Edgar Filing: PARAGON TECHNOLOGIES INC

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

--------------------------------
FORM 10-Q
--------------------------------

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended March 31, 2006

Commission File Number: 1-15729

PARAGON TECHNOLOGIES, INC.
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Delaware 22-1643428
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

600 Kuebler Road, Easton, Pennsylvania 18040
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(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: 610-252-3205
---------------------

Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|

Indicate by checkmark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer |_| Accelerated Filer |_| Non-Accelerated Filer |X|

Indicate by checkmark whether the Registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes |_| No |X|

The number of shares of the Registrant's Common Stock, $1.00 par value,
outstanding as of May 8, 2006 was 3,551,519.

[PARAGON LOGO]

Paragon Technologies, Inc.
TABLE OF CONTENTS

Page
Number
-----------

PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets (Unaudited)............................ 1
Consolidated Statements of Operations (Unaudited).................. 3
Consolidated Statements of Cash Flows (Unaudited).................. 4
Notes to Consolidated Financial Statements (Unaudited)............. 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 17

Item 3. Quantitative and Qualitative Disclosures About Market Risk............ 25

Item 4. Controls and Procedures............................................... 25

PART II -- OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 26

Item 1A. Risk Factors.......................................................... 26

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........... 26

Item 3. Defaults Upon Senior Securities....................................... 27

Item 4. Submission of Matters to a Vote of Security Holders................... 27

Item 5. Other Information..................................................... 27

Item 6. Exhibits.............................................................. 27

SIGNATURES.............................................................................. 28

EXHIBIT INDEX........................................................................... 29

PART I - FINANCIAL INFORMATION
------------------------------

Item 1. Financial Statements
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
March 31, 2006 and December 31, 2005
(In Thousands, Except Share Data)

(UNAUDITED)
March 31, December 31,
2006 2005
------------------- ------------------

Assets
------

Current assets:
Cash and cash equivalents....................... $ 2,476 687
Short-term investments.......................... 14,100 16,710
------------------- ------------------
Total cash and cash equivalents and
short-term investments.................... 16,576 17,397
------------------- ------------------

Receivables:
Trade......................................... 2,720 2,029
Notes and other receivables................... 1,073 1,066
------------------- ------------------
Total receivables........................... 3,793 3,095
------------------- ------------------

Costs and estimated earnings in excess
of billings................................... 411 616

Inventories:
Raw materials................................. 147 108
Work-in-process............................... 62 26
Finished goods................................ 269 210
------------------- ------------------
Total inventories........................... 478 344
------------------- ------------------

Deferred income tax benefits.................... 313 353
Prepaid expenses and other current assets....... 234 329
------------------- ------------------
Total current assets........................ 21,805 22,134
------------------- ------------------

Property, plant and equipment, at cost:
Machinery and equipment......................... 1,134 1,160
Less: accumulated depreciation................. 850 911
------------------- ------------------
Net property, plant and equipment............. 284 249
------------------- ------------------

Deferred income tax benefits....................... 204 203
Other assets....................................... 10 10
------------------- ------------------
Total assets....................................... $ 22,303 22,596
=================== ==================

See accompanying notes to consolidated financial statements.

Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Balance Sheets
March 31, 2006 and December 31, 2005
(In Thousands, Except Share Data)

(UNAUDITED)
March 31, December 31,
2006 2005
------------------- ------------------

Liabilities and Stockholders' Equity
------------------------------------

Current liabilities:
Accounts payable................................ $ 1,231 1,391
Customers' deposits and billings
in excess of costs and
estimated earnings ........................... 1,795 2,044
Accrued salaries, wages, and
commissions................................... 196 102
Income taxes payable............................ 566 650
Accrued product warranty........................ 177 189
Deferred gain on sale-leaseback................. 165 165
Accrued other liabilities....................... 947 796
------------------- ------------------
Total current liabilities................... 5,077 5,337
------------------- ------------------

Long-term liabilities:
Deferred gain on sale-leaseback................. 151 193
------------------- ------------------
Total long-term liabilities................. 151 193
------------------- ------------------

Commitments and contingencies

Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and
outstanding 3,551,519 shares as
of March 31, 2006 and 3,539,019
shares as of December 31, 2005.............. 3,552 3,539
Additional paid-in capital.................... 6,999 7,004
Retained earnings............................. 6,524 6,523
------------------- ------------------
Total stockholders' equity.................. 17,075 17,066
------------------- ------------------

Total liabilities and stockholders' equity.. $ 22,303 22,596
=================== ==================

See accompanying notes to consolidated financial statements.

Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Operations (Unaudited)
For the Three Months Ended March 31, 2006 and 2005
(In Thousands, Except Share and Per Share Data)

Three Months Ended
------------------------------------------
March 31, March 31,
2006 2005
------------------ ------------------

Net sales.................................................. $ 4,220 3,866
Cost of sales.............................................. 2,933 2,774
------------------ ------------------
Gross profit on sales...................................... 1,287 1,092
------------------ ------------------

Selling, general and
administrative expenses................................. 1,372 1,037
Product development costs.................................. 156 4
Interest expense........................................... 1 1
Interest income............................................ (128) (13)
Other income, net.......................................... (29) (40)
------------------ ------------------
1,372 989
------------------ ------------------

Income (loss) from
continuing operations before
income taxes............................................ (85) 103
Income tax expense (benefit)............................... (86) 39
------------------ ------------------
Income from
continuing operations................................... 1 64
Income from discontinued
operations, net of
income taxes............................................ - 130
------------------ ------------------
Net income................................................. $ 1 194
================== ==================

Basic earnings
per share:
Income from
continuing operations................................. $ - .02
Income from discontinued
operations............................................ - .03
------------------ ------------------
Net income............................................... $ - .05
================== ==================

Diluted earnings
per share:
Income from
continuing operations................................. - .01
Income from discontinued
operations............................................ - .03
------------------ ------------------
Net income.............................................. $ - .04
================== ==================

Weighted average
shares outstanding...................................... 3,542,144 4,266,323
Dilutive effect of
stock options........................................... 7,724 47,425
------------------ ------------------
Weighted average
shares outstanding
assuming dilution....................................... 3,549,868 4,313,748
================== ==================

See accompanying notes to consolidated financial statements.

Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31, 2006 and 2005
(In Thousands, Except Share Data)

Three Months Ended
----------------------------------------
March 31, March 31,
2006 2005
------------------- -------------------

Cash flows from operating activities:
Net income.......................................... $ 1 194
Less: Income from discontinued operations.......... - 130
------------------- -------------------
Income from continuing operations................... 1 64

Adjustments to reconcile net income
to net cash provided (used) by operating
activities:
Depreciation of plant and equipment............. 23 22
Loss on disposition of equipment................ 2 -
Deferred tax expenses........................... 39 22
Amortization of deferred gain on sale-
leaseback..................................... (42) (42)
Stock-based compensation........................ 8 5
Change in operating assets and liabilities:
Receivables................................. (698) 364
Costs and estimated earnings in
excess of billings....................... 205 (365)
Inventories................................. (134) (68)
Prepaid expenses and other
current assets........................... 95 43
Accounts payable............................ (160) (243)
Customers' deposits and billings
in excess of costs and estimated
earnings................................. (249) (127)
Accrued salaries, wages, and
commissions.............................. 94 49
Income taxes payable........................ (84) (14)
Accrued product warranty.................... (12) (82)
Accrued other liabilities................... 151 7
Net cash provided by operating activities
of discontinued operations.................... - 1,021
------------------- -------------------
Net cash provided (used) by
operating activities.............................. (761) 656
------------------- -------------------

Cash flows from investing activities:
Proceeds from sales of short-term
investments....................................... 2,610 -
Purchases of short-term investments................. - (400)
Additions to property, plant and equipment.......... (60) (32)
Net cash used by investing activities
of discontinued operations........................ - (117)
------------------- -------------------
Net cash provided (used) by investing
activities........................................ 2,550 (549)
------------------- -------------------

See accompanying notes to consolidated financial statements.

Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Three Months Ended March 31, 2006 and 2005
(In Thousands, Except Share Data)

Three Months Ended
----------------------------------------
March 31, March 31,
2006 2005
------------------- -------------------

Cash flows from financing activities:
Sale of common shares in connection with
employee incentive stock option plan............. - 9
------------------- -------------------
Net cash used by
financing activities......................... - 9
------------------- -------------------

Increase in cash and
cash equivalents................................. 1,789 116
Cash and cash equivalents,
beginning of period.............................. 687 1,702
------------------- -------------------
Cash and cash equivalents,
end of period.................................... $ 2,476 $ 1,818
=================== ===================

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest..................................... $ 1 1
=================== ===================
Income taxes................................. $ 9 42
=================== ===================

See accompanying notes to consolidated financial statements.

Item 1. Financial Statements (Continued)
------- --------------------
Paragon Technologies, Inc. and Subsidiary
Notes To Consolidated Financial Statements (Unaudited)
For the Three Months Ended March 31, 2006 and 2005

(1) In the opinion of the management of Paragon Technologies, Inc. ("Paragon"
or the "Company"), the unaudited interim financial statements furnished
reflect all adjustments and accruals that are necessary to present a fair
statement of results for the interim periods. The comparative financial
information for the period ended March 31, 2005 includes the accounts of
the Company and Ermanco Incorporated ("Ermanco"), a wholly owned subsidiary
company that was sold on August 5, 2005, after elimination of intercompany
balances and transactions. Certain prior year amounts have been
reclassified to conform to the current year's presentation. Results for
interim periods are not necessarily indicative of results expected for the
full fiscal year. This quarterly report should be read in conjunction with,
and is qualified in its entirety by reference to, the Consolidated
Financial Statements of the Company and the related Notes thereto appearing
in our annual report on Form 10-K for the year ended December 31, 2005 as
filed with the Securities and Exchange Commission on March 30, 2006. Refer
to the Company's annual report on Form 10-K for the year ended December 31,
2005 for more complete financial information. See Discontinued Operations -
Sale of Ermanco in Note 2 of the Notes to Consolidated Financial Statements
for further information regarding the sale of substantially all of the
assets and liabilities of Ermanco.

Use of Estimates
----------------
The preparation of the financial statements, in conformity with U.S.
generally accepted accounting principles, requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. The judgments made in assessing the appropriateness of the
estimates and assumptions utilized by management in the preparation of the
financial statements are based on historical and empirical data and other
factors germane to the nature of the risk being analyzed. Materially
different results may occur if different assumptions or conditions were to
prevail. Estimates and assumptions are mainly utilized to establish the
appropriateness of the inventory reserve, warranty reserve, and revenue
recognition.

(2) Discontinued Operations -- Sale of Ermanco
------------------------------------------
On May 20, 2005, the Company and Ermanco entered into an Asset Purchase
Agreement (the "Asset Purchase Agreement") with TGW Transportgerate GmbH,
an Austrian corporation ("Buyer Parent"), and Malibu Acquisition, Inc., a
Michigan corporation and wholly owned subsidiary of Buyer Parent ("Buyer"),
pursuant to which Paragon agreed to sell to Buyer substantially all of the
assets and liabilities of Ermanco, Paragon's conveyor and sortation
subsidiary located in Spring Lake, Michigan. The terms of the Asset
Purchase Agreement provided that Buyer pay cash in the amount of $23
million (subject to a working capital adjustment and an accounts receivable
adjustment) and assume certain liabilities of Ermanco, as more fully
described in the Asset Purchase Agreement, a copy of which was filed as an
attachment to the Company's definitive proxy statement with the Securities
and Exchange Commission on July 1, 2005. At a Special Meeting of
Stockholders held on August 3, 2005, the Company received approval from its
stockholders to sell substantially all of the assets and liabilities of
Ermanco.

On August 5, 2005, the Company completed the sale of substantially all of
the assets and liabilities of Ermanco, and received cash consideration of
$23,055,000 (subject to a working capital adjustment and an accounts
receivable adjustment). Transaction costs associated with the sale of the
assets and liabilities of Ermanco were approximately $1,038,000. During the
fourth quarter of 2005, the Company paid approximately $448,000 to the
Buyer in connection with the working capital

adjustment and $61,000 in connection with the accounts receivable
adjustment. Therefore, the Company received cash consideration of
$21,508,000, net of transactions costs and the working capital and accounts
receivable adjustments in connection with the sale of the assets and
liabilities of Ermanco, thereby resulting in a pre-tax loss on the sale of
approximately $964,000.

Ermanco and Paragon indemnified the Buyer and Buyer Parent for, among other
things, a breach of any representation, warranty, covenant, or agreement
set forth under the terms of the Asset Purchase Agreement. Paragon and
Ermanco will have no liability to Buyer or Buyer Parent with respect to
claims for breaches of representations and/or warranties until the
aggregate amount of loss relating to such breaches exceeds $230,000, and
then only for such amount that exceeds $230,000. The overall aggregate
indemnification liability of Paragon and Ermanco shall not exceed
$5,750,000. At the closing of the asset sale, Paragon delivered to the
Buyer an irrevocable letter of credit in the amount of $2 million as
security for its indemnification obligations. The letter of credit shall
remain in place for a period of one year following the closing of the asset
sale or longer in the event of any pending dispute thereunder; provided,
however, that if a dispute remains pending longer than the one year period
following the closing of the asset sale, the amount of the letter of credit
shall be reduced to an amount not less than an amount sufficient to resolve
such dispute. If applicable, the reduced letter of credit shall remain in
place following the one-year anniversary of the closing of the asset sale
until any pending dispute has been resolved.

Ermanco and Paragon agreed that for a period of 3 years following the
closing of the transaction, each will not solicit any employee, customer,
or supplier of Buyer to leave Buyer's employment or alter its business
dealings with the Buyer.

In accordance with Financial Accounting Standards Board ("FASB") Statement
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
the results of operations for Ermanco's business activities are reported as
a discontinued operation and accordingly, the accompanying consolidated
financial statements have been reclassified to report separately the
operating results of this discontinued operation.

The following are the condensed results of operations for Ermanco for the
three months ended March 31, 2005 (in thousands):

Three Months Ended
---------------------------
March 31,
2005
---------------------------

Net sales........................................................ $ 6,442
===========================

Income from operations 204
before income taxes...........................................
Income tax expense............................................... 74
---------------------------
Income from discontinued
operations, net of income
taxes......................................................... $ 130
===========================

(3) Short-Term Investments
----------------------
The Company's short-term investments are comprised of debt securities, all
classified as trading, that are carried at cost, which approximates fair
value of the investments at period end. These debt securities include state
and municipal bonds. The short-term investments are on deposit with a major
financial institution and are supported by letters of credit.

