended September 30, 2002 was a decrease of approximately $2,800,000 in sales related to the U.S. Postal Service. The Company's business is dependent upon a limited number of large contracts with a limited number of customers. This dependence can cause unexpected fluctuations in sales volume. Various external factors affect the customers' decision-making process on expanding and upgrading their current production or distribution sites. The customers' timing and placement of new orders is often affected by factors such as the current economy, current interest rates, and future expectations. The Company believes that its business is not subject to seasonality, although the rate of new orders can vary substantially from month to month. Fluctuations in the Company's sales and earnings occur with increases or decreases in major installations, since the Company recognizes sales on a percentage of completion basis for its system contracts. Gross profit, as a percentage of sales, was 24.5% for the nine months ended September 30, 2002 compared to 25.6% for the nine months ended September 30, 2001. Gross profit, as a percentage of sales, for the nine months ended September 30, 2002 was unfavorably impacted by 1.9% due to the underabsorption of overhead costs caused by a decline in sales volume. Gross profit, as a percentage of sales, for the nine months ended September 30, 2002, when compared to the nine months ended September 30, 2001, was favorably impacted by approximately 0.7% as a result of the reversal of previously established contract accruals due to changes in cost estimates. Selling, General and Administrative Expenses -------------------------------------------- Selling, general and administrative expenses of $6,774,000 were lower by $1,125,000 for the nine months ended September 30, 2002 than in the nine months ended September 30, 2001. The decrease of $1,125,000 was comprised of cost savings of approximately $525,000, attributable to the Company's restructuring of its business operations in the prior fiscal year and emphasis on cost reduction. Also contributing to the reduction in selling, general and administrative expenses was a reduction of approximately $325,000 in marketing expenses associated with marketing research and the Company's participation in a biannual industry trade show in the first quarter of the prior fiscal year, $200,000 of compensation expense based on profit performance, and $310,000 of charges during the second quarter of the prior fiscal year related to a strategic transaction that was not completed. Partially offsetting the aforementioned favorable variance was $150,000 of provision related to increasing the allowance for doubtful accounts associated with possible uncollectible receivables. Product Development Costs ------------------------- Product development costs, including patent expense, of $253,000 were lower by $149,000 for the nine months ended September 30, 2002 than in the nine months ended September 30, 2001. Development programs in the nine months ended September 30, 2002 were aimed at improvements to the Company's sortation and accumulation conveyor technologies and the Order Picking, Fulfillment, and Replenishment product line. Development programs in the nine months ended September 30, 2001 included enhancements to the Company's Order Picking, Fulfillment, and Replenishment product line and development efforts related to NBS 30(TM) and NBS 90(TM), narrow belt sorters, that were introduced in the material handling marketplace during the first quarter of 2001. 18 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Results of Operations --------------------- (a) Nine Months Ended September 30, 2002 Versus Nine Months Ended September 30, --------------------------------------------------------------------------- 2001 (Continued) ---- Amortization of Goodwill ------------------------ Amortization of goodwill represented costs associated with the acquisition of Ermanco. Due to the application of the non-amortization provision of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," goodwill is no longer amortized after December 31, 2001 as compared to amortization expense of $351,000 for the nine months ended September 30, 2001. Restructuring Expenses ---------------------- During the second quarter of 2001, the Company restructured its business operations and recorded a charge of $1,538,000 for restructuring costs. In conjunction with the restructuring plan, the Company reduced the number of office associates by 14 and discontinued production operations at its Easton, Pennsylvania facility. All production employees working in the Easton, Pennsylvania manufacturing plant were laid off by the end of November 2001. Prior to the restructuring, the Company employed approximately 20 production employees, with an additional 27 individuals on an extended layoff. The restructuring charges included costs of $678,000 for severance and other personnel costs, $562,000 for pension expense associated with the curtailment of the defined benefit plan for the Company's Easton, Pennsylvania production employees, and $298,000 for plant closure and professional service fees relating to the restructuring. The restructuring charges were determined based on formal plans approved by the Company's management and the Board of Directors. Interest Expense and Interest Income ------------------------------------ Interest expense of $803,000 was lower by $198,000 for the nine months ended September 30, 2002 than in the nine months ended September 30, 2001. The decrease in interest expense was attributable to the reduced level of term debt due to principal payments and lower interest rates. Interest income of $88,000 for the nine months ended September 30, 2002 decreased by $127,000, when compared to the nine months ended September 30, 2001. The decrease in interest income was primarily attributable to a reduction in the level of interest rates pertaining to short-term investments. Equity in Income of Joint Ventures ---------------------------------- Equity in income of joint ventures represents the Company's proportionate share of its investment in the SI/BAKER joint venture and prior to January 1, 2002 its investment in the SI-Egemin joint venture, that are accounted for under the equity method. The net unfavorable variance of $320,000 in the equity in income of joint ventures for the nine months ended September 30, 2002 as compared to the nine months ended September 30, 2001 was comprised of decreased earnings of approximately $384,000 attributable to the SI/BAKER joint venture and decreased losses of approximately $64,000 attributable to the SI-Egemin joint venture. The unfavorable