U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 24, 2000
Commission file number 000-24405
Pallet Management Systems, Inc.
(Name of Small Business issuer in its charter)
Florida 59-2197020
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
2855 University Drive
Coral Springs, Florida 33065
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(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: (954) 340-1290
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
Check 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
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Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained herein, and will not be contained, to the best
of the Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
The Company's revenues for fiscal year 2000 were: $ 62,445,175.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the Company is $14,483,742, based on the closing price of
$3.5625 as of August 31, 2000.
As of September 30, 2000, there were 4,065,612 shares of the issuer's Common
Stock, $.01 par value, outstanding.
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PALLET MANAGEMENT, INC.
FORM 10-KSB
FOR THE YEAR ENDED JUNE 24, 1999
TABLE OF CONTENTS
Page No.
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PART I ....................................................................................... 2
Item 1.Description of Business ............................................................... 2
Item 2.Description of Property ............................................................... 12
Item 3.Legal Proceedings ..................................................................... 12
Item 4.Submission of Matters to a Vote of Security Holders ................................... 13
PART II ...................................................................................... 14
Item 5.Market for Common Equity and Related Stockholder Matters .............................. 14
Item 6.Management's Discussion and Analysis or Plan of Operations ............................ 14
Item 7. Financial Statements ................................................................ 24
Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 24
PART III ..................................................................................... 25
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section
16(a) of the Exchange Act ........................................................... 25
Item 10. Executive Compensation ............................................................. 28
Item 11. Security Ownership of Certain Beneficial Owners and Management ..................... 32
Item 12. Certain Relationships and Related Transactions ..................................... 34
Item 13. Exhibits and Reports on Form 8-K ................................................... 34
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FORWARD-LOOKING STATEMENTS
Pallet Management Systems, Inc. ("Pallet Management," or the "Company")
cautions readers that certain important factors may affect Pallet Management's
actual results and could cause such results to differ materially from any
forward-looking statements which may be deemed to have been made in this Report
or which are otherwise made by or on behalf of Pallet Management. For this
purpose, any statements contained in this Report that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the generality of the foregoing, words such as "may," "expect," "believe,"
"anticipate," "intend," "could," "estimate," or "continue" or the negative other
variations thereof or comparable terminology are intended to identify
forward-looking statements. Pallet Management is also subject to risks detailed
herein (see Item 6, "Risk Factors") or detailed from time to time in Pallet
Management's filings with the Securities and Exchange Commission.
PART I
Item 1. Description of Business
Introduction
Pallet Management was the first pallet company in the United States to
become publicly traded, in an industry currently valued at an estimated $6
billion. The Company is a leader in total solutions for pallet and other
transport packaging requirements and offers a wide variety of products and
services, from manufacturing to reverse distribution services. The primary users
of Pallet Management's services are companies from various industries, including
food and beverage; steel and metal; chemical and fluid; paper and fiber; and
printing.
The Company is an industry leader in reducing product distribution
costs for major manufacturers and distributors by providing value-added
transport packaging products and logistical services. As one of the largest
pallet manufacturing companies in the United States, Pallet Management has
continued to expand its line of business to include related transport packaging,
logistical and repair services. With two related lines of business,
manufacturing and services, Pallet Management primarily manufactures wood
pallets, which are the base of all transport packaging, and
warehouse-manufactured goods. Services related to transport packaging, which are
focused at reducing customer distribution costs, include transport packaging
retrieval, repair, recycling, sorting, storage, reverse distribution, tracking,
and other value added information services.
A significant portion of Pallet Management's current business is the
sale of pallets and services to CHEP Americas, which is part of the worldwide
CHEP organization that manages the largest pallet rental pool worldwide, with
more than 110 million pallets and containers in over 30 countries. CHEP services
the retail, grocery and automotive industries with high quality pallets and
containers.
Pallet Management's strategy is to manufacture and service pallets or
containers for niche markets. Manufacturing operations complement expansion of
the Company's related pallet and other transport packaging services that will
increase gross margins. All of Pallet Management's products and services are
designed to assist its customers in reducing the cost per trip of shipments of
goods.
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In order to fulfill the increasing demand for transport management
services, Pallet Management expects to expand its service offerings and its
network of facilities by opening company-owned facilities as well as entering
into affiliations with other pallet and logistics companies in strategic
locations. These additional locations will provide local retrieval, repair,
sortation, storage and recycling services for Pallet Management's national
customers. Pallet Management also expects to be able to accelerate its internal
growth by marketing expanded value-added information services to new and
existing customers.
Pallet Management is also seeking acquisitions as part of its growth
strategy. Acquisitions will enable it to capitalize on the significant trends
currently affecting product manufacturing and distribution practices throughout
the U.S. These trends include the increasing reliance by shippers and logistics
agents on outsourcing to smaller, better-capitalized companies which specialize
in specific segments of the distribution chain.
Industry Overview
Pallet Industry
A pallet is a platform, usually made of wood and assembled with metal
nails that is used for storing and shipping goods. Pallets allow goods to be
transported or warehoused economically by providing a foundation for forklifts
and vertical storage. Pallets are used in virtually all U.S. industries where
products are physically distributed, including the automotive, chemical,
consumer products, grocery, produce and food production, paper and forest
products, retail, and steel and metals industries. Without pallets, shipping by
air, land and sea would be severely hampered. Pallets come in a wide range of
shapes and sizes. Although pallets are primarily made of wood, they may also be
made from steel, plastic, cardboard, molded wood fiber and other materials to
satisfy smaller niche markets. It is estimated by industry sources that there
are over 7 pallets for each person in the United States, and Pallet Management
believes that there are over 1,000 different sizes and specifications of pallets
used in North America. The grocery industry, however, which accounts for
approximately one-third of the all new pallets produced in the United States,
uses a standard size 48 x 40-inch pallet referred to as a GMA pallet. Other
industries utilize unique specifications that are appropriate for their
particular needs. According to a survey conducted by the National Wooden Pallet
and Container Association ("NWPCA"), 91% of pallet users reported using wood
pallets, with just 5% or less using plastic, a combination of wood and plastic,
or other material. The wooden pallet has traditionally been the basis for the
design of storage racks, warehouse storage areas, forklifts, docks and
containers used in shipping goods.
Many pallets are not durable enough for multiple trips. The
manufacturing capacity for the standard GMA pallet is in excess of demand and
unless one is manufacturing a top quality durable pallet for a customer who
wants to use their pallets for multiple trips, the margins are very slim.
Standard GMA pallets weigh approximately 45 lbs. and are designed to hold 1,500
pounds of goods. Since CHEP has a pool of pallets that are continually reused,
it demands a higher quality, better-engineered pallet, which is more durable. A
CHEP pallet weighs approximately 60 lbs., and is engineered to hold 2,800 pounds
of goods.
Based on information supplied by industry sources, Pallet Management
estimates that the U.S. pallet industry generated revenues of approximately $6
billion in 1998, and it is served by approximately 3,600 companies, most of
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which are small, privately-held entities. These companies are generally
operating in only one location and serving customers within a limited geographic
region. The industry is generally composed of companies that manufacture new
pallets and companies that repair and recycle pallets. According to the U.S.
Forest Service, there are approximately 2 billion pallets in the United States,
with 1 billion in use. They estimate 400 million new wood pallets are produced
annually, 175 million wood pallets are repaired and sent back into circulation,
and 225 million wood pallets are sent to landfills. New wood pallet sales in the
United States alone are in excess of $4 billion per year.
The pallet industry has experienced significant changes and growth
during the past several years. These changes are due, among other factors, to
the focus by Fortune 1000 businesses on improving the logistical efficiency of
their manufacturing and distribution systems. This focus has caused many of
these businesses to attempt to reduce significantly the number of vendors
serving them in order to simplify their procurement and product distribution
processes. It has also prompted large manufacturers and distributors to
outsource key elements of those processes that are not within their core
competencies and to develop just-in-time procurement, manufacturing, and
distribution systems. With the adoption of these systems, expedited product
movement has become increasingly important and the demand for a high quality
source of pallets has increased. Palletized freight facilitates movement through
the supply chain by reducing costly loading and unloading delays at distribution
centers and warehouse facilities. However, the use of low-quality or improperly
sized pallets may increase product damage during shipping or storage. As a
result, there has been an increased demand for high-quality pallets in an
attempt to decrease the cost per trip by reducing product damage during shipping
and storage, and increasing the number of trips for which pallets can be used.
The broad changes affecting the U.S. industry have created significant
demand for higher quality pallets distributed through an efficient, more
sophisticated system. Environmental and cost concerns have also accelerated the
trend toward increased reuse or "recycling" of pallets and certain other
transport packing materials, further increasing the importance of the quality of
newly manufactured pallets. In recognition of these trends, CHEP has established
an international system that provides high-quality pallets to customers
worldwide. CHEP is a partnership created by Brambles Industries Limited, an
Australian publicly-held corporation, and GKN, Ltd., a publicly held U.K.
corporation. CHEP outsources its pallet manufacturing and some of its repair
operations. During the fiscal year ending June 24, 2000, approximately 83% of
Pallet Management's revenues and a significant percentage of Pallet Management's
growth were attributable to CHEP. Pallet Management expects to continue to build
its relationship with CHEP. However, additional growth is anticipated to
diversify revenues into other areas.
CHEP's pallet leasing system represents a significant change in the
U.S. grocery pallet market. CHEP leases high quality, standardized and easily
identifiable (all CHEP pallets are painted blue) 48" by 40" pallets, primarily
for use by grocery and consumer product manufacturers. CHEP pallets are
manufactured to strict specifications by vendors, including Pallet Management,
that have been selected based on their ability to provide large volumes of high
quality pallets manufactured to CHEP specifications in a timely manner.
Due to the high cost of plastics and other materials, wood is the
preferred and "more environmentally conscious" material (a renewable resource)
for pallets. Wood pallets are also generally stronger, more repairable, and less
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expensive than comparable plastic pallets. Plastic pallets currently have a
limited market where "closed loop" systems can be individually monitored and
retrieved for reuse.
Third Party Logistics Industry
As manufacturers and retailers continue to drive down the costs of
distribution, they will continue to look to third party logistics companies. It
is estimated that about 7%, or approximately $40 billion, of relevant logistics
costs are currently managed by third party logistics companies. Within the next
3 to 5 years, this sector could capture 10% to 15% of the available market.
Third party logistics companies include outsourcing companies that manage
portions of a company's supply chain. Outsourcing supply chain management gives
companies a competitive edge and drives profitability. The third party logistics
industry is expected to experience an annual growth rate of about 20%, driven
primarily by the continued outsourcing of specific supply chain logistics
functions. Management believes that this industry will eventually be ready for
consolidation, as customers will want third-party logistic companies to increase
their scope of service offerings on a global level.
Reverse Distribution, a sub-industry of the logistics industry, is
estimated to have grown from $4.6 billion in 1997 to over $7.7 billion in 2000
in the United States. It is rapidly growing and becoming more diverse and
complex as its importance to the supply chain becomes more evident. Reverse
Distribution is defined as the opposite of direct distribution. It is moving
products back up the supply chain to the original manufacturer, and reverse
logistics is the process by which this occurs. The increasing importance of
reverse distribution in the market place is a key factor in the dramatic changes
taking place in the pallet industry.
Until recently, pallet manufacturers were focused on producing the
cheapest pallet for their customers, who considered their packaging material an
expense. Manufacturers and distributors are now discovering that the lowest cost
per trip for their packaging material is realized when high quality packaging is
utilized and subsequently returned for re-use in a reverse distribution system.
They are viewing packaging material now as an asset instead of an expense and
require a reverse distribution system to return their packaging assets. Pallet
Management is aggressively pursuing this market as a sub-specialist in reverse
distribution for packaging materials.
Growth Strategy
Pallet Management's goal is to become a leading national provider of
pallets and related transport packaging services by continuing to expand its
existing operations and seeking strategic acquisitions. Pallet Management
believes that a significant market opportunity exists for a company that can
consistently offer high-quality pallets and related value-added services to
large pallet users in the U.S. Pallet Management believes that its management's
experience, industry reputation, and existing customer base will provide the
Company with a significant competitive advantage as it pursues its growth
strategy. Elements of its strategy include:
o CHEP
o Specifically Engineered Niche Market Manufacturing
o Reverse Distribution Services
o Acquisitions
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CHEP
Pallet Management has entered into a series of multi-year manufacturing
agreements with CHEP to produce specially engineered grocery pallets in
strategic locations. CHEP is the world's largest pallet pooling company with a
pallet pool worth over $2 billion consisting of over 110 million pallets in more
than 30 countries worldwide. CHEP markets to the grocery, retail, and automotive
industries, where large volumes of standard size pallets can be contained in a
closed loop-system. Based on published information, CHEP has a market share of
88% of all leased pallets worldwide and dominates 90% of the markets in which
they operate. CHEP is by far the largest participant in the U.S. pallet industry
and does not have a significant pallet-pooling competitor. During each of the
calendar years 2000 and 2001, Chep is projected to invest several hundred
million dollars to purchase 16 million new pallets as their growth continues to
accelerate in the United States.
Pallet Management opened a new manufacturing facility in Rogersville,
Alabama, in September 1998, another manufacturing facility in Bolingbrook,
Illinois, just outside Chicago, in April 1999, and a third manufacturing
facility in Plainfield, Indiana, just outside Indianapolis, in August 1999.
Pallet Management is currently using these new facilities to manufacture CHEP
pallets. Pallet Management has invested over $4.2 million in "state-of the
art" pallet manufacturing equipment for these facilities, including a new
$1.5 million "Vanderloo" nailing machine system custom made for Pallet
Management in Holland and installed at the Company's Plainfield, Indiana
facility.