(4) Accrued Product Warranty
------------------------
The Company's products are warranted against defects in materials and
workmanship for varying periods of time depending on customer requirements
and the type of system sold, with a typical warranty period of one year.
The Company provides an accrual for estimated future warranty costs and
potential product liability claims based upon a percentage of cost of
sales, typically two percent of the cost of the system being sold, and a
detailed review of products still in the warranty period.

A roll-forward of warranty activities is as follows (in thousands):

Additions
(Reductions)
Beginning Charged to Ending
Balance Costs and Balance
January 1 Expenses Deductions March 31
-------------- ----------------- --------------- --------------------

2006................... $ 189 13 25 177
2005................... $ 490 (68) 14 408

(5) Business Operations
-------------------

Company Overview
----------------
Paragon provides a variety of material handling solutions, including
systems, technologies, products, and services for material flow
applications. The Company's capabilities include horizontal transportation,
rapid dispensing, order fulfillment, computer software, sortation,
integrating conveyors and conveyor systems, and aftermarket services.

The Company's Easton, Pennsylvania operation (hereafter referred to as "SI
Systems") is a specialized systems integrator supplying SI Systems' branded
automated material handling systems to manufacturing, assembly, order
fulfillment, and distribution operations customers located primarily in
North America, including the U.S. government. SI Systems is brought to
market as two individual brands, SI Systems' Order Fulfillment Systems
(hereafter referred to as "SI Systems OFS") and SI Systems' Production &
Assembly Systems (hereafter referred to as "SI Systems PAS"). Each brand
has its own focused sales force, utilizing the products and services
currently available or under development within the Company.

The SI Systems OFS sales force focuses on providing order fulfillment
systems to order processing and distribution operations, which may
incorporate the Company's proprietary DISPEN-SI-MATIC(R) and automated
order fulfillment solutions and specialized software from the SINTHESIS(TM)
Software Suite. SINTHESIS(TM) is comprised of eight proprietary software
groups, with 26 extendible software modules that continually assess
real-time needs and deploy solutions to accurately facilitate and optimize
planning, warehousing, inventory, routing, and order fulfillment within the
distribution process. The SI Systems PAS sales force focuses on providing
automated material handling systems to manufacturing and assembly
operations and the U.S. government, which may incorporate the Company's
proprietary LO-TOW(R) and CARTRAC(R) horizontal transportation
technologies.

The Company's automated material handling systems are marketed, designed,
sold, installed, and serviced by its own staff or subcontractors as
labor-saving devices to improve productivity, quality, and reduce costs.
The Company's integrated material handling solutions involve both standard
and specially designed components and include integration of
non-proprietary automated handling technologies so as to provide turnkey
solutions for its customers' unique material handling needs. The Company's
engineering staff develops and designs computer control programs required
for the efficient operation of the systems and for optimizing
manufacturing, assembly, and fulfillment operations.

Following the sale of Ermanco, the Company has continued to review
opportunities with the goal of maximizing resources, increasing stockholder
value, and considering strategies and transactions intended to provide
liquidity. At this time, the Company believes that an increase in
stockholder value will be best obtained through a redeployment of assets
from Ermanco to the Company's remaining business, through increases in the
Company's internal technology base, strengthening the Company's sales and
marketing capabilities, growth of the Company's continuing operations and
other higher growth markets, in particular, by the enhancement of the
Company's products with advanced proprietary software capabilities through
research and development efforts and/or possible acquisitions, mergers, and
joint ventures. Although the Company enters into preliminary discussions
and non-disclosure agreements from time to time, the Company does not have
any material definitive agreements in place. There is no assurance that the
Company will be able to consummate any such acquisition at all or an
acquisition on terms that the Company would consider reasonable.

------------------------------

The Company's systems vary in configuration and capacity. Historically,
system prices across the Company's product lines have ranged from $100,000
to several million dollars per system. Systems and aftermarket sales during
the three months ended March 31, 2006 and 2005 are as follows (in
thousands):

For the three months ended March 31, 2006 and 2005:

March 31, 2006 March 31, 2005
------------------------------ ------------------------------
% of Total % of Total
Sales Sales Sales Sales
-------------- ------------- -------------- --------------

Systems sales................. $ 3,291 78.0% $ 3,037 78.6%
Aftermarket sales............. 929 22.0% 829 21.4%
-------------- ------------- -------------- --------------
Total sales................ $ 4,220 100.0% $ 3,866 100.0%
============== ============= ============== ==============

The Company's products are sold worldwide through its own sales personnel.
Domestic and international sales during the three months ended March 31,
2006 and 2005 are as follows (in thousands):

For the three months ended March 31, 2006 and 2005:

March 31, 2006 March 31, 2005
------------------------------ ------------------------------
% of Total % of Total
Sales Sales Sales Sales
-------------- ------------- -------------- --------------

Domestic sales................ $ 4,189 99.3% $ 3,374 87.3%
International sales........... 31 .7% 492 12.7%
-------------- ------------- -------------- --------------
Total sales................ $ 4,220 100.0% $ 3,866 100.0%
============== ============= ============== ==============

All of the Company's sales originate in the United States, and there are no
long-lived assets existing outside the United States.

The Company's backlog of orders at March 31, 2006 and March 31, 2005 were
$8,184,000 and $6,875,000, respectively.

The Company's business is largely dependent upon a limited number of large
contracts with a limited number of customers. This dependence can cause
unexpected fluctuations in sales volume. Various external factors affect
the customers' decision-making process on expanding or upgrading their
current production or distribution sites. The customers' timing and
placement of new orders is often affected by factors such as the current
economy, current interest rates, and future expectations. The Company
believes that its business is not subject to seasonality, although the rate
of new orders can vary substantially from month to month. Since the Company
recognizes sales on a percentage of completion basis for its systems
contracts, fluctuations in the Company's sales and earnings occur with
increases or decreases in major installations.

(6) Recently Issued Accounting Pronouncements
-----------------------------------------
In November 2004, the Financial Accounting Standards Board issued SFAS No.
151, "Inventory Costs an Amendment of ARB No. 43, Chapter 4" ("FAS 151").
FAS 151 provides for certain fixed production overhead cost to be reflected
as a period cost and not capitalized as inventory. FAS 151 is effective for
the beginning of 2006. The adoption of FAS 151 did not have a material
impact on the Company's financial statements.

In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised) "Share-Based Payment" ("FAS 123R"). FAS 123R addresses all
forms of share-based payment awards, including shares issued under employee
stock purchase plans, stock options, restricted and non-vested stock, and
stock appreciation rights. It requires companies to recognize in the
statement of operations the grant-date fair value of stock options and
other equity-based compensation issued to employees. The statement
eliminates the intrinsic value-based method prescribed by APB Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations,
that the Company used prior to January 1, 2006. The Company adopted FAS
123R on January 1, 2006.