variance of $384,000 for the nine months ended September 30, 2002 in the equity in income of the SI/BAKER joint venture was attributable to a decline in sales of approximately $3,629,000, an increase of $107,000 in product development costs, an increase of $107,000 in selling, general and administrative expenses, and a reduction of $108,000 in interest income as compared to the nine months ended September 30, 2001. The sales decrease was primarily attributable to a larger backlog of orders at the beginning of the prior fiscal year and a lower volume of orders received during the first nine months of 2002, primarily associated with the current economic slowdown. SI/BAKER increased product development costs aimed at enhancing the Company's product offerings, while selling, general and administrative expenses primarily 19 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Results of Operations --------------------- (a) Nine Months Ended September 30, 2002 Versus Nine Months Ended September 30, --------------------------------------------------------------------------- 2001 ---- Equity in Income of Joint Ventures (Continued) ---------------------------------- rose due to the addition of resources aimed at expanding the customer base. The unfavorable variance in interest income was primarily attributable to a reduction in the level of funds and interest rates pertaining to short-term investments. Partially offsetting the aforementioned unfavorable variances was a reduction of $146,000 in revenue-based royalty costs due to the parent companies. The Company divested of its investment in the SI-Egemin joint venture at the end of calendar year 2001. The favorable variance of $64,000 for the nine months ended September 30, 2002 in the equity in income of the SI-Egemin joint venture was attributable to the prior fiscal year containing operating expenses of the joint venture. Other Income, Net ----------------- The favorable variance of $245,000 in other income, net for the nine months ended September 30, 2002 as compared to the nine months ended September 30, 2001 was primarily attributable to $300,000 of short-term licensing income received during the first half of 2002 relating to certain real property of the Company's Easton, Pennsylvania facility. Also contributing to the favorable variance in other income, net for the nine months ended September 30, 2002 was a gain on the sale of excess fixed assets associated with the Company's Easton, Pennsylvania facility during the first quarter of 2002 of approximately $100,000. Partially offsetting the favorable variance in other income, net was a reduction of revenue-based royalty income from the Company's SI/BAKER joint venture and license agreements related to international conveyor system sales. Income Tax Expense ------------------ The Company recognized income tax expense of $41,000 during the nine months ended September 30, 2002, compared to the recognition of an income tax benefit of $155,000 in the comparable prior year period. The income tax benefit recognized for the nine months ended September 30, 2001 represented the carryback of losses experienced during the nine months of 2001 against prior year income. Income tax expense for the first nine months of 2002 was generally recorded at statutory federal and state tax rates. Backlog of Orders ----------------- The total backlog of orders at September 30, 2002 was approximately $9,845,000. During the nine months ended September 30, 2002, the Company received orders totaling approximately $26,174,000. (b) Three Months Ended September 30, 2002 Versus Three Months Ended September ------------------------------------------------------------------------- 30, 2001 -------- With the exception of the following Statement of Operations captions, changes in the third quarter of calendar year 2002 compared to the prior year were consistent with those previously noted above for the nine month period. The Company's net loss for the three months ended September 30, 2002 was $402,000 compared to net earnings of $469,000 for the three months ended September 30, 2001. Contributing to the net loss for the three months ended September 30, 2002 was a decrease in sales of $3,786,000 due to the current economic slowdown, and severance costs of $171,000 due to a reduction in office associates. 20 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Results of Operations --------------------- (b) Three Months Ended September 30, 2002 Versus Three Months Ended September ------------------------------------------------------------------------- 30, 2001 (Continued) -------- Net Sales and Gross Profit on Sales ----------------------------------- Net sales of $9,010,000 for the three months ended September 30, 2002 decreased 29.6% compared to net sales of $12,796,000 for the three months ended September 30, 2001. The sales decrease of $3,786,000 was primarily attributable to a lower volume of orders associated with the current economic slowdown. The net sales decrease was comprised of a decrease in SI Systems branded sales of approximately $620,000 and a decrease in Ermanco branded sales of approximately $3,166,000 for the three months ended September 30, 2002 when compared to the three months ended September 30, 2001. The decline in SI Systems branded sales was primarily due to the prior year comparable period containing a greater amount of aftermarket sales related to Cartrac(R) products. The decline in Ermanco branded sales was primarily due to the prior year comparable period containing a greater amount of sales to distributors and companies in the technology sector. Gross profit, as a percentage of sales, was 21.0% for the three months ended September 30, 2002 compared to 25.8% for the three months ended September 30, 2001. Gross profit, as a percentage of sales, for the three months ended September 30, 2002 was unfavorably impacted by approximately 2% due to the underabsorption of overhead costs caused by a decline in sales volume. Gross profit, as a percentage of sales, for the three months ended September 30, 2001 was favorably impacted by approximately 2.0% as a result of the reversal of previously established contract accruals due to changes in cost estimates. Selling, General and Administrative Expenses -------------------------------------------- Selling, general and administrative expenses of $2,251,000 were higher by $38,000 for the three months ended September 30, 2002 than in the three months ended September 30, 2001. The increase was primarily attributable to $171,000 of expenses pertaining to a reduction of office associates during the third quarter of 2002, partially offset by a reduction in compensation expense of