In addition to pallet manufacturing, Pallet Management also offers to
CHEP Reverse Distribution Services. Pallet Management has a facility which
sorts, repairs, warehouses and returns pallets to the CHEP pallet pool.
Pallet Management has had a business relationship with CHEP for over
ten years and CHEP is expected to be Pallet Management's largest customer for
the next several years during which Pallet Management will support CHEP's
projected growth. While Pallet Management is continuously developing its CHEP
relationship, it continues to aggressively pursue other areas of growth, which
are expected to generate higher margins.
Specifically Engineered Niche Market Manufacturing
Many manufacturers require specially engineered pallets to transport
their goods. Pallet Management targets these markets due to the limited number
of pallet manufacturers that can produce specialized pallets, the established
reputation of Pallet Management in the industry for being a high quality pallet
manufacturer, and the higher profit margins realized in the production of these
pallets.
Niche market pallets are uniquely engineered to transport a specific
product and are not universally used like the standard GMA or CHEP pallet.
Examples of niche pallets Pallet Management builds include those for the metals
and the fibers industries. These types of pallets are specially engineered by
Pallet Management by using PDS (Pallet Design System), a system developed by
Virginia Tech's Pallet Laboratory in conjunction with the National Wooden Pallet
and Container Association.
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Most niche market pallets cost more than high volume grocery pallets
and yield high margins due to their uniqueness and strict specifications, which
are required for automated warehousing operations. Pallet Management is
aggressively marketing its experience and expertise in this area, as it believes
that large manufacturing companies will always have a demand for specially
engineered pallets to transport certain kinds of goods.
Reverse Distribution Services
As large manufacturers have focused more of their attention on reducing
distribution costs, Pallet Management has expanded the marketing of its Reverse
Distribution Services. Reverse Distribution is the systematic retrieval,
sortation, repair, warehouse and return of pallets and other packaging material
that creates closed-loop return systems between the manufacturer, their
customers, and their vendors. Pallet Management's customers own the pallets or
containers that are loaded with their products for transport. Large
manufacturing companies often make sizable investments in specially engineered
and heavy-duty pallets. Pallet Management can recover, sort, repair, warehouse
and return a niche pallet to a customer for significantly less than the cost of
a new pallet, thereby eliminating or reducing some of its customers'
distribution expenses. At the same time, Pallet Management generates greater
margins than when a new pallet is built. The key to successfully implementing a
large-scale reverse distribution program is to have an integrated retrieval
network. Pallet Management is actively seeking strategic relationships to more
fully develop a nationwide reverse distribution network.
Pallet Management is forming the majority of its reverse distribution
network through the utilization of the over 3,600 existing pallet manufacturers
and recyclers across the United States, as well as creating its own facilities.
Many of the smaller pallet companies are looking for an affiliation with a
national company as they lack the ability to market their company beyond a
limited geographic region, customers demand more diverse geographical services,
and CHEP continues to impact the grocery pallet market. Pallet Management
believes that many of these companies have excess capacity and are willing to
affiliate with Pallet Management on a fee-for-service basis.
During this fiscal year, the Company launched PalletNet, an Internet
logistics and information system that manages the flow of pallets and other
shipping platforms and containers throughout industrial supply chains. As part
of the Company's strategy to use the Internet to enhance customer service,
PalletNet provides reverse distribution with a single source national contact.
This service is supported by leading edge technology that enables users to
improve asset control and reduce cost and waste from their supply chain.
With PalletNet, the Company creates added value for the customer
through lower costs and improved efficiencies. Several Fortune 500 companies
currently use the expanded services of PalletNet, which enables the Company to
gain additional business from both existing and potential customers.
The PalletNet e-portal is a browser-based user interface combined with
three levels of security management which delivers safe and unlimited access to
customers. Customers can view exactly where their shipping platforms and
containers are in their supply chain at any given moment. The system also offers
a full range of personalization options, so each company can configure PalletNet
to their operations. In addition, PalletNet has the capacity to use bar codes
and integrate radio frequency identification ("RFID") tags to track individual
pallets and the equipment transported on them.
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These additional services provide the Company's customers the
flexibility to meet almost any industrial needs in terms of reverse distribution
and transport packaging, and an even higher level of customer service and
improved supply chain efficiency.
Acquisitions
Pallet Management intends to actively pursue acquisitions within its
existing markets and new markets to increase its market penetration, as well as
to provide a broader range of services to existing customers in those markets.
These acquisitions will primarily involve transport services businesses and
smaller pallet companies whose operations can be incorporated into Pallet
Management's existing operations without a significant increase in
infrastructure, as well as those that will provide Pallet Management with the
ability to service new customers or existing customers in new locations. Pallet
Management does not currently plan to acquire any significant additional
manufacturing capacity and does not have any current agreements or
understandings for any acquisitions. The Company will avoid such activities
until current operations are stabilized. The consideration for such
acquisitions, if consummated, could consist of cash, debt, equity or any
combination thereof.
Current Operations
Manufacturing
o High volume, high quality CHEP grocery pallet manufacturing
o Low volume, specially engineered niche pallet manufacturing
Services
o Reverse Distribution Services
o Retrieval, sort, repair, warehouse and return services
o Other Products
Manufacturing. New pallet manufacturing represents approximately 92% of
Pallet Management's revenues. The manufacturing process for new pallets at each
of Pallet Management's facilities is generally the most capital intensive part
of the business, with the majority of assembly and construction being automated.
New pallets are manufactured from an assortment of wood products, varying in
type and quality, with construction specifications determined by the pallet's
end user. Pallet Management believes that approximately 70% of the wood used in
new pallets manufactured in North America consists of hardwood (including, oak,
poplar, alder and gum), with the balance consisting of pine or other softwoods.
Pallet Management utilizes sawing equipment, which cuts large wood
sections to specification. The Company also purchases a vast quantity of pre-cut
lumber from outside vendors for pallet manufacturing. The cut wood is then
transported to assembly points where employees load the stringers ("runners") or
blocks and deck boards into nailing machines which nail the pallets together. A
typical nailing machine produces 1500 - 2,000 pallets per 8-hour shift with
three to ten employees. After construction is completed, pallets are prepared
for shipment or storage.
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All the high volume CHEP pallets and most of the lower volume
specifically engineered niche pallets are manufactured on automated nailing
machines. More customized or smaller niche pallet orders may be manufactured by
hand on assembly tables utilizing two laborers with pneumatic nailers. Pallet
Management typically manufactures pallets upon receipt of customer orders and
does not generally maintain significant finished goods inventory.
Services. Reducing the cost of product distribution in the supply chain
is the focus of Pallet Management's value-added services. Retrieval, sortation,
repair, warehouse and return services enable the customer to better utilize
their packaging assets. Besides being environmentally friendly, a properly
repaired used pallet will provide the customer significant savings over having
to buy a new pallet. Pallet Management initiates the retrieval or purchase of
used pallets from a variety of sources. The condition and size of these pallets
vary greatly. Once obtained, the pallets are sorted by size, condition and
potential customer. Pallets that can be repaired have their damaged boards
replaced with salvaged boards or boards from new stock inventory at the
facility. Pallets that cannot be repaired are dismantled and the salvageable
boards are recovered for use in repairing and building other pallets. Pallet
Management sells the remaining damaged boards to be ground into wood fiber,
which is used as landscaping mulch, fuel, animal bedding, gardening material and
other goods. Despite recent increases in levels of automation, pallet return
operations remain a labor-intensive process.
Other Products and Services. Pallet Management functions as a wholesale
distributor of other various returnable transport packaging such as plastic and
metal pallets; collapsible plastic bulk boxes; wood, plastic, and metal slave
pallets; wooden boxes and crates; and various other products. Due to lack of
demand, sales of pallets made from materials other than wood are minimal.
The Nelson Company Acquisition
In June of 1999, Pallet Management entered into an acquisition
agreement with The Nelson Company, a Baltimore, Maryland based pallet company.
Due to the inability to timely complete bank financing, the acquisition was
unwound in December 1999.
Pallet Management and The Nelson Company continue to work closely in
co-venture business relationships as they have done over the past 20 years. The
Nelson Company has a seasoned sales force that is strong in the analysis and
sales of reverse distribution networks, and compliments Pallet Management's
sales force in its drive for new PalletNet business.
Marketing and Distribution
Pallet Management uses its internal sales force in marketing its
products and services. With services being the primary focus of all marketing
efforts, Pallet Management seeks to efficiently serve large numbers of customers
across diverse markets and industries to provide a stable and diversified base
for ongoing sales of services and products.
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Pallet Management has over 200 customers, many of which are Fortune
1000 companies, including Honeywell, CHEP Americas, DuPont, IAMS, Mitsubishi,
Monsanto, Scotts Company, and various governmental agencies.
During the fiscal year ended June 24, 2000, CHEP accounted for
approximately 83% of Pallet Management's revenues. No other single customer
accounted for 10% or more of Pallet Management's revenues. Pallet Management
enters into contracts with CHEP on a facility by facility basis, and the terms
of such contracts vary in accordance with the service to be provided. The
Company's depot/repair agreement with CHEP, entered into in Petersburg,
Virginia, may be terminated with or without cause and has a fixed term of three
years, which is to expire in December 2000. We are working with Chep to extend
this agreement. Manufacturing contracts are on a multi-year basis and have
varying minimum pallet purchase requirements for each facility. All of the CHEP
contracts prohibit Pallet Management from engaging the corresponding facilities
to compete with CHEP during the term of the agreement and for up to three years
thereafter in the pallet leasing business and from repairing pallets for other
pallet leasing companies.
Suppliers
Pallet Management believes that there is an adequate supply of raw
material components for pallet production. The primary raw materials are
hardwood, softwood, used lumber, used pallets and nails. Pallet Management has
several principal suppliers, which are rotated depending on availability. During
the fiscal year ended June 24, 2000, Pallet Management purchased lumber and
plywood from over 50 vendors. The three largest suppliers accounted for
approximately 35%, 17% and 11 % of the lumber purchases. During the fiscal year
ended June 24, 2000, Pallet Management purchased approximately 5.6% of its
lumber from Clary Lumber Company, Inc., a North Carolina corporation ("Clary"),
at prices comparable to vendors other than Clary. Clary is owned by John C.
Lucy, Jr., a significant shareholder and former Director of Pallet Management,
and his son, John C. Lucy III, who is Pallet Management's CEO. See Item 12,
"Certain Relationships and Related Transactions." Pallet Management expects its
percentage of purchases from Clary to decrease in the future as Pallet
Management's lumber demands increase outside of Clary's geographic supply areas.
Pallet Management does not believe that the loss of any vendor would materially
adversely affect its financial condition or results of operations. Pallet
Management intends to continue to pursue a strategy of purchasing from
alternative sources of lumber.
Pallet Management's sales prices are closely related to the changing
costs and availability of lumber. While Pallet Management believes that it will
benefit from strong relationships with multiple lumber suppliers, there can be
no assurance that Pallet Management will be able to secure adequate lumber
supplies in the future. Lumber supplies and costs are affected by many factors
outside Pallet Management's control, including governmental regulation of
logging on public lands, lumber agreements between Canada and the U.S., and
competition from other industries that use similar grades and types of lumber.
In addition, adverse weather conditions may affect Pallet Management's ability
to obtain adequate supplies of lumber at a reasonable cost. Pallet Management is
also able to buy low quality lumber and upgrade such lumber at its own plants.
Though Pallet Management has studied the broad use of alternative materials for
the manufacture of pallets, such as plastic, it believes that there is not
currently an available alternative raw material that possesses the tensile
strength, recyclability and low cost of wood. Pallet Management continues to
evaluate alternatives to wood and is receptive to their future use in pallet
production.
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Competition
Pallet Management believes that the principal competitive factors in
the pallet industry are price, quality of services and reliability. With over
3,600 industry participants, the pallet manufacturing industry has been and is
expected to remain extremely fragmented and highly competitive. While there are
several companies which have attempted to establish national pallet operations,
most of Pallet Management's competitors are small, privately held companies that
operate in only one location and serve customers within a limited geographic
region. Pallet Management does not directly compete against many of these
companies to a large extent due to its concentration on CHEP and specialty
pallets, which are not made by most of its competitors, although they may at any
time attempt to compete directly with Pallet Management. New pallet
manufacturers can typically service up to a 300-mile radius, although recyclers
rarely market beyond a 100-mile radius. Pallet Management believes that it will
have a competitive advantage as it expands its national network of facilities,
thus benefiting from economies of scale while interfacing with customers'
nationwide distribution systems.
Competition is often intense and Pallet Management faces most of its
competition from other manufacturers. Pallet rental systems compete with new
pallet sales to the grocery and wholesales distribution industries, and may
expand into other industries in the future. Pallet Management does not compete
to any significant extent with pallet rental systems in the grocery industry and
intends to focus on industries and products in which pallet rental systems are
not competitive.
In addition, pallet manufacturing and recycling operations are not
highly capital intensive and the barriers to entry in such businesses are
minimal. Certain other smaller competitors may have lower overhead costs and,
consequently, may be able to manufacture or recycle pallets at lower costs than
Pallet Management. Other companies with significantly greater capital and other
resources than Pallet Management (including CHEP) may enter or expand their
operations in the pallet manufacturing and recycling businesses in the future,
changing the competitive dynamics of the industry. While Pallet Management
estimates, based on industry sources, that non-wooden pallets currently account
for less than 10% of the pallet market, there can be no assurance that Pallet
Management will not face increasing competition from pallets fabricated from
non-wooden components in the future. Pallet Management does not believe that
non-wooden pallets will be widely used until it is demonstrated that they
replicate the strength of wood pallets and until their cost decreases from their
current levels, which are well above the cost of similar wood pallets.
On a national level, at least one other company, IFCO systems, has
announced plans for national expansion.