In May 2005, the Financial Accounting Standard Board issued SFAS No. 154,
"Accounting Changes and Error Corrections - A Replacement of APB Opinion
No. 20 and FASB Statement No. 3" ("FAS 154"). FAS 154 requires
retrospective application to prior periods' financial statements for
changes in accounting principle, unless it is impracticable to determine
either the period-specific effects or the cumulative effect of the change.
This statement also requires that retrospective application of a change in
accounting principle be limited to the direct effects of the change.
Indirect effects of a change in accounting principle, such as a change in
non-discretionary profit-sharing payments resulting from an accounting
change, should be recognized in the period of the accounting change. FAS
154 also requires that a change in depreciation, amortization, or depletion
method for long-lived non-financial assets be accounted for as a change in
accounting estimate affected by a change in accounting principle. This
statement is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. The Company adopted
the provisions of this statement, as applicable, on January 1, 2006, and
there was no impact of the adoption.

In November 2005, the FASB issued FSP No. FAS 123(R)-3, "Transition
Election Related to Accounting for the Tax Effects of Share-Based Payment
Awards." This FSP provides an elective alternative transition method for
calculating the pool of excess tax benefits available to absorb tax
deficiencies recognized subsequent to the adoption of SFAS No. 123R.
Companies may take up to one year from the effective date of the FSP to
evaluate the available transition alternatives and make a one-time election
as to which method to adopt. The Company is currently in the process of
evaluating the alternative methods.

(7) Sale-Leaseback
--------------
The Company's principal office is located in a 173,000 square foot,
concrete, brick, and steel facility in Easton, Pennsylvania. In connection
with the February 2003 sale of the Company's Easton, Pennsylvania facility,
the Company entered into a leaseback arrangement for 25,000 square feet of
office space for five years. The leasing agreement requires fixed monthly
rentals of $18,781 (with annual increases of 3%). The terms of the lease
also require the payment of a proportionate share of the facility's
operating expenses. The leasing agreement is secured with a $200,000 letter
of credit. The lease expires on February 21, 2008. In accordance with SFAS
No. 13 and SFAS No. 28, the leaseback does not meet the criteria for
classification as a capital lease; hence, it is classified as an operating
lease. The sale-leaseback resulted in a total gain of $2,189,000, of which
$1,363,000 was recorded as a gain in 2003. The seller-lessee (Company)
retained more than a minor part (25,000 square feet) but less than
substantially all of the use of the property (173,000 square feet) through
the leaseback and realized a profit on the sale in excess of the present
value of the minimum lease payments over the lease term. The present value
of the stream of lease payments utilizing the Company's incremental
borrowing rate of 10.0% was $826,000. The $826,000 of deferred profit is
amortized in equal amounts as a reduction in rent expense over the
five-year term of the lease. During the three months ended March 31, 2006
and 2005, $42,000 and $42,000, respectively, of the deferred gain was
recognized.

(8) Line of Credit
--------------
The Company has a line of credit facility which may not exceed $5,000,000
and is to be used primarily for working capital purposes. Interest on the
line of credit facility is at the LIBOR Market Index Rate plus 1.4%.
Effective August 5, 2005 the Company issued a $2,000,000 letter of credit
in connection with the sale of substantially all of the assets and
liabilities of Ermanco, thereby reducing the amount of available line of
credit to $2,800,000. As of March 31, 2006, the Company did not have any
borrowings under the line of credit facility, and the line of credit
facility expires effective June 30, 2006. The Company expects to renew the
line of credit facility under similar terms and conditions during 2006.

The line of credit facility contains various non-financial covenants and is
secured by all accounts receivables and inventory. The Company was in
compliance with all covenants as of March 31, 2006.

(9) Stock Repurchase Program
------------------------
On August 12, 2004, the Company's Board of Directors approved a program to
repurchase up to $1,000,000 of its outstanding common stock. The Company's
Board of Directors amended its existing stock repurchase program on several
occasions during 2005 by increasing the amount it has authorized management
to repurchase from up to $1,000,000 of the Company's common stock to up to
$10,000,000. There were no repurchases during the three months ended March
31, 2006. Through March 31, 2006, the Company repurchased 858,800 shares of
common stock at a weighted average cost, including brokerage commissions,
of $9.79 per share. Cash expenditures for the stock repurchases since the
inception of the program were $8,406,514. As of March 31, 2006, $1,593,486
remained available for repurchases under the stock repurchase program.
Based on market conditions and other factors, additional repurchases may be
made from time to time, in

compliance with SEC regulations, in the open market or through privately
negotiated transactions at the discretion of the Company. There is no
expiration date with regards to the stock repurchase program. All shares of
common stock that were repurchased by the Company since the inception of
the program were subsequently retired.

(10) Stock-Based Compensation
------------------------
Effective January 1, 2006, the Company adopted SFAS No. 123R and related
interpretations and began expensing the grant-date fair value of employee
stock options over the related requisite service period. Prior to January
1, 2006, the Company applied Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations
in accounting for its stock option plans. Accordingly, no compensation
expense was recognized in net income for employee stock options, as options
granted had an exercise price equal to the market value of the underlying
common stock on the date of grant. The Company recognized compensation
expense on options granted to non-employee directors. The estimated impact
of adopting SFAS No. 123R in 2006 is approximately $7,000 and is not
expected to have a significant impact on basic and diluted earnings per
share for the year. The pro forma impact of expensing employee stock
options in 2005 would have been $27,000 or a reduction of basic and diluted
earnings per share by approximately $.01 for the year based on the
disclosures required by SFAS No. 123.

The Company adopted SFAS No. 123R using the modified prospective transition
method and therefore has not restated prior periods. Under this transition
method, compensation cost associated with employee stock options recognized
in 2006 includes amortization related to the remaining unvested portion of
stock option awards granted prior to January 1, 2006, and amortization
related to new awards granted after January 1, 2006.

The expense associated with stock-based compensation arrangements is a
non-cash charge. In the Consolidated Statements of Cash Flows, stock-based
compensation expense is an adjustment to reconcile net income to cash
provided (used) by operating activities.

Prior to the adoption of SFAS No. 123R, the Company presented tax benefits
resulting from stock-based compensation as operating cash flows in the
Consolidated Statements of Cash Flows. SFAS No. 123R requires that cash
flows resulting from tax deductions in excess of compensation cost
recognized in the financial statements be classified as financing cash
flows. For the first quarter of 2006, no excess tax benefits were
generated.

SFAS No. 123R modified the disclosure requirements related to stock-based
compensation. Accordingly, the disclosures prescribed by SFAS No. 123R are
included below.

For stock options granted prior to the adoption of SFAS No. 123R, the
effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," to its stock option plan would have been as
follows:

Three Months Ended
March 31, 2005
------------------------

Net income, as reported......................................... $ 194
Deduct: total stock-based employee compensation
expense determined under fair value based method,
net of related tax effects................................... (11)
------------------------
Pro forma net income............................................ $ 183
========================

Basic earnings per share:
As reported.................................................. $ .05
Pro forma.................................................... $ .04

Diluted earnings per share:
As reported.................................................. $ .04
Pro forma.................................................... $ .04

1997 Equity Compensation Plan
The Company has a stock-based compensation program, the 1997 Equity
Compensation Plan ("ECP"), which will expire in July 2007. The ECP provides
for grants of stock options, restricted and non-vested stock, and stock
appreciation rights to selected key employees, key advisors who perform
valuable services, and directors of the Company. In addition, the ECP
provides for grants of performance units to employees and key advisors. The
ECP, as amended by stockholders in August 2000 and June 2001, authorizes up
to 1,012,500 shares of common stock for issuance pursuant to the terms of
the plan. Under the Company's ECP, officers, directors, and key employees
have been granted options to purchase shares of common stock at the market
price at the date of grant. Options become exercisable in increments of 25%
on the anniversary date of the grant; thus, at the end of four years, the
options are fully exercisable. Vested stock option awards may be exercised
through payment of cash, exchange of mature shares, or through a broker. As
of March 31, 2006, 51,035 options are outstanding under the plan, and all
options have a term of five or seven years.