approximately $130,000 based on profit performance. Other Income, Net ----------------- The unfavorable variance of $77,000 in other income, net for the three months ended September 30, 2002 as compared to the three months ended September 30, 2001 was primarily attributable to a reduction of revenue-based royalty income from the Company's SI/BAKER joint venture and license agreements related to international conveyor system sales. Income Tax Expense ------------------ The Company recognized an income tax benefit of $267,000 during the three months ended September 30, 2002 compared to the recognition of income tax expense of $366,000 during the three months ended September 30, 2001. The income tax benefit recognized for the three months ended September 30, 2002 represented the carryback of losses experienced during the three months ended September 30, 2002 against prior period income. Income tax expense for the three months ended September 30, 2001 was generally recorded at statutory federal and state tax rates. 21 Item 2. Management's Discussion and Analysis of Financial Condition and ------ ---------------------------------------------------------------- Results of Operations --------------------- Results of Operations --------------------- Cautionary Statement -------------------- Certain statements contained herein are not based on historical fact and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 or by the Securities and Exchange Commission rules, regulations, and releases. The Company intends that such forward-looking statements be subject to the safe harbors created thereby. Among other things, they regard the Company's acquisition activities, earnings, liquidity, financial condition, and certain operational matters. Words or phrases denoting the anticipated results of future events, such as "anticipate," "believe," "estimate," "expect," "may," "will," "will likely," "are expected to," "will continue," "should," "project," and similar expressions that denote uncertainty, are intended to identify such forward-looking statements. The Company's actual results, performance, or achievements could differ materially from the results expressed in, or implied by, such "forward-looking statements": (1) as a result of risks and uncertainties identified in connection with those forward-looking statements, including those factors identified herein, and in the Company's other publicly filed reports; (2) as a result of risks associated with the Company's restructuring, including the failure to achieve anticipated operating savings, and the possibility that the restructuring charges will be greater than anticipated; (3) as a result of factors over which the Company has no control, including the strength of domestic and foreign economies, sales growth, competition, and certain costs increases; or (4) if the factors on which the Company's conclusions are based do not conform to the Company's expectations. Quantitative and Qualitative Disclosures ---------------------------------------- The Company's primary interest rate market risk exposure is from changes in interest rates. The Company's policy is to manage interest rate exposure through the use of a combination of fixed and floating rate debt instruments, and since September 30, 1999, an interest rate swap agreement. Generally, the Company seeks to match the terms of its debt with its purpose. The Company uses a variable rate line of credit facility to provide working capital for operations. On September 30, 1999, the Company entered into an interest rate swap agreement for 50% of its new term loan from its principal bank to effectively convert half of the term loan from a variable rate note to a fixed rate note. A standard interest rate swap agreement involves the payment of a fixed rate times a notional amount by one party in exchange for a floating rate times the same notional amount from another party. The counterpart to the swap agreement is the Company's principal bank. The Company does not believe that its exposures to interest rate risk or foreign currency exchange risk, risks from commodity prices, equity prices and other market changes that affect market risk sensitive instruments, including the interest rate swap agreement, are material to its results of operations. 22 Item 4. Controls and Procedures ------- ----------------------- (a) Evaluation Of Disclosure Controls And Procedures ------------------------------------------------ The Company's Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of a date within 90 days of filing date of the quarterly report (the "Evaluation Date"), have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this quarterly report was being prepared. (b) Changes in Internal Controls ---------------------------- There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls and procedures subsequent to the Evaluation Date, nor any significant deficiencies or material weaknesses in such internal controls and procedures requiring corrective actions. 23 PART II -- OTHER INFORMATION ---------------------------- Item 6. Exhibits and Reports on Form 8-K ------- -------------------------------- (a) Exhibits: 10.23 Amended and Restated Executive Employment Agreement with Leon C. Kirschner dated as of August 28, 2002 (filed herewith). 10.24 Sixth Amendment to Line of Credit Note and Loan Agreement dated August 9, 2002 (filed herewith). 99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by William R. Johnson, President and CEO, and Ronald J. Semanick, Chief Financial Officer and Vice President - Finance and Treasurer (filed herewith). (b) No reports on Form 8-K were filed during the quarter ended September 30, 2002. 24 Paragon Technologies, Inc. and Subsidiary SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PARAGON TECHNOLOGIES, INC. /S/ William R. Johnson ----------------------------------------------- William R. Johnson President & CEO /S/ Ronald J. Semanick ----------------------------------------------- Ronald J. Semanick Chief Financial Officer Dated: November 14, 2002 ------------------------ 25 CERTIFICATION I, William R. Johnson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Paragon Technologies, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 --------------------- /s/ William R. Johnson ---------------------------- William R. Johnson President and CEO 26 CERTIFICATION I, Ronald J. Semanick, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Paragon Technologies, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 ------------------------------ /s/ Ronald J. Semanick ------------------------------------- Ronald J. Semanick Chief Financial Officer, and Vice President - Finance and Treasurer 27