Employees
Pallet Management currently has over 325 employees. These include
production workers who work on new and recycled pallets, clerical personnel,
logistical and computer personnel, facility management personnel, regional
management personnel, sales force, customer service personnel, administrative
personnel, and executive personnel.
11
<PAGE>
Item 2. Description of Property
Facilities: Pallet Management currently has 5 facilities in 4 states.
Bolingbrook, Illinois - Manufacturing Plant: This facility opened in
April 1999 at 335 Crossroads Suite B, Bolingbrook, Illinois in a 110,000-sq.-ft.
facility with a 5-year lease ending February 2004. It will employ up to 65
people once fully operational and will manufacture pallets on high-speed,
automated manufacturing lines.
Lawrenceville, Virginia - Manufacturing Plant: Located at 10324 Liberty
Road, Lawrenceville, Virginia, new pallet manufacturing is performed at this
Company-owned facility using automated equipment. This facility's primary
production is specifically engineered niche pallets and cutting lumber to size
for pallet production at this facility and shipment to other company facilities.
In addition, pallet recycling and repair services are performed at this
location, which has 60,000 sq. ft. of manufacturing buildings located on 70
acres, a 3,000-sq.-ft. office building and employs over 145 people.
Plainfield Indiana - Manufacturing Plant: This facility opened at 6030
Gateway Dr., Plainfield, Indiana, in August 1999 in a 130,000-sq.-ft. facility
with a 5-year lease ending September 2004. It will employ up to 65 people once
fully operational and will manufacture pallets on high-speed automated
manufacturing lines.
Petersburg, Virginia - Repair Depot: Located at 1925 Puddledock Road,
Petersburg, Virginia, this facility processes, repairs, and stores all types of
pallets. It contains a 40,000-sq.-ft. warehouse on eight acres of Company-owned,
mortgage-free property. There are approximately 50 people employed at this
facility, which contains "state of the art" automated sorting and repair
equipment.
Rogersville, Alabama - Manufacturing Plant: Located at 120 Industrial
Park Road, Rogersville, Alabama, this facility opened in September 1998 in a
25,500-sq.-ft. facility on seven acres with a three-year lease terminating
September 2001. It employs over 45 people manufacturing pallets on a high-speed
automated manufacturing line.
Corporate and Regional Offices: Corporate and regional offices are
located at the following addresses.
2900 Highwoods Parkway, Raleigh, North Carolina - Regional Offices -
Three year lease expiring September 2002.
2855 University Blvd, Suite 510, Coral Springs, Florida - Corporate
Headquarters - Five year lease expiring in October 2005.
Item 3. Legal Proceedings
None.
12
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
On April 27, 2000 the Company held its annual meeting of shareholders.
At the meeting, (i) five of the seven director nominees were elected, although
three of the existing board members/nominees (John C. Lucy, III, Zachary M.
Richardson and Donald Radcliffe) resigned prior to the meeting, (ii) the
Company's 1998 Omnibus Stock Option Plan was ratified to increase the number of
shares in the plan by 500,000, and (iii) the appointment of Pricewaterhouse
Coppers, LLC as the independent auditors was ratified.
(i) The following individuals were elected to the Company's Board of Directors
for a one-year term by the votes indicated, although three of the nominees (John
C. Lucy, III, Zachary M. Richardson and Donald Radcliffe) resigned prior to the
meeting:
<TABLE>
<CAPTION>
Name Votes For Votes Against Abstain
------------------------------------------- ------------------ ------------------ ------------
<S> <C> <C> <C>
John C. Lucy, III 1,667,963 2,070,044 25,150
------------------------------------------- ------------------ ------------------ ------------
Zachary M. Richardson 3,277,954 33,400 25,150
------------------------------------------- ------------------ ------------------ ------------
Donald Radcliffe 1,706,954 2,037,594 25,150
------------------------------------------- ------------------ ------------------ ------------
David W. Sass 3,920,189 0 25,150
------------------------------------------- ------------------ ------------------ ------------
Philip Feltman 3,298,895 19,000 25,150
------------------------------------------- ------------------ ------------------ ------------
Ronald Shindler 3,914,939 1,500 25,150
------------------------------------------- ------------------ ------------------ ------------
Robert Steiler 3,485,814 3,750 25,150
------------------------------------------- ------------------ ------------------ ------------
</TABLE>
(ii) Pallet Management's Omnibus Stock Option Plan was ratified by a vote of
3,038,292 for, 93,440 against and 18,400 abstaining.
(iii) The appointment of Pricewaterhouse Coopers, LLP. was ratified by a vote
of 3,836,238 for, 10,450 against and 725 abstaining.
13
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Pallet Management's Common Stock is quoted on the OTC Bulletin Board
under the symbol PALT. The following table sets forth the average of the high
and low bid prices of the Pallet Management's Common Stock as reported on the
OTC Bulletin Board for each quarter from June 28, 1999 through June 24, 2000.
The quotations are over-the-market quotations and, accordingly, reflect
inter-dealer prices, without retail mark-up, markdown or commission and may not
represent actual transactions.
<TABLE>
<CAPTION>
High Bid Low Bid
---------------------- ---------------------
FISCAL 1999
<S> <C> <C>
June 28, 1998 through September 26, 1998 14 1/8 3 1/2
September 27, 1998 through December 26, 1998 10 1/8 5
December 27, 1998 through March 27 , 1999 11 1/4 6 5/8
March 28, 1999 through June 26, 1999 10 15/16 5 1/4
June 27 , 1999 through September 25, 1999 6 1/4 3 7/8
September 26, 1999 through December 25, 1999 4 2 1/8
December 26, 1999 through March 25, 2000 5 5/8 1 1/2
March 26, 2000 through June 24, 2000 4 3/4 3 1/8
</TABLE>
As of September 30, 2000, there were 967 holders of record of the
Company's Common Stock. Pallet Management has not declared or paid any dividends
on its Common Stock in the last two fiscal years. All stock data and per share
amounts have been restated to give effect to the one-for-four reverse stock
split in February 1998.
The quotations in the foregoing table represent prices between dealers
and do not include retail markup, markdown, or commissions paid and may not
represent actual transactions. Such quotations are not necessarily
representative of actual transactions or of the value of the Company's
securities.
Dividend Policy
Pallet Management has not paid any cash dividends on its Common Stock
since its inception. Pallet Management presently intends to retain future
earnings, if any, to finance the expansion of its business and does not
anticipate that any cash dividends will be paid in the foreseeable future.
Future dividend policy will depend on Pallet Management's earnings, capital
requirements, expansion plans, financial condition and other relevant factors.
Sales of Unregistered Securities
None.
Item 6. Management's Discussion and Analysis or Plan of Operations
The following discussion and analysis should be read in conjunction
with Pallet Management's Consolidated Financial Statements and the Notes thereto
included in Part II, Item 7 of this Report.
The following discussion regarding Pallet Management and its business
and operations contains "forward-looking statements" within the meaning of
Private Securities Litigation Reform Act 1995. These statements consist of any
statement other than a recitation of historical fact and can be identified by
the use of forward-looking terminology such as "may," "expect," "anticipate,"
"estimate" or "continue" or the negative thereof or other variations thereon or
comparable terminology. The reader is cautioned that all forward-looking
statements are necessarily speculative and there are certain risks and
uncertainties that could cause actual events or results to differ materially
from those referred to in such forward looking statements, including the limited
history of profitable operations, dependence on a key customer, competition,
risks related to acquisitions, difficulties in managing growth, dependence on
key personnel and other risk factors discussed in this report. See "Risk
Factors." Pallet Management does not have a policy of updating or revising
forward-looking statements and thus it should not be assumed that silence by
management of the Pallet Management over time means that actual events are
bearing out as estimated in such forward looking statements.
14
<PAGE>
Results of Operations
General
The Company has grown to be one of the largest pallet companies in the
more than $6 billion U.S. pallet industry, by providing value-added products and
services to our customers. Our customer base has grown to over 200 Fortune 1000
companies with sales for fiscal year 2000 being $62,445,175 from five facilities
in four states.
The majority of the Company's revenues have traditionally been
generated from providing high quality, specially engineered pallets to
manufacturers, wholesalers and distributors. As supply chain logistics have
become increasingly complex, the Company's existing customers as well as
prospective customers are seeking new ways to streamline distribution and reduce
costs, which is opening a huge service-orientated market for the Company.
With this shift in focus toward services and cost efficiency, the
Company is providing "state of the art" logistical services known as Reverse
Distribution. Reverse Distribution is simply defined as maximizing the use of
transport packaging, the base of which is the pallet, by reusing assets to
reduce the overall cost per trip.
This shift in focus toward supply chain cost efficiency by the
Company's customer base is by far the most dramatic shift in focus and provides
the most opportunity for the Company. Driven mainly by economics, reusable
packaging in a Reverse Distribution system also has environmental marketing
benefits.
As this market of Reverse Distribution is just starting to be created,
the economic advantages to companies that are implementing it are huge; thus the
demand is overwhelming. The Company is working diligently as an industry leader
in this area, as the growth potential continues to unfold.
Reverse logistics, a sub-industry of the logistics industry, is growing
rapidly and is estimated to be $7.7 billion by the end of calendar year 2000.
The Company is positioning itself to become a third-party sub-specialist in
reverse logistics of pallets and other packaging material. The third-party
logistics industry is estimated to be in excess of $35 billion and growing
rapidly as companies are discovering the benefits of outsourcing their
logistical demands.
The Company has two lines of revenue, manufacturing and services;
Manufacturing: The Company has two primary categories of manufacturing:
CHEP grocery pallets and specifically engineered niche market pallets. The
Company has multi-year contracts to manufacture high quality grocery pallets for
CHEP, the world's largest pallet rental pool. The Company has three
manufacturing facilities which currently produce CHEP pallets.
15
<PAGE>
Pallets that are uniquely engineered to transport a specific product
are classified as niche market pallets. Besides CHEP, our company's customer
base is primarily composed of customers who require niche pallets. Niche pallets
are lower volume and higher margin than CHEP pallets.
Services: The Company provides three types of services: 1) Retrieval,
sortation, repair, warehousing and return, 2) reverse distribution, and 3) other
products.
Retrieval, sortation, repair, warehousing and return services enable
the Company's customers to better utilize their packaging assets. Besides being
environmentally friendly, a properly repaired used pallet will provide the
customer significant savings over having to buy a new pallet. A large portion of
new pallets is currently discarded by pallet users after one use. Pallet
Management initiates the retrieval or purchase of used pallets from a variety of
sources. The condition and size of these pallets vary greatly. Once obtained,
the pallets are sorted by size, condition and potential customer. The pallets
are sorted and repaired as necessary, placed in storage and made available for
return to service ("depot services"). Pallets that can be repaired have their
damaged boards replaced with salvaged boards or boards from new stock
inventoried at the facility. Pallets that cannot be repaired are dismantled and
the salvageable boards are recovered for use in repairing and building other
pallets. Pallet Management sells the remaining damaged boards to be ground into
wood fiber, which is used as landscaping mulch, fuel, animal bedding, gardening
material and other items. Despite recent increases in levels of automation,
pallet repair and return operations remains a labor-intensive process.
Reverse Distribution Services can carry the retrieval, sort, repair,
warehouse and return services one step further by contracting with a customer to
track either their pallet flow or individual pallets themselves.
Pallet Management functions as a wholesale distributor of other various
returnable transport packaging such as plastic and metal pallets; collapsible
plastic bulk boxes; wood, plastic, and metal slave pallets; wooden boxes and
crates; and various other products. Due to lack of demand, sales of pallets made
from materials other than wood are minimal.
Without the pallet, the supply chain would be severely hampered, though
it is also the weak link in the supply chain. If a manufacturer or wholesaler
can manage their pallet assets, distribution logistics become dramatically
simplified and more cost effective. Unlike most companies that are entering the
logistical distribution arena through the transportation industry, the Company
is responding to customer demands for Reverse Distribution Logistics through the
pallet industry. This approach will provide the Company with a more
cost-effective "seamless system" which provides increased benefits to the
customer base and will give Pallet Management Systems an advantage over
competition from current logistic companies.
Fiscal Year Ended June 24, 2000 Compared to Fiscal Year Ended June 26, 1999
For the year ended June 24, 2000, net sales increased 61% to
$62,445,175 from $38,744,129 for the prior year. This increase was due mainly to
an increase in new pallet sales, which accounted for 92% of net revenues, as
opposed to 77% of net revenues the previous year. The increase in new pallet
sales resulted from a significant increase from one major customer, which
accounted for approximately 83% and 75% of 2000 and 1999 net sales respectively.
16
<PAGE>
Sales other than new pallet sales, comprised principally of service, accounted
for 8% of net revenues, as opposed to 23% of net revenues the previous year.
These sales dropped from approximately $8,911,000 in fiscal year 1999 to
approximately $ 4,996,000 in fiscal year 2000. The decrease is a result of
selling the Ocala facility and closing the Orlando facility at the end of fiscal
year 1999, and closing the Lakeland facility in fiscal year 2000.
Cost of sales for 2000 was $59,097,842 or 95% of net sales, as compared
to $35,012,585 or 90% of net sales for 1999. This increase reflects the higher
expenses associated with the opening of a new facility in Indiana in the first
quarter of fiscal year 2000, which did not recognize significant sales until the
end of the second quarter. In addition, the Company lost sales at its
Lawrenceville facility as CHEP sales were shifted to other facilities. The
Company was unable to reduce costs commensurate with the decrease in sales. The
Company also experienced operational problems and a significant theft at its
Bolingbrook, Illinois facility, which opened during the third quarter of the
previous fiscal year. See Liquidity and Capital Resources. Other costs remained
consistent as lumber prices remained stable. The Company hopes to recognize
efficiencies in fiscal 2001 with larger production runs and improved management
structure. For the fourth quarter of fiscal 2000, cost of sales were equal to
90% of the Company's revenues, as the gross profit increased by $1,885,000
during the fourth quarter of the fiscal year.