The compensation cost charged against income in the first quarter of 2006
for stock-based compensation programs was $8,000, which consisted of
expensing $1,000 for employee stock options, $4,000 for directors' stock
options, and $3,000 for non-vested stock. Of the compensation cost
recognized, all of the $8,000 was a component of selling, general and
administrative expenses.

Stock Options
On March 8, 2006, the Board of Directors of the Company granted 12,500
stock options to its executive officers. The fair value of options granted
in the first quarter of 2006 was estimated using the Black Scholes option
valuation model that used the assumptions noted in the table below.
Expected volatility and expected dividend yield are based on actual
historical experience of the Company's stock and dividends over the
historical period equal to the option term. The dividend yield on the
Company's common stock is assumed to be zero since the Company has not paid
any cash dividends since 1999 and has no present intention to declare cash
dividends. The expected life represents the period of time that options
granted are expected to be outstanding and was calculated using the
simplified method prescribed by the Securities and Exchange Commission
Staff Accounting Bulletin No. 107. The assumptions given below results from
certain groups of employees exhibiting different behavior. Separate groups
of employees that have similar historical exercise behavior were considered
separately for valuation purposes. The Company does not expect to have any
forfeitures of its recent stock option awards based on the historical
experience of the group of employees that received the stock option awards.
The risk-free rate is based on the U. S. Treasury Securities with terms
equal to the expected time of exercise as of the grant date.

------------------------------------------------------------------------------

Expected volatility............................................. 18.0%
Expected dividend yield......................................... 0.0%
Expected life (in years)........................................ 4.75
Risk-free interest rate......................................... 4.75%
------------------------------------------------------------------------------

The grant-date fair value of options granted during the first quarter of
2006 was $2.60 per option.

A summary of stock option activity is presented below:

Weighted
Average
Weighted Remaining
Average Contractual Aggregate
Exercise Term Intrinsic
Options Price (In Years) Value
------------- --------------- ---------------- ---------------

Outstanding at January 1, 2006........... 38,535 $ 7.86
Granted................................ 12,500 10.01
Exercised.............................. - -
Forfeited.............................. - -
------------- ---------------
Outstanding at March 31, 2006............ 51,035 $ 8.39 2.3 $ 128,000
============= ===============

Exercisable at March 31, 2006............ 33,535 $ 7.81 .7 $ 83,000

There were no stock options exercised during the first quarter of 2006. The
compensation cost charged against income in the first quarter of 2006 for
stock options was $5,000. Compensation cost is recognized on a
straight-line basis over the stated vesting period consistent with the
terms of the arrangement.

As of December 31, 2005, there were no unvested employee stock options.
Therefore, no compensation cost related to stock options granted to
employees prior to January 1, 2006 will be recognized.

Non-Vested Stock
The grant-date fair value of non-vested stock is determined on the date of
grant based on the market price of the stock, and compensation cost is
generally amortized to expense on a straight-line basis over the vesting
period during which employees perform related services.

On March 8, 2006, the Company issued 12,500 shares of non-vested stock to
its executive officers. Participants are entitled to cash dividends and to
vote their respective shares. The shares are subject to forfeiture if
employment is terminated prior to March 8, 2010.

A summary of restricted stock activity is presented below:

Restricted Grant Date
Shares Fair Value
-------------- ------------------

Nonvested at January 1, 2006.............................. - $ -
Granted................................................ 12,500 10.01
Vested................................................. - -
Forfeited.............................................. - -
-------------- ------------------
Nonvested at March 31, 2006............................... 12,500 $ 10.01
============== ==================

The compensation cost charged against income in the first quarter of 2006
for restricted stock awards was $3,000. The total compensation cost is
expected to be recognized over the four-year vesting period.

(11) Income Taxes
------------
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
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. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.

The Company recognized an income tax benefit of $86,000 during the three
months ended March 31, 2006 compared to income tax expense of $39,000
during the three months ended March 31, 2005. The income tax benefit for
the first quarter of 2006 was higher than the statutory federal and state
tax rates due primarily to the reversal of accruals for the expiration of
tax return statutes. Income tax expense for the first quarter of 2005 was
generally recorded at statutory federal and state tax rates.

(12) Legal Proceedings
-----------------
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or
liquidity.

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations
---------------------

The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the unaudited
consolidated financial statements for the period ended March 31, 2006, and the
cautionary statements and consolidated financial statements and related notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005. The discussion and analysis contains "forward-looking
statements" based on management's current expectations, assumptions, estimates,
and projections. These forward-looking statements involve risks and
uncertainties. The Company's actual results could differ materially from those
included in these "forward-looking statements" as a result of risks and
uncertainties, identified in connection with those forward-looking statements,
including those factors identified herein, and in the Company's other publicly
filed reports.

------------------------------

Business Overview
-----------------
Paragon Technologies, Inc. provides a variety of material handling
solutions, including systems, technologies, products, and services for material
flow applications. Founded in 1958, the Company's material handling solutions
are based on core technologies in horizontal transportation and order
fulfillment and are aimed at improving productivity for manufacturing, assembly,
and distribution center operations.
On August 5, 2005, the Company completed the sale of substantially all of
the assets and liabilities of Ermanco, and received cash consideration of
$23,055,000 (subject to a working capital adjustment and an accounts receivable
adjustment). Transaction costs associated with the sale of the assets and
liabilities of Ermanco were approximately $1,038,000. During the fourth quarter
of 2005, the Company paid $448,000 to the Buyer in connection with the working
capital adjustment and $61,000 in connection with the accounts receivable
adjustment. Therefore, the Company received cash consideration of $21,508,000,
net of transaction costs and the working capital and accounts receivable
adjustments in connection with the sale of the assets and liabilities of
Ermanco, thereby resulting in a pre-tax loss of approximately $964,000. See Note
2 of the Notes to Consolidated Financial Statements for further information
regarding the sale of substantially all of the assets and liabilities of
Ermanco. The discussion that follows reflects the operations of the Company
following the sale of substantially all of the assets and liabilities of
Ermanco.

------------------------------

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Key Performance Metrics Relevant to the Company
-----------------------------------------------

Capacity Utilization
--------------------
Capacity Utilization, as documented in the Federal Reserve Statistical
Release(1), is a key economic indicator that the Company follows as a barometer
that may lead to capital spending for material handling systems. Capacity
Utilization attempts to measure what percent of available capacity is actually
being utilized. Management believes that when Capacity Utilization rises and
falls, the Company may see a corresponding change in rate of new orders, and
therefore, a corresponding change in backlog and sales may also occur. The
backlog of orders represents the uncompleted portion of systems contracts along
with the value of parts and services from customer purchase orders related to
goods that have not been shipped or services that have not been rendered.
Backlog is generally indicative of customer demand for the Company's products.
As the demand for the Company's products increases, the backlog of orders, the
rate of new orders, and sales also typically increases. The following table
depicts the Company's backlog, orders, sales, and Capacity Utilization for the
three months ended March 31, 2006, and for the years ended December 31, 2005,
2004, 2003, 2002, and 2001:

Three Months
Ended Year Ended December 31,
March 31, -----------------------------------------------
(Dollars in Thousands) 2006 2005 2004 2003 2002 2001
------------------ -----------------------------------------------

Backlog of orders - Beginning............ $ 6,918 5,514 4,052 4,834 7,666 16,353
Add: orders........................... 5,486 18,080 13,164 11,301 12,074 10,321
Less: sales........................... 4,220 16,676 11,702 12,083 14,906 19,008
------------------ -----------------------------------------------
Backlog of orders - Ending............... $ 8,184 6,918 5,514 4,052 4,834 7,666
================== ===============================================

Capacity Utilization(1).................. 81.0% 80.0% 78.6% 75.7% 75.1% 76.3%

Current Ratio
-------------
Management of the Company monitors the current ratio as a measure of
determining liquidity and believes the current ratio illustrates that the
Company's financial resources are adequate to satisfy its future cash
requirements through the next year. The following table depicts the Company's
current assets, current liabilities, and current ratio as of March 31, 2006 and
as of December 31, 2005, 2004, 2003, 2002, and 2001:

As of As of December 31,
March 31, --------------------------------------------------------------
(Dollars in Thousands) 2006 2005 2004 2003 2002 2001
------------------- ---------- ---------- ---------- ---------- ----------

Current assets............... $ 21,805 22,134 14,249 14,720 15,444 19,200
------------------- ---------- ----------- ----------- ---------- ----------
Current liabilities.......... $ 5,077 5,337 7,355 9,583 9,416 13,357

Current ratio................ 4.29 4.15 1.94 1.54 1.64 1.44

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Debt to Equity Ratio
--------------------
With an emphasis over the past several years on generating cash flows to
eliminate the Company's senior and subordinated debt, the Company has eliminated
its financial leverage as evidenced by its debt to equity ratio, which is the
ratio of total debt to stockholders' equity. Management believes the absence of
debt provides greater protection for its stockholders and enhances the Company's
ability to obtain additional financing, if required. The following table
illustrates the calculation of the debt to equity ratio as of March 31, 2006 and
as of December 31, 2005, 2004, 2003, 2002, and 2001 and also includes the number
of shares outstanding at the end of each fiscal period:

As of As of December 31,
March 31, -------------------------------------------------------------
(Dollars in Thousands) 2006 2005 2004 2003 2002 2001
------------------- ---------- ---------- ---------- ---------- ----------

Current installments of
long-term debt ............. $ - - - - 1,437 2,305
Long-term debt ............... - - - - 7,263 9,900
--------- --------- --------- --------- --------- ---------
Total debt ................... - - - - 8,700 12,205
--------- --------- --------- --------- --------- ---------
Total stockholders'
equity (1) ................. $ 17,075 17,066 23,308 22,061 17,885 16,912
========= ========= ========= ========= ========= =========

Debt to equity ratio ......... - - - - .49 .72

Number of shares
outstanding at the
end of the fiscal
period ..................... 3,551,519 3,539,019 4,265,310 4,277,595 4,256,098 4,221,635
========= ========= ========= ========= ========= =========

(1) During the year ended December 31, 2005, the Company repurchased 824,100
shares of common stock at a weighted average cost, including brokerage
commissions, of $9.81 per share. Cash expenditures for the stock
repurchases during the year ended December 31, 2005 were $8,080,882. See
Stock Repurchase Program in Note 9 of the Notes to Consolidated Financial
Statements regarding the Company's Stock Repurchase Program.

-------------------------------

Critical Accounting Policies and Estimates
------------------------------------------
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amount of assets and liabilities, revenues
and expenses, and other financial information, including the related disclosure
of commitments and contingencies at the date of our financial statements. Actual
results may, under different assumptions and conditions, differ significantly
from our estimates.
We believe that our accounting policies related to revenue recognition on
system sales, warranty, and inventories are our "critical accounting policies."
These policies have been reviewed with the Audit Committee of the Board of
Directors and are discussed in greater detail below.

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Revenue Recognition on Systems Sales
------------------------------------
Revenues on systems contracts, accounted for in accordance with SOP 81-1 of
the American Institute of Certified Public Accountants, are recorded on the
basis of the Company's estimates of the percentage of completion of individual
contracts. Gross margin is recognized on the basis of the ratio of aggregate
costs incurred to date to the most recent estimate of total costs. As contracts
may extend over one or more years, revisions in cost and profit estimates during
the course of the work are reflected in the accounting periods in which the
facts requiring revisions become known. At the time a loss on a contract becomes
known, the entire amount of the estimated ultimate loss is accrued. As of March
31, 2006, there are no contracts that are anticipated to result in a loss.
The Company believes that it has the ability to reasonably estimate the
total costs and applicable gross profit margins at the inception of the contract
for all of its systems contracts. However, where cost estimates change, there
could be a significant impact on the amount of revenue recognized. The Company's
failure to estimate accurately can result in cost overruns which will result in
the loss of profits if the Company determines that it has significantly
underestimated the costs involved in completing contracts. The Company has not
had any significant cost overruns resulting in loss of profits during the three
months ended March 31, 2006.

Accrued Product Warranty
------------------------
The Company's products are warranted against defects in materials and
workmanship for varying periods of time depending on customer requirements and
the type of system sold, with a typical warranty period of one year. The Company
provides an accrual for estimated future warranty costs and potential product
liability claims based upon a percentage of cost of sales, typically two percent
of the cost of the system being sold, and a detailed review of products still in
the warranty period. Historically, the level of warranty reserve has been
appropriate based on management's assessment of estimated future warranty
claims. However, if unanticipated warranty issues arise in the future, there
could be a significant impact on the recorded warranty reserve. The recorded
warranty reserve as of March 31, 2006 was $177,000.

Inventories
-----------
Inventories are valued at the lower of average cost or market. The Company
provides an inventory reserve determined by a specific identification of
individual slow moving items and other inventory items based on historical
experience. The reserve is considered to be a write-down of inventory to a new
cost basis. Upon disposal of inventory, the new cost basis is removed from the
accounts.

-------------------------------

Results of Operations - Three Months Ended March 31, 2006 Compared to
---------------------------------------------------------------------
the Three Months Ended March 31, 2005
-------------------------------------

Net Sales and Gross Profit on Sales
-----------------------------------

2006 2005
------------------ ------------------

Net sales............................................ $ 4,220,000 3,866,000
Cost of sales........................................ 2,933,000 2,774,000
------------------ ------------------
Gross profit on sales................................ $ 1,287,000 1,092,000
================== ==================

Gross profit as a percentage of sales................ 30.5% 28.2%
================== ==================

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Results of Operations - Three Months Ended March 31, 2006 Compared to the
-------------------------------------------------------------------------
Three Months Ended March 31, 2005 (Continued)
---------------------------------

Net Sales and Gross Profit on Sales (Continued)
-----------------------------------
The increase in sales was associated with a larger backlog of orders
entering fiscal 2006 when compared to the backlog of orders entering fiscal
2005. Contributing to the increase in sales was progress made on contracts
received prior to the start of the year and during the first quarter of 2006 in
accordance with contract completion requirements associated with customers in
the vehicle assembly, health and beauty aids, and entertainment marketplace as a
result of a demand for the Company's products in these industry sectors.
Gross profit, as a percentage of sales, for the three months ended March
31, 2006, when compared to the three months ended March 31, 2005, was favorably
impacted by 4.6% as a result of a reduction in overhead costs as a percentage of
sales due to the higher sales volume to cover fixed overhead costs in the three
months ended March 31, 2006. Partially offsetting the aforementioned favorable
variance by 2.3% was the impact of the favorable performance on the Company's
contracts that were completed or nearing completion in the three months ended
March 31, 2005 as compared to the three months ended March 31, 2006, along with
competitive pricing pressures and product mix.