Selling, general and administrative expenses were $4,899,091 or 7.8% of
net sales in 1999, as compared to $2,944,355 or 7.6% of net sales in 1999. This
dollar increase was a result of additional administrative costs related to the
sales volume increase and expenses related to expanding the Reverse Distribution
business and investments in the PalletNet web page and Pallet Net e-portal.
Net interest expense increased to $545,119 in 2000 from $299,019 in
1999. This increase resulted from increased borrowing related to increased sales
volume, as well as to sustain operations. This increase in sales volume required
increased purchasing of raw materials for production, which in turn increased
the average borrowing base and the related interest expense.
Net loss for 2000 was $2,249,967 compared to a profit of $537,529 in
1999. During the first three quarters of the fiscal year, the Company underwent
a reorganization of management in which management positions were eliminated and
substantial charges were incurred totaling approximately $725,000. Of this
amount, costs included in selling, general and administrative consisted of
$32,000 for legal and accounting expenses related to a postponed equity offering
and the Nelson Company transaction, $67,000 for closing the Cary, North
Carolina, and Richmond, Virginia offices and $192,000 for custom software which
is outdated and no longer used. Costs included in other expenses or in cost of
goods sold consisted of $77,000 for equipment at the Bolingbrook, Illinois
facility that is not economically efficient, and $325,000 related to the closing
of the Lakeland, Florida facility. Included in interest expense is $72,000 in
costs relating to costs of obtaining the National Bank of Canada loan, which
were amortized over the life of the loan. During the fourth quarter of fiscal
2000, the Company focused on cost control while assembling a core management
team to oversee the operations of the Company. The results can be seen as the
Company had a gross profit of approximately $1,885,000 and a net income of
$47,800 for the fourth quarter of fiscal year 2000. The Company continues to
focus on cost control in normal pallet manufacturing while investing in the
service and system side of the business to ensure long term viability. Future
profitability will be directly related to the Company's ability to sell higher
than average quality pallets and link this with Reverse Distribution.
17
<PAGE>
Liquidity and Capital Resources
The Company had $577,052 of cash on hand at June 24, 2000, compared to
$262,117 at the beginning of fiscal year 1999. Net cash used in operating
activities was $2,143,000 for the year, primarily for covering the net operating
loss for the year as well as for funding accounts receivable and inventory
increases. During fiscal year 2000, the Company purchased approximately
$1,198,000 of fixed assets, including $79,000 pursuant to capital lease
obligations.
In connection with the exercise of options by two stockholders, who are
officers of the Company, the Company received notes receivable totaling $276,000
during this period.
In the third quarter of fiscal 2000, the company secured $9,609,000 in
financing with LaSalle Business Credit, Inc. This new funding replaced the
previous $10,000,000 from the National Bank of Canada. The new credit facility
has more favorable terms than the previous agreement with the National Bank of
Canada, with additional availability for real estate. The new facility bears
interest at a rate of prime for the revolver, and prime plus one quarter to one
half for the term loans. At August 31, 2000, the Company had approximately
$2,829,000 of availability (inclusive of loan balances of approximately
$1,157,000) under the line of credit.
In mid-September, 1999 the Company discovered a theft at its
Bolingbrook facility, estimated to be $640,000, consisting of raw material, work
in process and finished goods. The Company has changed the management at this
facility, a private investigator has been retained, and this theft is being
pursued with the local authorities. This loss has been included in cost of goods
sold over a time frame which included a portion of fiscal year 1999.
Pallet Management intends to pursue expansion and acquisition plans,
which may include the opening of additional facilities as well as the
acquisition of additional facilities or companies. The success and timing of any
such plans and required capital expenditures cannot be reasonably estimated at
this time and the Company has no current arrangements with respect to any such
acquisition or expansion. Funding for these plans and for ongoing operations
could be a combination of issuance of additional equity, working capital,
additional borrowings, and profits from operations. Pallet Management can not
make any assurances that such funding would become available for such plans.
Management believes that existing cash on hand, cash provided by future
operations including both the expansion of the Plainfield manufacturing facility
and PalletNet distribution products and services, additional borrowings under
its current line of credit, and a net working capital of $3,124,000 as of June
24, 2000, will be sufficient to finance its operations and expected working
capital and capital expenditure requirements for at least the next twelve
months.
At the December 1999 Board of Directors meeting, Donald Radcliffe was
elected as Chairman. At the April 27th annual shareholder's meeting, the
shareholders elected three new outside directors to its Board of Directors.
Philip Feltman, Robert Steiler and Ronald Shindler were elected to join David
Sass on the Board who became Chairman. Prior to the meeting, John C. Lucy III,
Donald Radcliffe and Zachary Richardson resigned from the Board. Mr. Lucy
remains Chief Executive Officer and Mr. Richardson remains President.
18
<PAGE>
Year 2000
Pallet Management did not experience any significant occurrences
related to the "Year 2000 Problem."
Risk Factors
Limited History of Profitable Operations
The Company reported a net loss of $2,249,967 for the fiscal year
ended June 24, 2000, net income of $537,529 for the fiscal year ended June 26,
1999, net income of $191,627 for the fiscal year ended June 27, 1998 and a net
loss of $882,977 for the fiscal year ended June 30, 1997. The Company reported
a net profit of approximately $47,800 for the last quarter of fiscal 2000. The
Company cannot guarantee that it will sustain growth, that it will again
become profitable or that it will maintain sufficient revenues for
profitability. The Company cannot guarantee that it will sustain or increase
profitability on a quarterly or annual basis in the future.
Dependence on Key Customer
The Company currently depends on CHEP for a material portion of its
business. During the fiscal year ended June 24, 2000, approximately 83% of the
Company's revenues and a significant percentage of its growth was attributable
to CHEP. The Company expects that the revenues from CHEP may account for up to
80% of its revenues and will continue to be a material portion of its business
for the next fiscal year until the Company grows its Reverse Distribution
business. In addition, CHEP is the predominant customer of certain of the
Company's facilities. If CHEP were to materially decrease its purchase of
pallets and services from the Company for any reason, the Company's financial
condition and results of operations would be materially adversely affected. The
Company has entered into a separate agreement with CHEP for each facility that
performs CHEP repair or depot services. These agreements do not contain fixed
volume requirements and have various terms of up to three years. The Company
cannot guarantee that CHEP will not terminate its existing agreements with the
Company, or that CHEP will renew its existing agreements with the Company.
Supply and Demand for Lumber
Pallet prices are closely related to the market price of lumber, the
principal raw material used in the manufacture and repair of wooden pallets. If
lumber prices increase sharply, the Company may not be able to pass this
increase on to its customers. The Company has attempted to index the sale prices
of its pallets based on its lumber costs, although the Company has not always
been able to do so.
The price of lumber has been volatile in recent years due to factors
beyond the Company's control, including:
o weather and other natural events,
o governmental regulation of logging on public lands,
o lumber agreements between Canada and the U.S., and
o competition from other industries that use similar grades and
types of lumber.
19
<PAGE>
Although the Company typically buys its lumber in the open market, the
Company purchased approximately 64% of its lumber from 3 suppliers in fiscal
2000. The Company purchased approximately 5.6% of its lumber from a related
company, Clary Lumber Company, Inc., a North Carolina corporation. See Item 12,
"Certain Relationships and Related Transactions." However, the Company might be
unable to purchase adequate lumber supplies to meet its needs. To the extent the
Company encounters adverse lumber prices or is unable to procure adequate
supplies of lumber, the Company's financial condition and results of operations
could be materially adversely affected.
Competition from Other Companies
There are over 3,600 companies that manufacture pallets or provide
pallet recycling services. Many of these are small companies that concentrate on
the grocery and retail businesses in which the Company does not generally
compete, although they might at any time attempt to compete directly with the
Company. The Company generally services specialty markets and other services in
which there are not as many competitors. CHEP's pallet rental system competes
with new pallet sales to the grocery and wholesale distribution industries, and
may expand into other industries in the future.
Pallet manufacturing and recycling operations are not highly capital
intensive, and the barriers to entry in these businesses are minimal. Smaller
competitors might have lower overhead costs and consequently, may be able to
manufacture or recycle pallets at lower costs than the Company. Other companies
with significantly greater capital and other resources than the Company
(including CHEP) might enter or expand their operations in the pallet
manufacturing and recycling businesses in the future, which could change the
competitive dynamics of the industry. The Company has competed in the past and
will continue to compete with lumber mills for sales of new pallets. While
industry sources estimate that non-wooden pallets currently account for less
than 10% of the pallet market, the Company might face increasing competition
from pallets fabricated from non-wooden components in the future.
Potential Increase in Debt and Interest Expense
On August 26, 2000, the Company established a $9,609,000 borrowing
facility with LaSalle Business Credit, Inc., of which approximately $4,498,000
is outstanding. The Company uses the facility to finance receivables, inventory,
and real estate as well as for various other corporate purposes including the
purchase of new equipment. Thus, the Company's debt and interest expense may be
substantially higher in the future, which could limit the Company's flexibility.
In addition, this bank has a lien on substantially all of the Company's assets.
Potential Risks Related to Acquisitions
One of the Company's growth strategies is to acquire additional pallet
manufacturing and recycling companies to increase the Company's revenues and
markets. Acquisitions involve a number of risks, including:
o adverse short-term effects on the Company's operating results;
o difficulties in successfully integrating and managing
additional businesses;
o diversion of management's attention;
o dependence on retention, hiring and training of key personnel;
o loss of existing or anticipated customers of the acquired
companies;
o unanticipated problems or legal liabilities; and
o amortization of acquired intangible assets.
20
<PAGE>
Some or all of these risks could have a material adverse effect on the
Company's financial condition or results of operations. In addition, to the
extent that consolidation becomes more prevalent in the industry, the prices for
attractive acquisition candidates might increase and the number of attractive
acquisition candidates might decrease. The Company cannot guarantee that it will
be able to acquire additional businesses or successfully integrate and manage
such additional businesses.
Potential Problems in Financing Acquisitions
The Company intends to issue additional shares of its Common Stock as
partial consideration for future acquisitions. If the Common Stock does not
maintain a sufficient valuation or potential acquisition candidates are
unwilling to accept Common Stock as part of the consideration for the sale of
their businesses, the Company might be required to use more cash or bank
financing, if available, in order to complete acquisitions. If the Company does
not have sufficient cash resources or borrowing availability, the Company's
growth could be limited unless the Company is able to obtain additional capital
through future debt or equity financing. The Company does not currently have
sufficient availability under its current facility to finance any additional
acquisitions. Using cash to complete acquisitions and finance internal growth
could substantially limit the Company's financial flexibility. Using debt could
result in financial covenants that limit the Company's operations and financial
flexibility. The Company might be unable to obtain financing if and when needed
on acceptable terms. As a result, the Company might be unable to pursue its
acquisition strategy successfully.
Transactions With Affiliates
For fiscal 2000, the Company purchased approximately $2,349,000 or 5.6%
of its lumber supply from Clary Lumber Company, Inc., a North Carolina
corporation ("Clary"), which is owned by the family of John C. Lucy, Jr., a
principal shareholder and former Director of Pallet Management. John C. Lucy,
III, Mr. Lucy's son, is Pallet Management's Chief Executive Officer and a
minority shareholder of Clary. After procedures were performed by the Company's
auditors at the request of the Company, the Company believes that these
transactions were made at prices comparable to vendors other than Clary in the
ordinary course of business. The Company expects to purchase less than 5.6% of
its lumber from Clary for the foreseeable future.
Volatility of Stock Price
The trading price of the Company's Common Stock has been, and in the
future is expected to be, volatile. The Company expects to experience further
market fluctuations as a result of a number of factors, including:
o current and anticipated results of operations;
o changes in the Company's business, operations or financial
results;
o general market and economic conditions;
o competition;
o the number of shares outstanding;
o the number of market makers in the Company's stock;
o lumber prices; and
o other factors.
21
<PAGE>
Difficulties in Managing Rapid Growth
In the last year, the Company has experienced rapid growth, which has
placed a significant strain on the Company's personnel, its financial importing
system and other resources. The Company might be unable to:
o successfully implement its business strategy;
o generate sufficient cash flow from operations;
o manage its costs;
o obtain adequate financing on acceptable terms to fund continuing
growth; or
o successfully manage continued growth.
The failure to manage growth effectively might have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on Key Personnel
The Company materially depends upon the services of the following
individuals:
o John C. Lucy, III, Chief Executive Officer
o Zachary M. Richardson, President
o Marc Steinberg, Corporate Controller, Secretary and Treasurer
o Ellen Chambers, Director of Information Technologies
o Sandra Stoller, Director of Human Resources
The Company has five-year employment agreements with Messrs. Lucy and
Richardson that expire October 2003. In addition, the Company currently has
Key-man insurance in the amount of $1,000,000 for Messrs. Lucy and Richardson,
but does not have such insurance for any other director or officer of the
Company. The Company would be adversely affected by the loss of the services of
any of the above-mentioned individuals.
No Dividend Payments
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying cash dividends on its Common Stock in the foreseeable
future. The future payment of dividends is directly dependent upon the Company's
future earnings, capital requirements, financial requirements and other factors
to be determined by the Company's Board of Directors. For the foreseeable
future, it is anticipated that earnings, if any, which may be generated from the
Company's operations will be used to finance the Company's growth. See Item 5,
"Dividend Policy."
22
<PAGE>
Vulnerable Stock Price
If the Company's stockholders sell substantial amounts of their Common
Stock (including shares issued upon the exercise of outstanding options), the
market price of the Company's Common Stock could fall. As of September 30, 2000,
the Company had outstanding 4,065,612 shares of Common Stock, of which 3,069,550
shares are freely tradable in the public market, and of which 996,062 shares are
"restricted securities" under the Securities Act of 1933, as amended (the
"Securities Act"). The Company's officers, directors and employees own options
to purchase up to 1,488,884 additional shares of Common Stock.
Restricted securities may only be sold pursuant to an effective
registration statement under the Securities Act or in compliance with Rule 144
under the Securities Act or other exemption from registration. Rule 144 provides
that a person holding restricted securities for a period of one year may sell
such securities during any three-month period, subject to certain exceptions, in
limited amounts. Rule 144 also permits, under certain circumstances, the sale of
shares without any quantity limitations by a person who is not our affiliate and
who has held the shares for a two year holding period. No predictions can be
made as to the effect, if any, that market sales of such shares or the
availability of such shares for future sale will have on the market price of the
Common Stock prevailing from time to time.
Potential Issuance of Preferred Stock
The Company's Articles of Incorporation authorize 7,500,000 shares of
preferred stock, none of which are issued and outstanding as of the date hereof.
As provided in the Company's Articles of Incorporation, preferred stock may be
issued by resolutions of the Company's Board of Directors from time to time
without any action of the stockholders. These resolutions may authorize issuance
of the preferred stock and set dividend and liquidation preferences, voting
rights, conversion privileges, redemption terms and other privileges and rights.
Accordingly, the Company's Board of Directors may, without stockholder approval,
issue preferred stock with dividend, liquidation, conversion, voting or other
rights which could adversely affect the voting power or the rights of the
holders of the Company's Common Stock. The preferred stock could be utilized,
under certain circumstances, as a method of discouraging, delaying or preventing
a change in control of Pallet Management.
Antitakeover Effects in Our Charter Documents and Under Florida Law
Certain provisions of our Articles and Bylaws may be deemed to have
antitakeover effects and may delay, defer or prevent a hostile takeover,
including prohibition of shareholder action by written consent and advance
notice requirements for shareholder proposals and director nominations In
addition, Florida has enacted legislation that may deter or hinder takeovers of
Florida corporations. The Florida Control Share Act generally provides that
shares acquired in excess of certain specified thresholds will not have any
voting rights unless such voting rights are approved by a majority of the
corporation's disinterested shareholders. The Florida Affiliated Transactions
Act generally requires supermajority approval by disinterested shareholders of
certain specified transactions between a public corporation and holders of more
than 10% of the outstanding voting shares of the corporation (or their
affiliates).
23
<PAGE>
Item 7. Financial Statements
The financial statements are attached at the end of this document.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
On July 25, 2000, the Board of Directors of Pallet Management Systems,
Inc. (the "Company") recommended and approved the replacement of its principal
accountants, Pricewaterhouse Coopers LLP ("PWC"). Also, on July 25, 2000, the
Board of Directors recommended and approved the replacement firm of Kaufman,
Rossin & Co. ("Kaufman") as the Company's independent auditors, effective July
25, 2000.
PWC has not issued an audit report on the Company's financial
statements. A reportable event, within the meaning of Item 304(a)(1)(v) of
Regulation S-K, which is set forth in the following sentence, has occurred
during the two most recently completed years and subsequent interim periods,
preceding this change. The Company recently advised PWC that the Company and an
affiliate of two principal stockholders, one of whom is also an executive
officer of the Company, have agreed to conduct additional procedures of certain
transactions between the parties for potential conflicts of interest, and to
evaluate certain actions of the executive officer.
During the period of PWC's engagement, commencing on August 16, 1999
through July 25, 2000, and subsequent interim periods preceding this change,
there have been no disagreements with PWC on any matter of accounting principles
or practices, financial statement disclosures, or auditing scope or procedure,
which, if not resolved to the satisfaction of PWC, would have caused them to
make reference to the subject matter of such disagreements in connection with
issuing their reports. No reportable events, within the meaning of Item
304(a)(1)(v) of Regulation S-K, other than a set forth in the preceding
paragraph, have occurred during the two most recently completed years and
subsequent interim periods, preceding this change.
The Company reported the above change in its certifying accountants on
a Form 8-K, filed with the Securities and Exchange Commission (the "SEC") on
August 1, 2000. On August 16, 2000, the Company filed an amendment to its Form
8-K with the SEC, attaching a letter written by PWC to the SEC which stated that
it agreed with the statements made by the Company in its Form 8-K.
24
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
The following table sets forth the names, ages and positions held with
respect to each Director and Executive Officer of the Company.
<TABLE>
<CAPTION>
Name Age Position
------------------------------------------------ -------- -------------------------------------------------
<S> <C> <C>
John C. Lucy, III 42 Chief Executive Officer
Zachary M. Richardson 45 President
Marc Steinberg 38 Corporate Controller, Treasurer and Secretary
David W. Sass 64 Chairman of the Board
Alan P. Sklar 61 Director
Philip Feltman 80 Director
Ronald Shindler 53 Director
Robert Steiler 52 Director
</TABLE>
Directors and Officers
John C. Lucy, III has served as Chief Executive Officer of the Company
since 1995. In addition to being CEO of the Company, he is President of Clary
Lumber, a hardwood lumber sawmill located in Gaston, North Carolina (see Item
12, "Certain Relationships and Related Transactions"), and is also
Vice-President of Blacksburg Enterprises, Inc., which operates Baskin-Robbins
and Sub-Station II franchises in Blacksburg, Virginia. From 1995 through 1999,
Mr. Lucy served the Company as both CEO and Chairman of the Board. Mr. Lucy has
also been actively involved in the National Wooden Pallet and Container
Association ("NWPCA"), where he served for two years as Chairman of the Military
Packing Task Force, and for three years as Chairman of the Research Steering
Committee. Mr. Lucy graduated from Virginia Tech University with a Bachelor of
Science degree in business.
Zachary M. Richardson has been President of the Company since 1994,
when Pallet Recycling Technologies, Inc. (PRTI) acquired the Company in a
reverse acquisition. Mr. Richardson was president and founder of PRTI and has
been involved in the pallet industry since 1991 with over 24 years of management
and sales experience as well as investment banking and financial management
experience. From 1994 until April 2000, Mr. Richardson also served the Company
as a Director. After graduating from Franklin and Marshall College in 1977, he
was commissioned in the United States Navy and designated a Naval Aviator. On
active duty for eight years he maintained his reserve status in the Navy until
his retirement from the reserves in 1997. Mr. Richardson is an active member of
the NWPCA and has served on the association's Recyclers Council Executive
Committee, which deals with national issues related to pallet recycling.
25
<PAGE>
Marc Steinberg joined the Company in July, 2000 as its Corporate
Controller. Mr. Steinberg was also appointed Treasurer and Secretary effective
August 2000. Mr. Steinberg has worked in the field of accounting for the past 17
years, and has extensive experience in the manufacturing industry. Prior to
joining the Company, Mr. Steinberg served as the controller for the
transportation and education subsidiaries of TFG Corporation. Prior to that, Mr.
Steinberg served as the controller of RTP Corp. (an electronics equipment
manufacturer), controller for Mederer Corporation (a candy manufacturer), and
cost accounting manager for Sensormatic Electronics Corp. (an electronics
equipment manufacturer). Mr. Steinberg has a CPA license, a CMA license and is
certified in Production and Inventory Management. Mr. Steinberg graduated from
the University of Florida in 1984 with a Bachelors degree in Accounting.
David W. Sass was appointed a Director of the Company in July 1998, and
became Chairman of the Board in April 2000. Mr. Sass has, for the past 39 years,
been a practicing attorney in New York City and is currently a senior partner in
the law firm of McLaughlin & Stern, LLP. Mr. Sass is a director of BarPoint.com,
Inc., a company that will operate a patent pending search engine and software
technology to allow consumers to use the standard UPC barcode to search for
product specific information on the Internet. Mr. Sass also serves as an officer
for Westbury Metals Group, Inc., a company engaged in the refining of precious
metals, and as an officer for Pioneer Commercial Funding Corp., a company
formally engaged as a mortgage warehouse lender providing short term financing
to mortgage bankers. Mr. Sass is a member and Vice Chairman of the Board of
Trustees of Ithaca College.
Alan P. Sklar was appointed a Director for the Company in August 2000.
Mr. Sklar has been a CPA for 39 years. Mr. Sklar founded the Chicago CPA and
management consulting firm, Gleeson, Sklar, Sawyers & Cumpata LLP in 1967, and
is presently a senior partner in the firm, where he primarily consults with
middle market manufacturers and distributors. Mr. Sklar serves as an advisor to
the board of his firm for many of his firm's clients. Mr. Sklar also serves on
the board of directors of several non-profit business related organizations, and
is former president of the International Group of Accounting Firms. Mr. Sklar is
a graduate of Northwestern University.
Philip D. Feltman was elected a Director of the Company on April 27,
2000. Mr. Feltman has over 50 years of management experience starting in 1947
when he established a drug store chain in Manchester Connecticut. He and several
friends later went on to found Ames Department Stores, which became a major
chain of discount department stores. He left Ames in 1978 to found K & F
Industries, Inc., a foreign auto parts importer. Mr. Feltman went on to
participate in the concept, construction, and development of Villas Tacul, a
resort in Cancun, Mexico, and was part of its management team. In addition, Mr.
Feltman was President of Feltman Enterprises Inc., an investment management
company which wholly owned New Nurses, a medical personnel pool; a director of
Royalpar Inc., a public company; and President of Pequot Spring Water Company.
Currently, Mr. Feltman is an active partner in FW Enterprises, which owns office
buildings and apartments; a principal in Travacon Inc., a full service travel
agency located in West Hartford, Connecticut; and a principal in F & R
Associates, Inc., a builder of high quality homes in the Westbrook area of
Connecticut. With a Bachelor of Science degree from the University of
Connecticut, College of Pharmacy, in 1943 he served in the European Theater of
Operations with the 4th Armored Division, Third Army. Mr. Feltman has also been
involved with many charitable causes for many years.
26
<PAGE>
Ronald Shindler was elected as a Director of the Company in April 2000.
He has been a shareholder of Fowler, White, Burnett, Hurley, Banick &
Strickroot, a Miami, Florida law firm, since 1989. He also served as a Vice
President and Senior Counsel for Drexel Burnham Lambert Incorporated from 1979
to 1987, as well as managed a large brokerage office. Mr. Shindler's firm serves
as one of the Company's outside counsel. He received his B.A. degree from the
University of Pennsylvania, his law degree from Boston University and a Master
of Law in taxation from New York University. Mr. Shindler specializes in
securities law.
Robert L. Steiler was elected as a Director of the Company in April
2000. He has been a principal of Lewis Management Group, a consulting firm
specializing in business strategy, business development, manufacturing
operations and logistics, since its founding in 1990. Mr. Steiler's firm has
served as a manufacturing consultant to the Company since his election to the
Board. See Item 12, "Certain Relationships and Related Transactions." Prior to
founding the Lewis Management Group, Mr. Steiler was associated with KPMG Peat
Marwick from 1988 to 1990. Earlier in his career he was Vice President of
Materials with Stone Management Corporation, a large consumer goods company,
where he directed the material management functions and a highly sophisticated
computer-controlled picking and storage system. He was also Vice President of
Materials for SmithKline Beecham, a Fortune 100 pharmaceutical company. Mr.
Steiler graduated from St. John's University with an MBA in Management.
Significant Employees
Ellen M. Chambers joined the Company in March 1999, as Director of
Information Technologies. Ms. Chambers previously acted as Information Systems
Coordinator for AIDS Community Services, Inc. She also served as Operations
Manager at Advanced Logic Technologies, Inc., a company specializing in custom
CAD/CAM design. Ms. Chambers has extensive experience in both accounting and
systems development, design and implementation, and has worked in the accounting
and information technology fields for over 12 years. Ms. Chambers graduated from
the University of Buffalo with a B.S. in Accounting, Finance and Management
Information Systems, as well as an MBA in Management Information Systems and
Management Science/Statistics.
Sandra R. Stoller joined the Company in August 2000, as Human Resources
Director. Ms. Stoller previously served as Human Resources Manager for the
Tri-County Commuter Rail Authority for six years. Prior to that, Ms. Stoller
held various Human Resources positions at the University of Miami, including
Director of Personnel, where she started the Human Resources operation of the
Sylvester Comprehensive Cancer Center. Ms. Stoller earned a B.S. in Human
Resources Management, and a Certification in Human Resources Administration,
from Florida International University.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and on representations that no other
reports were required, there were no reports required under Section 16(a) of the
Securities Exchange Act of 1934, which were not timely filed during fiscal 2000.
27
<PAGE>
Item 10. Executive Compensation
The following table summarizes all compensation accrued by the Company
in each of the last three fiscal years for the Company's executive officers
serving as such whose annual compensation exceeded $100,000.
<TABLE>
<CAPTION>
Long Term
Name and Annual Compensation Compensation
Principal Position Year Salary($)(1) Bonus Other(2) Options
---------------------------- -------- -------------------- ----------- ---------- -----------------
<S> <C> <C> <C> <C> <C>
Zachary M. Richardson, 2000 161,114 0 59,900(3) 40,626
President 1999 119.000 0 13,200 79,890
1998 58,104 0 0 69,000
John C. Lucy, III 2000 161,451 0 16,800(4) 40,626
Chief Executive Officer 1999 119,000 0 25,200 79,890
1998 58,546 0 0 69,000
David Shumate(5) 2000 162,030 0 12,000 0
Executive Vice President of Sales 1999 67,725 0 6,000 0
</TABLE>
--------------
(1) Includes medical insurance reimbursements.
(2) Includes car allowances and other miscellaneous benefits.