Selling, General and Administrative Expenses
--------------------------------------------
Selling, general and administrative expenses of $1,372,000 were higher by
$335,000 for the three months ended March 31, 2006 than for the three months
ended March 31, 2005. The increase was attributable to the addition of resources
aimed at expanding the customer base and an increase in salaries and fringe
benefits totaling $164,000, an increase of $69,000 in marketing expenses
primarily associated with product promotion, marketing research, and
participation in trade shows, and an increase of $56,000 in professional fees
and shareholder relations expenditures.

Product Development Costs
-------------------------
Product development costs, including patent expense, of $156,000 were
higher by $152,000 for the three months ended March 31, 2006 than for the three
months ended March 31, 2005. Development programs in the three months ended
March 31, 2006 were primarily aimed at improvements to the Company's Order
Fulfillment systems technologies. Order Fulfillment development efforts during
the three months ended March 31, 2006 included DISPEN-SI-MATIC(R) software and
hardware enhancements aimed at promoting workplace efficiencies for the
Company's customers.

Interest Income
---------------
Interest income of $128,000 was higher by $115,000 for the three months
ended March 31, 2006 than for the three months ended March 31, 2005. The
increase in interest income was attributable to the higher level of funds
available for investment as a result of the cash proceeds from the sale of
substantially all of the assets and liabilities of Ermanco.

Other Income, Net
-----------------
The unfavorable variance of $11,000 in other income, net for the three
months ended March 31, 2006 as compared to the three months ended March 31, 2005
was attributable to a decrease in royalty income from a license agreement
related to material handling equipment sales.

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Income Tax Expense (Benefit)
---------------------------
The Company recognized an income tax benefit of $86,000 during the three
months ended March 31, 2006 compared to income tax expense of $39,000 during the
three months ended March 31, 2005. The income tax benefit for the first quarter
of 2006 was higher than the statutory federal and state tax rates primarily due
to the reversal of accruals for the expiration of tax return statutes. Income
tax expense for the first quarter of 2005 was generally recorded at statutory
federal and state tax rates.

-------------------------------

Liquidity and Capital Resources
-------------------------------
The Company's cash and cash equivalents and short-term investments at March
31, 2006 were $16,576,000, representing 74.3% of total assets, down from
$17,397,000, or 77.0% of total assets, at December 31, 2005. The decrease was
primarily due to cash used by operating activities totaling $761,000.
Cash used by operating activities totaling $761,000 during the three months
ended March 31, 2006 was primarily due to the following factors:
o an increase in receivables in the amount of $698,000 in accordance with
contractual requirements associated with a customer in the office
supplies industry and the U.S. government; and
o a decrease in customers' deposits and billings in excess of costs and
estimated earnings in the amount of $249,000 in accordance with
contractual requirements associated with customers in the vehicle
assembly and entertainment marketplace.
Partially offset by a decrease in costs and estimated earnings in excess of
billings in the amount of $205,000 in accordance with contractual requirements
associated with customers in the healthcare marketplace.
The Company's cash and cash equivalents and short-term investments at March
31, 2005 rose to $4,118,000 at March 31, 2005 from $3,602,000 at December 31,
2004. The increase resulted primarily from cash provided by operating activities
totaling $656,000.
Cash provided by operating activities totaling $656,000 during the three
months ended March 31, 2005 was primarily due to the following factors:
o an increase in net cash provided by operating activities of discontinued
operations of $1,021,000; and
o a decrease in receivables in the amount of $364,000 in accordance with
contractual requirements associated with customers in the health and
beauty aids, entertainment, and retail marketplace.
Partially offset by the following factors:
o a decrease in customers' deposits and billings in excess of costs and
estimated earnings in the amount of $127,000 in accordance with
contractual requirements associated with customers in the health and
beauty aids and entertainment marketplace;
o an increase in costs and estimated earnings in excess of billings in
the amount of $365,000 in accordance with contractual requirements
associated with customers in the vehicle assembly and the healthcare
marketplace; and
o a decrease in accounts payable in the amount of $243,000 associated
with the payment of goods and services rendered in accordance with job
completion requirements.

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Liquidity and Capital Resources (Continued)
-------------------------------
The Company's line of credit facility may not exceed $5,000,000 and is to
be used primarily for working capital purposes. Effective August 5, 2005, the
Company issued a $2,000,000 letter of credit in connection with the sale of
substantially all of the assets and liabilities of Ermanco, thereby reducing the
amount of available line of credit to $2,800,000. The line of credit facility
contains various non-financial covenants and is secured by all accounts
receivables and inventory. As of March 31, 2006, the Company did not have any
borrowings under the line of credit facility, and the line of credit facility
expires effective June 30, 2006. The Company expects to renew the line of credit
facility under similar terms and conditions during 2006.
The Company anticipates that its financial resources, consisting of cash
generated from operations, its line of credit, and the sale of Ermanco will be
adequate to satisfy its future cash requirements through the next year. Sales
volume, as well as cash liquidity, may experience fluctuations due to the
unpredictability of future contract sales and the dependence upon a limited
number of large contracts with a limited number of customers.
The Company is currently exploring various business strategies designed to
enhance the value of the Company's assets for its stockholders. The Company is
continuing to evaluate and actively explore a range of possible options,
including transactions intended to provide liquidity and maximize stockholder
value, and consideration of the acquisition of complementary assets and/or
businesses. The Company may not be able to effect any of these strategic options
on favorable terms or at all.

------------------------------

Contractual Obligations
-----------------------
The Company's leases 25,000 square feet in Easton, Pennsylvania for use as
its principal office. The leasing agreement requires fixed monthly rentals of
$18,781 (with annual increases of 3%). The terms of the lease also require the
payment of a proportionate share of the facility's operating expenses. The
leasing agreement is secured with a $200,000 letter of credit. The lease expires
on February 21, 2008.
Future contractual obligations and commercial commitments at March 31, 2006
as noted above are as follows:

Payments Due by Period
--------------------------------------------------------------
Total 2006 2007 2008 2009 2010
--------------- ---------- ---------- ---------- ---------- ----------

Contractual obligations:
Operating leases........... $ 434,000 169,000 231,000 34,000 - -
--------------- ---------- ---------- ---------- ---------- ----------

Total...................... $ 434,000 169,000 231,000 34,000 - -
=============== ========== ========== ========== ========== ==========

Amount of Commitment
Expiration Per Period
Total Amounts ------------------------------------------------------------------
Committed 2006 2007 2008 2009 2010
------------- ---------- ---------- ---------- ---------- ----------

Other commercial
commitments:
Letters of credit.......... $ 2,200,000 2,000,000 200,000 - - -

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Off-Balance Sheet Arrangements
------------------------------
As of March 31, 2006 the Company had no off-balance sheet arrangements in
the nature of guarantee contracts, retained or contingent interests in assets
transferred to unconsolidated entities (or similar arrangements serving as
credit, liquidity, or market risk support to unconsolidated entities for any
such assets), or obligations (including contingent obligations) arising out of
variable interests in unconsolidated entities providing financing, liquidity,
market risk, or credit risk support to the Company, or that engage in leasing,
hedging, or research and development services with the Company.