(3) Includes $13,200 for car allowances and $16,800 for reimbursement of
income taxes paid. Also, at the request of the Company, Mr. Richardson
sold his home and incurred expenses in connection with this sale. In
fiscal year 2000, the Company reimbursed Mr. Richardson for closing
costs in connection with this sale, which totaled $29,900.
(4) Includes $13,200 for car allowances and other miscellaneous benefits,
and $3,600 for reimbursement of closing costs incurrred in connection
with the sale of Mr. Lucy's home.
(5) Mr. Shumate served the Company as an Executive Vice President of Sales
from February 1999 through September 2000. Mr. Shumate is no longer
employed with the Company.
The following table sets forth information concerning individual grants
of stock options made during the fiscal year ended June 24, 2000 to each of the
Named Executive Officers:
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
Number of Shares % of Total Options Exercise or
Underlying Options Granted to Employees Base Price
Name Granted(#)(1) in Fiscal Year ($/Share) Expiration Date
---- ------------- -------------------- --------- ---------------
<S> <C> <C> <C> <C>
John C. Lucy, III 40,626 31% 5.25 6/26/09
Zachary M. Richardson 40,626 31% 5.25 6/26/09
</TABLE>
(1) Options to purchase 8,125 shares vest each year, beginning July 1, 2000 and
continuing through July 1, 2004.
28
<PAGE>
<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
Number Of Value Of
Securities Underlying Unexercised
Shares Unexercised In-The-Money
Acquired Options Options
On at FY-End (#) at FY-End ($)
Exercise Value Realized Exercisable/ Exercisable/
Name (#) ($) Unexercisable Unexercisable
---- --- --- ------------- -------------
<S> <C> <C> <C> <C>
John C. Lucy, III 69,000 0 463,240/76,626 $602,934/$0
Zachary M. Richardson 69,000 0 463,240/76,626 $602,934/$0
</TABLE>
Compensation of Directors
Starting in fiscal year 2000, directors are paid a monthly retainer of
$500, a payment of $1,000 per board meeting day and $500 per teleconference
meeting plus all related business expenses. All audit committee members are paid
$250 per quarter. All directors are granted 30,000 ten-year options when they
are appointed or elected to the board and 5,000 options for each additional year
they are on the board at the then market value. These options vest in one year
and when services are terminated, all unexercised options are forfeited. See
also "Stock Option Plans."
Employment Agreements
In November 1998, the Company entered into five-year employment
agreements (the "Employment Agreements") with John C. Lucy, III and Zachary M.
Richardson. Pursuant to the terms of these Employment Agreements, each executive
is entitled to receive (i) annual base compensation of $156,000, with increases
in future years by the percentage increase of the Consumer Price Index and (ii)
a bonus up to 100% of base salary based on the increase in pretax earnings per
share over the prior year. The Employment Agreements also provide for annual
grants of common stock options commencing in fiscal 2000 equal to 1% of the then
outstanding number of common shares at an exercise price of fair market value at
date of grant, and the granting of 150,000 stock appreciation rights that vest
only upon a "Change of Control" as defined in the Employment Agreements.
During the term of the Employment Agreements, should there be a Change
of Control of the Company as that term is defined therein, the Company, at its
sole option, may terminate the Employment Agreements upon 30 days prior written
notice and thereafter will be obligated to pay the executives the balance of the
compensation payable under the Employment Agreements, had they not been
terminated prior to their expiration, together with an additional sum equal to
299% of Executives' annual base compensation. The Employment Agreements also
contain non-competition and confidentiality provisions.
Stock Option Plans
Pallet Management has adopted two combined stock option and
appreciation rights plans (the "Plans") to attract and to induce officers,
directors and key employees of the Company to remain with the Company. The Plans
provide for options which qualify as incentive stock options under Section
422(a) of the Internal Revenue Code of 1986, as amended (the "Code"), as well as
nonstatutory options. No more than fifteen percent (15%) of the Common Stock
outstanding will be reserved for issuance upon exercise of options to be granted
from time-to-time. The 1997 Omnibus Stock Option Plan (the "1997 Plan") was
approved in August, 1997. Pallet Management's 1998 Omnibus Stock Option Plan
(the "1998 Plan") became effective on September 1, 1998. An aggregate of 250,000
shares is reserved for issuance under the 1997 Plan and 1,000,000 shares are
reserved for issuance under the 1998 Plan.
29
<PAGE>
As of September 30, 2000, an aggregate of 16,231 options were
outstanding under the 1997 Plan with an exercise price of $2.00, and an
aggregate of 609,694 options were outstanding under the 1998 Plan with exercise
prices ranging from $2.25 to $5.78. These options vest over a five-year period
and expire ten years from date of grant. From 1997 through 2000, the Company
granted Messrs. Lucy, III and Richardson options to acquire an aggregate of
241,032 shares. See Item 11, "Security Ownership of Certain Beneficial Owners
and Management."
The Plans provide for a combined stock option and appreciation rights
plan. The Plans provide for options which will qualify as incentive stock
options under Section 422(a) of the Internal Revenue Code of 1986, as amended,
as well as for options which do not so qualify. Incentive Awards may be granted
under the Plans in the form of Options, Stock Appreciation Rights, Restricted
Stock, and Performance Awards.
No more than 50,000 common shares may be allocated to Incentive Awards
and no more than 300,000 common shares may be allocated to Non-Incentive Awards
granted to any one employee during a single calendar year.
All present and future employees of the Company or of any parent or
subsidiary of the Company ("Employee") and any person retained to provide
services to the Company (other than as an Employee, a member of the Board of
Directors or a member of the board of directors of any subsidiary or parent of
the Company), and who is selected by the committee, is eligible to receive
Incentive Awards under the Plan.
All present and future Non-Employee Directors are eligible to receive
Non-Statutory Options under the Plan. Non-Employee Directors shall not be
entitled to receive any other form of Incentive Award under the Plan.
The exercise price of shares of Company Stock covered by an Incentive
Stock Option cannot be less than 100% of the fair market value of such shares on
the date of grant; provided that if an Incentive Stock Option is granted to an
Employee who, at the time of the grant, is a 10% Shareholder, then the exercise
price of the shares covered by the Incentive Stock Option will not less than
110% of the fair market value of such shares on the date of grant. The exercise
price of Nonstatutory Stock Options will not be less than 85% of fair market
value of such shares on the date of grant.
Whenever the Board of Directors of the Company (the "Board") deems it
appropriate, Stock Appreciation Rights may be granted in connection with all or
any part of an Option, either concurrently with the grant of the Option or, if
the Option is a Nonstatutory Stock Option, by an amendment to the Option at any
time thereafter during the term of the Option. Stock Appreciation Rights may be
exercised in whole or in part at such times and under such conditions as may be
specified by the Committee in the participant's stock option agreement.
The Board may terminate or amend the Plans in such respects as it shall
deem advisable. The Board may unilaterally amend the Plans and Incentive Awards
as it deems appropriate to ensure compliance with Rule 16b-3 and to cause
Incentive Awards to meet the requirements of the Code, including Code section
422, and regulations thereunder.
30
<PAGE>
Accelerated Options
In August 1997, the Company granted 1,000,000 options to Messrs. Lucy
and Richardson. Messrs. Lucy and Richardson immediately allocated approximately
one-third of these options to other members of the Company's management. If an
employee terminated employment with the company, for any reason or no reason,
the options allocated to them would immediately revert back to Messrs. Lucy and
Richardson. The options provided that vesting would accelerate if the Company
achieved specified income before taxes, depreciation, amortization and certain
other charges at different measurement dates, which milestones were determined
based on management's internal projections through fiscal 1999. All three
milestones were met and the options vested according to the accelerated
schedule. The options expire in October 2004. See Item 11, "Security Ownership
of Certain Beneficial Owners and Management."
31
<PAGE>
The following table summarizes the terms of these vested but
unexercised options:
<TABLE>
<CAPTION>
Name Exercise Price Vested Expiration Date
---- -------------- ------ ---------------
<S> <C> <C> <C>
John C. Lucy, III $1.50 161,537 October 1, 2004
$1.75 124,863
$2.25 132,950
Zachary M. Richardson $1.50 161,537 October 1, 2004
$1.75 124,863
$2.25 132,950
Other Employees $1.50 76,926 October 1, 2004
$1.75 50,274
$2.25 34,100
---------
1,000,000
---------
</TABLE>
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of the close of business on
September 30, 2000 (a) the name, and number of shares of each person known by
the Company to be the beneficial owner of more than 5% of the Company's Common
Stock and (b) the number of shares of Common Stock owned by each director and
all officers and directors as a group, together with their respective percentage
holdings of such shares:
<TABLE>
<CAPTION>
Name and Percent of
Address of Amount of Beneficial Class
Beneficial Owner(1) Ownership of Stock Outstanding
---------------------------------------- -------------------------------- --------------------
<S> <C> <C>
John C. Lucy, III 670,305(2) 14.7%
Zachary M. Richardson 671,443(3) 14.7%
Marc S. Steinberg 0(4) 0
David W. Sass 10,000(5) *
Philip Feltman 11,000(5) *
Ronald Shindler 0(5) 0
Robert Steiler 1,000(6) *
Alan P. Sklar 5,000(5) *
All Officers and Directors 1,368,748(7) 27.1%
as a Group (eight persons)
John C. Lucy Jr. 625,696(8) 14.9%
</TABLE>
* Less than 1%
32
<PAGE>
(1) The address of all persons listed above is 2855 University Drive,
Coral Springs, Florida 33065.
(2) This figure includes 182,097 shares owned of record by Mr. Lucy and
his children and options to acquire 488,208 shares, which options are
exercisable within 60 days from the date hereof. This figure excludes
options to acquire 94,932 shares, which options are not exercisable
within 60 days from the date hereof. This figure also excludes
beneficial ownership of Mr. Lucy Jr., the father of Mr. Lucy III.
Together, Mr. Lucy III and Mr. Lucy Jr. (including Clary, see footnote
8 below) own 682,793 shares of record and options and warrants to
acquire 613,208 shares, which options and warrants are exercisable
within 60 days from the date hereof, or 27.7% of the Company.
(3) This figure includes 177,203 shares owned of record by Mr. Richardson
and options to acquire 494,240 shares, which options are exercisable
within 60 days from the date hereof. It excludes options to acquire
94,932 shares, which options are not exercisable within 60 days from
the date hereof.
(4) This figure excludes options to acquire 7,500 shares, which options are
not exercisable within 60 days from the date hereof.
(5) This figure excludes options to acquire 30,000 shares, which options
are not exercisable within 60 days from the date hereof.
(6) This figure excludes options to acquire 50,000 shares, which options
are not exercisable within 60 days from the date hereof.
(7) This figure includes 386,300 shares owned of record by the Company's
directors and executive officers as a group, and options to acquire
982,448 shares as a group, which options are exercisable within 60 days
from the date hereof. This figure excludes options to acquire 337,364
shares as a group, which options are not exercisable within 60 days
from the date hereof.
(8) This figure includes 450,696 shares owned of record by Mr. Lucy Jr.,
the father of Mr. Lucy III, and options to acquire 125,000 shares,
which options are exercisable within 60 days from the date hereof. This
figure also includes 50,000 shares owned of record by Clary Lumber
Company, Inc., a North Carolina corporation ("Clary"), and warrants to
acquire 50,000 shares, which warrants are exercisable within 60 days
from the date hereof. Mr. Lucy Jr. owns two-thirds of Clary, with the
other one-third ownership shared between Mr. Lucy III and his sister.
This figure does not include beneficial ownership of Mr. Lucy III.
Together, Mr. Lucy Jr. (including Clary) and Mr. Lucy III own 682,793
shares of record and options to acquire 613,208 shares, which options
are exercisable within 60 days from the date hereof, or 27.7% of the
Company.
33
<PAGE>
Item 12. Certain Relationships and Related Transactions
The Lewis Management Group ("LMG"), a firm that provides manufacturing
consulting services to the Company, is partially owned by Robert L. Steiler, a
Director of the Company. Under a consulting agreement between LMG and the
Company, the Company pays LMG $1,000 per man day, with a maximum of 25 man days,
or a maximum of $25,000, per month. The total amount paid by the Company to LMG
did not exceed $60,000 during fiscal year 2000, but the Company anticipates that
it will pay LMG in excess of $60,000 during fiscal year 2001.
Clary Lumber Company, Inc., a North Carolina corporation ("Clary"),
which is owned by the family of John C. Lucy, Jr., a principal shareholder and
former Director of Pallet Management, and his son, John C. Lucy III, who is
Pallet Management's CEO, sold $2,633,000 of pallets and lumber and $2,359,000 of
pallets and lumber to the Company during the fiscal years 2000 and 1999,
respectively. Lumber purchases from Clary amounted to 5.6% and 8% of the
Company's lumber purchases for fiscal years 2000 and 1999, respectively. After
procedures were performed by the Company's auditors at the request of the
Company, the Company believes that these transactions were made at prices
comparable to vendors other than Clary in the ordinary course of business.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits: See Exhibit Index.
(b) Reports on Form 8-K: The Company reported a change in its
certifying accountants on a Form 8-K, filed with the Securities and Exchange
Commission (the "SEC") on August 1, 2000. On August 16, 2000, the Company filed
an amendment to its Form 8-K with the SEC, attaching a letter written by its
former accountant to the SEC which stated that it agreed with the statements
made by the Company in its Form 8-K. See Item 8, "Changes in and Disagreements
with Accountants on Accounting and Financial Disclosure."
34
<PAGE>
<TABLE>
<CAPTION>
Exhibit Index
Exhibit No. Description
----------- -----------
<S> <C>
3.1 Articles of Incorporation. (2)
3.2 Amendment to Articles of Incorporation filed June 7, 1985. (2)
3.3 Amendment to Articles of Incorporation filed July 10,1985. (2)
3.4 Amendment to Articles of Incorporation filed October 12, 1994. (2)
3.5 Amendment to Articles of Incorporation filed November 21, 1994. (2)
3.6 Amendment to Articles of Incorporation filed February 3, 1998. (3)
3.7 Amended and Restated By-Laws. (2)
4.1 Specimen Certificate of Common Stock. (2)
10.1 1997 Omnibus Stock Plan. (4)*
10.2 Employment Agreement between the Company and John C. Lucy, III. (6)*
10.3 Employment Agreement between the Company and Zachary M. Richardson. (6)*
10.5 1998 Omnibus Stock Plan. (5)*
21.1 Subsidiaries (2)
27.1 Financial Data Schedule.
</TABLE>
(1) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated August 18,1999.
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-KSB
for the fiscal year ended June 30, 1996.
(3) Incorporated by reference to the Registrant's Registration Statement on Form
SB-2 (file number 46245).
(4) Incorporated by referenced to the Annual Report on Form 10-K for the fiscal
year ended June 30, 1998.
(5) Incorporated by reference to the Registrant's Proxy Statement filed November
30, 1998.
(6) Incorporated by reference to the Registrant's Quarterly Report on Form
10-QSB for the period ended December 26, 1998.
*Management compensation plan or arrangement
35
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant has caused its Annual Report on Form 10-KSB to be signed
on its behalf by the undersigned, thereunto duly authorized.
PALLET MANAGEMENT SYSTEMS, INC.
Date: October 10, 2000 By: /s/ John C. Lucy III
--------------------
John C. Lucy III, CEO
In accordance with the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ John C. Lucy, III Chief Executive Officer October 10, 2000
-----------------------
John C. Lucy, III
/s/ Zachary M. Richardson President October 10, 2000
---------------------------
Zachary M. Richardson
/s/ Marc Steinberg Controller, Secretary, Treasurer October 10, 2000
--------------------------- (Principal Financial
Marc S. Steinberg and Accounting Officer)
/s/ David Sass Chairman October 10, 2000
---------------------------
David Sass
/s/ Philip Feltman Director October 10, 2000
---------------------------
Philip Feltman
/s/ Alan Sklar Director October 10, 2000
---------------------------
Alan Sklar
/s/ Ronald Shindler Director October 10, 2000
---------------------------
Ronald Shindler
/s/ Robert Steiler Director October 10, 2000
---------------------------
Robert Steiler
</TABLE>
36
<PAGE>
PALLET MANAGEMENT SYSTEMS, INC.
AND SUBSIDIARIES
FINANCIAL STATEMENTS
JUNE 24, 2000
<PAGE>
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Pallet Management Systems, Inc.
We have audited the accompanying consolidated balance sheet of Pallet Management
Systems, Inc. and Subsidiaries as of June 24, 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for the years (52
weeks) ended June 24, 2000 and June 26, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pallet Management
Systems, Inc. and Subsidiaries as of June 24, 2000, and the results of their
operations and their cash flows for the years (52 weeks) ended June 24, 2000 and
June 26, 1999, in conformity with generally accepted accounting principles.
KAUFMAN, ROSSIN & CO.
Miami, Florida
August 18, 2000
F-1
<PAGE>
<TABLE>
<CAPTION>
Pallet Management Systems, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEET
June 24, 2000
ASSETS
<S> <C>
CURRENT ASSETS
Cash $ 577,052
Accounts receivable, net of allowance for doubtful accounts of $100,436 4,885,302
Inventories 2,259,110
Prepaid expenses 237,577
---------------
Total current assets 7,959,041
Property, plant and equipment - net 4,407,092
Other assets 984,863
---------------
Total assets $ 13,350,996
===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 1,190,138
Current portion of capital lease obligations 70,608
Accounts payable 2,760,217
Accrued liabilities 814,077
---------------
Total current liabilities 4,835,040
---------------
LONG-TERM LIABILITIES
Long-term debt 5,414,685
Capital lease obligations 182,805
---------------
Total long-term liabilities 5,597,490
---------------
Total liabilities 10,432,530
---------------
STOCKHOLDERS' EQUITY
Preferred stock, authorized 7,500,000 shares at $.001 par
value; no shares issued and outstanding -
Common stock, authorized 100,000,000 shares at $.001 par
value; issued and outstanding 4,065,612 shares 4,066
Additional paid-in capital 7,269,556
Accumulated deficit ( 4,079,156)
Notes receivable from stockholders ( 276,000)
----------------
Total stockholders' equity 2,918,466
---------------
Total liabilities and stockholders' equity $ 13,350,996
===============
The accompanying notes are an integral part of these statements.
</TABLE>
F - 2
<PAGE>
<TABLE>
<CAPTION>
Pallet Management Systems, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years (52 weeks) Ended June 24, 2000 and June 26, 1999
2000 1999
----------------- -----------------
<S> <C> <C>
Net sales $ 62,445,175 $ 38,744,129
Cost of goods sold 59,097,842 35,012,585
-------------- -------------
Gross profit 3,347,333 3,731,544
Selling, general and administrative expenses 4,899,091 2,944,355
-------------- -------------
Operating income (loss) ( 1,551,758) 787,189
--------------- -------------
Other income (expense)
Other income 84,629 64,521
Other expense ( 782,838) ( 335,562)
--------------- --------------
Other income (expense) ( 698,209) ( 271,041)
--------------- --------------
Income (loss) before income taxes ( 2,249,967) 516,148
Income tax benefit - 21,381
-------------- -------------
Net income (loss) ($ 2,249,967) $ 537,529
=============== =============
Earnings (loss) per common share:
Basic ($ 0.57) $ .15
=============== =============
Diluted ($ 0.57) $ .11
=============== =============
Shares used in computing earnings (loss) per common share:
Basic 3,981,199 3,582,195
============== =============
Diluted 3,981,199 4,788,764
============== =============
The accompanying notes are an integral part of these statements.
</TABLE>
F - 3
<PAGE>
<TABLE>
<CAPTION>
Pallet Management Systems, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years (52 weeks) Ended June 24, 2000 and June 26, 1999
Notes
Additional Receivable
Common Stock Paid-In From Accumulated
Shares Amount Capital Stockholders Deficit
----------------- ----------------- ---------------- ----------------- ---------------
<S> <C> <C> <C> <C> <C>
Balance at June 27, 1998 2,342,034 $ 2,342 $ 4,526,340 $ - ($ 2,366,718)
Exercise of options and warrants 1,575,578 1,576 2,302,364 - -
Options issued for services - - 130,000 - -
Unrealized loss on available-for-sale
investments - - - - -
Net income - - - - 537,529
----------------- ----------------- ---------------- ----------------- ---------------
Balance at June 26, 1999 3,917,612 3,918 6,958,704 - ( 1,829,189)
Exercise of options 138,000 138 275,862 ( 276,000) -
Common stock issued for services 10,000 10 34,990 - -
Sale of investments - - - - -
Net loss - - - - ( 2,249,967)
----------------- ----------------- ---------------- ----------------- ---------------
Balance at June 24, 2000 4,065,612 $ 4,066 $ 7,269,556 ( $ 276,000) ($ 4,079,156)
================= ================= ================ ================= ===============
[re-stubbed table]
Accumulated
Other
Comprehensive
Income (1) Total
----------------- ----------------
<S> <C> <C>
Balance at June 27, 1998 $ 13,477 $ 2,175,441
Exercise of options and warrants - 2,303,940
Options issued for services - 130,000
Unrealized loss on available-for-sale
investments ( 2,993) ( 2,993)
Net income - 537,529
----------------- ----------------
Balance at June 26, 1999 10,484 5,143,917
Exercise of options - -
Common stock issued for services - 35,000
Sale of investments ( 10,484) ( 10,484)
Net loss - ( 2,249,967)
----------------- ----------------
Balance at June 24, 2000 $ - $ 2,918,466
================= ================
(1) Consisting of unrealized gains on available-for-sale securities.
The accompanying notes are an integral part of these statements.
</TABLE>
F - 4
<PAGE>
<TABLE>
<CAPTION>
Pallet Management Systems, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years (52 weeks) Ended June 24, 2000 and June 26, 1999
2000 1999
---------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ($ 2,249,967) $ 537,529
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 602,230 524,371
Issuance of common stock and options for services 35,000 130,000
(Gain) loss on sale of property, plant and equipment 226,238 ( 29,826)
Bad debt expense 76,766 6,857
(Increase) decrease in operating assets:
Accounts receivable ( 2,309,469) ( 967,629)
Inventories ( 392,615) ( 691,149)
Prepaid expenses ( 81,156) ( 690)
Other assets 12,989 ( 969,757)
Increase (decrease) in operating liabilities:
Accounts payable 1,636,702 529,991
Accrued liabilities 300,421 106,896
Deferred income taxes - ( 31,381)
------------- -------------
Net cash used in operating activities ( 2,142,861) ( 854,788)
-------------- -------------
Cash flows from investing activities:
Purchase of fixed assets ( 1,119,333) ( 1,661,323)
Proceeds from sale of property, plant and equipment 221,706 65,712
------------- ------------
Net cash used in investing activities ( 897,627) ( 1,595,611)
-------------- -------------
Cash flows from financing activities:
Proceeds (repayments) under line of credit, net 1,837,346 ( 171,998)
Proceeds from lenders 3,631,804 1,433,193
Repayments to lenders ( 2,113,727) ( 1,253,785)
Exercise of options and warrants - 2,303,940
------------- ------------
Net cash provided by financing activities 3,355,423 2,311,350
------------- ------------
Increase (decrease) in cash 314,935 ( 139,049)
Cash at beginning of period 262,117 401,166
------------- ------------
Cash at end of period $ 577,052 $ 262,117
============= ============
Supplemental disclosure of cash flow information: Cash paid during the period
for:
Interest $ 512,289 $ 315,803
============= ============
Income taxes $ - $ -
============= ============
</TABLE>
Schedule of non-cash investing and financing activities:
Capital lease obligations of $78,896 and $191,024 were incurred during the
years ended June 24, 2000 and June 26, 1999, respectively.
In January 2000, stockholders of the Company issued notes receivable to the
Company in the aggregate amount of $276,000 for the exercise of stock
options.
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 24, 2000 and June 26, 1999
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the Company's significant accounting policies consistently
applied in the preparation of the accompanying consolidated financial
statements follows:
1. Nature of Operations
Pallet Management Systems, Inc. and Subsidiaries (the "Company"/"Pallet") is
principally engaged in the manufacture and repair of wooden pallets in
Virginia, Alabama, Illinois and Indiana. The Company's revenues are derived
primarily from the sale of new and used pallets.
2. Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries Pallet Recycling Technology,
Inc. ("PRTI"), Abell Lumber, Inc. ("Abell"), Pallet Systems-Lakeland, FL,
Inc., Pallet Management Systems of Alabama, Inc., Pallet Management Systems
of Illinois, Inc. and Pallet Management Systems of Indiana, Inc.
Intercompany balances and transactions are eliminated in consolidation.
3. Accounts Receivable
Trade receivable accounts are principally comprised of amounts due from
large distributors, national retail chains and major manufacturers. The
Company evaluates each account receivable balance to establish an estimate
for uncollectible accounts.
4. Inventories
Inventories, consisting of raw materials, work in process, and finished
goods, are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method.
5. Property, Plant and Equipment
Property, plant and equipment are stated at cost, net of accumulated
depreciation. Major renewals and improvements are capitalized. Repairs and
maintenance are expensed as incurred. Depreciation is computed by using the
straight-line method over the expected useful lives of the related assets
which are as follows:
Years
-----
Machinery and equipment 5 - 15
Vehicles 5 - 10
Buildings and improvements 7 - 40
Furniture and equipment 5 - 10
F-6
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
6. Estimates
In preparing financial statements in accordance with generally accepted
accounting principles, management makes estimates and assumptions that
affect the reported amounts and disclosures of assets and liabilities at the
date of the financial statements, as well as the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
The Company has recorded a deferred tax asset of approximately $1,433,000 at
June 24, 2000, which is completely offset by a valuation allowance.
Realization of the deferred tax asset is dependent on generating sufficient
taxable income in the future. The amount of the deferred tax asset
considered realizable could change in the near term if estimates of future
taxable income are modified.
7. Income Taxes
The Company accounts for income taxes under the liability method. Deferred
tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statements carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
8. Earnings (Loss) Per Share
Basic earnings (loss) per common share is computed using the weighted
average number of shares outstanding during the period. Diluted earnings
(loss) per common and common equivalent share is computed using the weighted
average number of shares outstanding during the period adjusted for
incremental shares attributed to outstanding options and warrants to
purchase common stock of 1,206,569 for the year ended June 26, 1999. For the
year ended June 24, 2000, outstanding stock options and warrants were not
considered in the calculation of diluted earnings (loss) per common and
common equivalent share as their effect would have been antidilutive.
Securities that could potentially dilute basic earnings per share in the
future consist of 1,342,199 options to purchase common stock discussed in
Note M, 270,000 options to purchase common stock granted subsequent to June
24, 2000 and 142,935 warrants outstanding to purchase common stock at $2.00
per share. The warrants expire December 31, 2001.
9. Financial Instruments
Statement of Financial Accounting Standards No. 107 requires disclosure of
the estimated fair value of financial instruments. The carrying values of
cash, accounts receivable and accounts payable approximate fair value due to
the short-term maturities of these instruments. The carrying value of debt
approximates fair value due to the length of the maturities, the interest
rates being tied to market indices and/or due to the interest rates not
being significantly different from the current market rates available or
offered to the Company.
F-7
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
10. Stock Options (SFAS 123)
Options granted to employees under the Company's Stock Option Plan are
accounted for by using the intrinsic method under APB Opinion 25, Accounting
for Stock Issued to Employees (APB 25). In October 1995, the Financial
Accounting Standards Board issued Statement No. 123, Accounting for
Stock-Based Compensation (SFAS 123), which defines a fair value based method
of accounting for stock options. The accounting standards prescribed by SFAS
123 are optional and the Company has continued to account for stock options
under the intrinsic value method specified in APB 25. Pro forma disclosures
of net earnings and earnings per share have been made in accordance with
SFAS 123.
11. Concentration of Credit
The Company, from time to time, maintained deposits at financial
institutions in excess of federally insured limits. The Company is currently
monitoring amounts on deposit at the financial institutions.
12. Comprehensive Income
Comprehensive income is not reported in the accompanying consolidated
financial statements as it is not materially different from net income.
NOTE B - INVENTORIES
Inventories consisted of the following at June 24, 2000:
Raw materials $ 1,408,008
Work in process 549,858
Finished goods 301,244
--------------
$ 2,259,110
==============
F-8
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE C - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at June 24, 2000:
Machinery and equipment $ 5,087,856
Building and improvements 1,623,000
Vehicles 575,160
Furniture and equipment 519,233
Land 136,044
--------------
7,941,293
Less: accumulated depreciation
and amortization 3,534,201
--------------
$ 4,407,092
==============
Depreciation and amortization expense was $602,230 and $524,371 in 2000 and
1999, respectively, and is included in "cost of goods sold" and "selling,
general and administrative" expenses in the accompanying consolidated
financial statements. Property, plant and equipment at June 24, 2000
included assets recorded under capital leases and related accumulated
amortization of approximately $363,000 and $61,000, respectively.
Amortization expense related to assets under capital leases was
approximately $38,000 and $23,000 in 2000 and 1999, respectively.
NOTE D - OTHER ASSETS
Other assets consisted of the following at June 24, 2000:
Deposits on machinery $ 647,213
Software costs - in process 233,266
Security deposits 97,059
Other 7,325
--------------
$ 984,863
==============
F-9
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE E - INCOME TAXES
The income tax benefit consisted of the following:
<TABLE>
<CAPTION>
Years Ended
-------------------------
June 24, 2000 June 26, 1999
------------- -------------
<S> <C> <C>
Current:
Federal $ - $ -
State - 10,000
--------------- -------------
- 10,000
--------------- -------------
Deferred:
Federal ( 759,622) ( 256,455)
State ( 80,784) ( 20,205)
Change in valuation allowance 840,406 245,279
--------------- -------------
( -) ( 31,381)
-------------- --------------
($ -) ($ 21,381)
============== ==============
</TABLE>
Deferred income taxes were recognized in the consolidated balance sheet at
June 24, 2000 due to the tax effect of temporary differences and loss
carryforwards as follows:
Deferred tax assets:
Net operating loss carryforwards $ 1,657,639
Other 87,317
------------
1,744,956
Deferred tax liabilities:
Depreciation 312,208
------------
Net deferred tax asset 1,432,748
Less valuation allowance 1,432,748
------------
$ -
============
The major elements contributing to the difference between the income tax
benefit and the amount computed by applying the federal statutory tax rate
of 34% to income (loss) before income taxes are as follows:
Years Ended
June 24, 2000 June 26, 1999
Statutory rate ( $ 764,989) $ 175,490
State income taxes ( 80,784) 30,205
Change in valuation allowance 840,406 ( 245,279)
Permanent differences and other 5,367 18,203
---------------- ----------------
( $ -) ( $ 21,381)
================= =================
As of June 24, 2000, the Company had net operating loss carryforwards of
approximately $4,405,000 which expire in various years through June 2020.
Approximately $976,000 of these net operating losses are subject to
substantial restrictions imposed under the change in ownership and separate
return limitation year rules.
F-10
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE F - LONG-TERM DEBT
<TABLE>
<S> <C>
$5,000,000 revolving credit agreement with a bank. Interest is paid monthly at the bank's
prime rate or at the borrower's election LIBOR plus 2.75%. As of June 24, 2000 interest
was being charged at 9.5%, the bank's prime rate. The line is collateralized by
substantially all the assets of the Company, and expires in March 2003 at which time all
principal and accrued interest is due. Advances are based on 85% of eligible accounts
receivable and 55% of eligible inventories, as defined, less certain other outstanding
obligations. $ 3,246,711
Bank note payable in monthly installments of $21,083 plus interest at the bank's prime rate
plus .25% or at the borrower's election LIBOR plus 3.0%, through March 2003. As of June
24, 2000 interest was being charged at 9.75%, the bank's prime rate plus .25%. The note is
collateralized by substantially all the assets of the Company. 1,777,642
Bank note payable in monthly installments of $11,567 plus interest at the bank's prime rate
plus .50% or at the borrower's election LIBOR plus 3.25%, through March 2003. As of June
24, 2000 interest was being charged at 10.00%, the bank's prime rate plus .50%. The note
is collateralized by substantially all the assets of the Company. 1,364,867
Industrialized development notes payable in quarterly installments of $3,381, including
interest at 5.25%, maturing October 2017 and uncollateralized. 153,810
Notes payable in monthly installments of $440 to $3,343, including interest ranging from 8%
to 16%, collateralized by equipment and vehicles, maturing at various dates through
February 2002. 55,765
Note payable in monthly installments of $594, including interest of 16%, collateralized by
equipment and vehicles, maturing in May 2001. 6,028
-------------
Total debt 6,604,823
Less: current maturities of long-term debt 1,190,138
-------------
Long-term debt $ 5,414,685
=============
</TABLE>
The revolving credit agreement and bank notes payable are subject to
certain restrictive covenants including, but not limited to, minimum
tangible net worth and interest and debt service coverage ratios, as
defined. The agreement also provides restrictions as to the payment of
dividends.
Interest expense for the years ended June 24, 2000 and June 26, 1999
amounted to $551,444 and $332,818, respectively, and is included in other
expense in the accompanying consolidated statements of income.
Scheduled maturities of long-term debt for years subsequent to June 24,
2000 are as follows:
2001 $ 443,428
2002 413,210
2003 5,611,711
2004 6,427
2005 130,047
-------------
$ 6,604,823
=============
F-11
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE G - CAPITAL LEASE OBLIGATIONS
Minimum future annual lease payments under capital leases as of June 24, 2000,
in the aggregate, are as follows:
<TABLE>
<S> <C>
2001 $ 87,522
2002 87,522
2003 80,782
2004 32,261
-------------
Total minimum future lease payments 288,087
Less: imputed interest 34,674
-------------
Present value of future minimum lease payments 253,413
Less: current portion of capital lease obligations 70,608
-------------
Long-term portion of capital lease obligations $ 182,805
=============
</TABLE>
NOTE H - ACCRUED LIABILITIES
Accrued liabilities consisted of the following at June 24, 2000:
<TABLE>
<S> <C>
Accrued compensation $ 217,627
Other accrued liabilities 596,450
-------------
$ 814,077
=============
</TABLE>
NOTE I - COMMITMENTS
1. Operating Leases
The Company leases manufacturing facilities, office space, equipment and
vehicles under non-cancelable operating leases. The following is a schedule, by
years, of the minimum rental commitments remaining on leased property and
equipment:
<TABLE>
<S> <C> <C>
2001 $ 900,644
2002 879,860
2003 837,086
2004 574,643
-------------
Total $ 3,192,233
=============
</TABLE>
Total rent expense was approximately $1,030,000 and $530,000 for the years ended
June 24, 2000 and June 26, 1999, respectively.
F-12
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE I - COMMITMENTS (Continued)
2. Purchase of Machinery
During the year ended June 26, 1999, the Company entered into an agreement with
Vanderloo, BV for the purchase of machinery for approximately $1,233,000.
Deposits paid on the machinery amounted to approximately $647,000 through June
24, 2000. This amount is included in other assets on the accompanying
consolidated balance sheet. The Company is committed under this agreement to pay
approximately $586,000 during the next fiscal year. In connection with this
agreement, the Company obtained a $600,000 letter of credit with its primary
lender in favor of Vanderloo, BV.
NOTE J - RELATED PARTY TRANSACTIONS
The Company paid approximately $76,000 during the year ended June 26, 1999, to
Clary Lumber Co. (Clary), an entity owned by an officer and former directors of
the Company, for compensation of certain employees who perform services for both
Clary and the Company.
The Company purchased approximately $2,633,000 and $2,359,000 of lumber and
pallets from Clary during the years ended June 24, 2000 and June 26, 1999,
respectively. Lumber purchases from Clary amounted to approximately 6% and 8% of
the Company's lumber purchases for the years ended June 24, 2000 and June 26,
1999, respectively.
NOTE K - EMPLOYMENT AND CONSULTING AGREEMENTS
The Company has employment agreements with two senior executives that provide
for, among other things, annual compensation totaling $312,000, a bonus based on
diluted earnings per share, stock appreciation rights to vest upon a change of
control, as defined, and stock options to be granted annually. The agreements
are cancellable by the Company upon 30 days written notice to the executives and
payment of requisite compensation and expire on October 31, 2003.
NOTE L - STOCKHOLDERS' EQUITY
In January 2000, the Company loaned two officers an aggregate of $276,000 to
exercise options to purchase an aggregate of 138,000 shares of common stock. The
loans bear interest at 5% per annum, with interest payment due annually and
principal due the earlier of January 12, 2003 or upon registering the shares and
are collateralized by mature shares of stock previously owned by the
stockholders. The loans receivable are recorded as a separate component of
stockholders' equity in the accompanying balance sheet.
F-13
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE M - STOCK BASED COMPENSATION
In April 1997 and September 1998, the Company established Stock Option Plans
which authorize the Company to issue options to employees, directors and outside
consultants of the Company. The issuance and form of the options shall be at the
discretion of the Company's board of directors, except that the exercise price
may not be less than 85% of the fair market value at the time of grant. The
options vest over a four year period and expire in ten years or three months
after separation of service, whichever occurs earlier.
The Company has elected to follow Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" (APB 25") in accounting for its
employees stock options. Under APB 25, because the exercise price of the
Company's employee stock options issued was greater than the market price of the
underlying stock on the date of grant, no compensation expense was recognized.
Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based
Compensation," ("SFAS No. 123") requires the Company to provide proforma
information regarding net income (loss) and earnings (loss) per common share as
if compensation cost for the Company's Stock Option plan had been determined in
accordance with the fair value based method prescribed in SFAS No. 123. The
Company estimated the fair value of each stock option on the date of grant by
using the Black-Scholes pricing model with the following assumptions: expected
volatility of 90%; expected life of the option of 75% of the stated life for 10
year options and the stated life for all others; no dividends; and a risk free
interest rate of 5.5%.
Under the accounting provisions of SFAS No. 123, the Company's net income (loss)
and basic and diluted earnings (loss) per common share for the years ended June
24, 2000 and June 26, 1999 would have been approximately ($2,497,000), ($.63)
and ($.63) and $294,000, $.08 and $.06, respectively.
A summary of the Company's stock option activity, and related information for
the years ended June 24, 2000 and June 26, 1999, is as follows:
<TABLE>
<CAPTION>
# of Weighted Average
Options Exercise Price
<S> <C> <C> <C> <C>
Outstanding June 27, 1998 1,231,107 $ 1.84
Granted 322,780 5.20
Exercised - -
Forfeited 6,701 2.00
--------------- ---------------
Outstanding June 26, 1999 1,547,186 $ 2.56
Granted 240,709 4.06
Exercised 138,000 2.00
Forfeited 307,696 3.66
--------------- ---------------
Outstanding June 24, 2000 1,342,199 $ 2.63
=============== ===============
Exercisable at June 24, 2000 1,102,187 $ 2.07
=============== ===============
</TABLE>
F-14
<PAGE>
Pallet Management Systems, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
June 24, 2000 and June 26, 1999
NOTE M - STOCK BASED COMPENSATION (Continued)
The weighted-average fair value of options granted during the years ended June
24, 2000 and June 26, 1999 was $3.90 and $1.87, respectively.
Exercise prices for options outstanding as of June 24, 2000 ranged from $1.50 to
$6.63. The weighted average remaining contractual life of these options is as
follows:
<TABLE>
<CAPTION>
Weighted Average
Exercise # of Weighted Average Remaining
Price Options Exercise Price Contractual Life
--------------------- ------------------- ------------------- ---------------------
<S> <C> <C> <C>
$1.50 - $2.50 1,016,835 $1.80 3.07
$5.00 - $6.63 325,364 $5.21 8.00
</TABLE>
NOTE N - SIGNIFICANT CUSTOMERS
The Company entered into multi-year manufacturing agreements with a significant
customer, which provide for, among other things, minimum purchase commitments.
The agreements are for initial terms expiring during 2001 through 2003 and
automatically continue in effect from year to year for successive one year
renewal terms unless cancelled in writing by either party at least 180 days
prior to the expiration date. Sales to this customer represented approximately
83% and 75% of net sales for the years ended June 24, 2000 and June 26, 1999,
respectively.
At June 24, 2000 two customers accounted for approximately 80% of trade accounts
receivable, with one customer accounting for approximately 66%.
NOTE O - PENSION AND PROFIT SHARING PLAN
The Company has a salary reduction / profit-sharing plan under the provisions of
Section 401(k) of the Internal Revenue Code. The Plan covers all full-time
employees who have completed one year of service with the Company. The Company's
contributions to the plan are made at the discretion of the Board of Directors
and amounted to approximately $40,000 and $23,000 for the years ended June 24,
2000 and June 26, 1999, respectively.
NOTE P - CONTINGENCY
In June 1999, the Company was named as a co-defendant in a lawsuit whereby the
plaintiff is alleging damages of up to $300,000 related to lost income from a
facility formerly leased to the Company in Jessup, Maryland. Management believes
the claim is without merit and intends to vigorously contest the claim. The
outcome of the action as well as the extent of the Company's liability, if any,
can not be determined at this time.
F-15