Recently Issued Accounting Pronouncements
-----------------------------------------
In November 2004, the Financial Accounting Standards Board issued SFAS No.
151, "Inventory Costs an Amendment of ARB No. 43, Chapter 4" ("FAS 151"). FAS
151 provides for certain fixed production overhead cost to be reflected as a
period cost and not capitalized as inventory. FAS 151 is effective for the
beginning of 2006. The adoption of FAS 151 did not have a material impact on the
Company's financial statements.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised) "Share-Based Payment" ("FAS 123R"). FAS 123R addresses all forms
of share-based payment awards, including shares issued under employee stock
purchase plans, stock options, restricted and non-vested stock, and stock
appreciation rights. It requires companies to recognize in the statement of
operations the grant-date fair value of stock options and other equity-based
compensation issued to employees. The statement eliminates the intrinsic
value-based method prescribed by APB Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations, that the Company used prior to
January 1, 2006. The Company adopted FAS 123R on January 1, 2006.
In May 2005, the Financial Accounting Standard Board issued SFAS No. 154,
"Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20
and FASB Statement No. 3" ("FAS 154"). FAS 154 requires retrospective
application to prior periods' financial statements for changes in accounting
principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. This statement also requires
that retrospective application of a change in accounting principle be limited to
the direct effects of the change. Indirect effects of a change in accounting
principle, such as a change in non-discretionary profit-sharing payments
resulting from an accounting change, should be recognized in the period of the
accounting change. FAS 154 also requires that a change in depreciation,
amortization, or depletion method for long-lived non-financial assets be
accounted for as a change in accounting estimate affected by a change in
accounting principle. This statement is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The Company adopted the provisions of this statement, as applicable, on January
1, 2006, and there was no impact of the adoption.
In November 2005, the FASB issued FSP No. FAS 123(R)-3, "Transition
Election Related to Accounting for the Tax Effects of Share-Based Payment
Awards." This FSP provides an elective alternative transition method for
calculating the pool of excess tax benefits available to absorb tax deficiencies
recognized subsequent to the adoption of SFAS No. 123R. Companies may take up to
one year from the effective date of the FSP to evaluate the available transition
alternatives and make a one-time election as to which method to adopt. The
Company is currently in the process of evaluating the alternative methods.

Item 2. Management's Discussion and Analysis of Financial Condition and
------- ---------------------------------------------------------------
Results of Operations (Continued)
---------------------

Cautionary Statement
--------------------
Certain statements contained herein are not based on historical fact and
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 or by the Securities and Exchange Commission
rules, regulations, and releases. The Company intends that such forward-looking
statements be subject to the safe harbors created thereby. Among other things,
they regard the Company's earnings, liquidity, financial condition, review of
strategic alternatives, and other matters. Words or phrases denoting the
anticipated results of future events, such as "anticipate," "believe,"
"estimate," "expect," "may," "will," "will likely," "are expected to," "will
continue," "should," "project," and similar expressions that denote uncertainty,
are intended to identify such forward-looking statements. The Company's actual
results, performance, or achievements could differ materially from the results
expressed in, or implied by, such "forward-looking statements": (1) as a result
of risks and uncertainties identified in connection with those forward-looking
statements, including those factors identified herein, and in the Company's
other publicly filed reports; (2) as a result of factors over which the Company
has no control, including the strength of domestic and foreign economies, sales
growth, competition, and certain costs increases; or (3) if the factors on which
the Company's conclusions are based do not conform to the Company's
expectations.

------------------------------

Item 3. Quantitative and Qualitative Disclosures About Market Risk
------- ----------------------------------------------------------

The Company does not believe that its exposures to interest rate risk or
foreign currency exchange risk, risks from commodity prices, equity prices and
other market changes that affect market risk sensitive instruments are material
to its results of operations.

Item 4. Controls and Procedures
------- -----------------------

(a) Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the
participation of the Company's management, including its Chief Executive
Officer, or CEO, and Chief Financial Officer, or CFO, of the effectiveness
of the Company's disclosure controls and procedures, as such term is
defined under Rule 13a-15(e) promulgated under the Securities Exchange Act
of 1934, as amended (the "Exchange Act") as of March 31, 2006. Based on
that evaluation, the Company's management, including the CEO and CFO,
concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act, is
accumulated and communicated to the Company's management, including the
Company's CEO and CFO, to allow timely decisions regarding required
disclosure, and is recorded, processed, summarized and reported as
specified in Securities and Exchange Commission rules and forms.

(b) Change in Internal Control Over Financial Reporting

There were no changes in the Company's internal control over financial
reporting identified in connection with the evaluation of such controls
that occurred during the Company's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect the
Company's internal control over financial reporting.

PART II -- OTHER INFORMATION
----------------------------

Item 1. Legal Proceedings
------- -----------------

The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.

Item 1A. Risk Factors
-------- ------------

Item 1A, "Risk Factors," of our 2005 Form 10-K includes a detailed
discussion of our risk factors.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
------- -----------------------------------------------------------

The following table represents the periodic repurchases of equity
securities made by the Company during the three months ended March 31, 2006:

-------------------------------------------------------------------------------------------------------
Total Number Approximate
Average of Shares Approximate Dollar Value
Price Paid Repurchased Dollar Value of Shares
Total Per Share as Part of a of Shares That May Yet
Number (Including Publicly Purchased Be Purchased
Fiscal of Shares Brokerage Announced Under the Under the
Period Repurchased Commissions) Program Program Program
-------------------------------------------------------------------------------------------------------

1/1/06 - 1/31/06 - $ - - $ - $ 1,593,486
2/1/06 - 2/28/06 - $ - - $ - $ 1,593,486
3/1/06 - 3/31/06 - $ - - $ - $ 1,593,486
-------------------------------------------------------------------------------------------------------

On August 12, 2004, the Company's Board of Directors approved a program to
repurchase up to $1,000,000 of its outstanding common stock. The Company's
Board of Directors amended its existing stock repurchase program on several
occasions during 2005 by increasing the amount it has authorized management
to repurchase from up to $1,000,000 of the Company's common stock to up to
$10,000,000. There were no repurchases during the three months ended March
31, 2006. Through March 31, 2006, the Company repurchased 858,800 shares of
common stock at a weighted average cost, including brokerage commissions,
of $9.79 per share. Cash expenditures for the stock repurchases since the
inception of the program were $8,406,514. As of March 31, 2006, $1,593,486
remained available for repurchases under the stock repurchase program.
Based on market conditions and other factors, additional repurchases may be
made from time to time, in compliance with SEC regulations, in the open
market or through privately negotiated transactions at the discretion of
the Company. There is no expiration date with regards to the stock
repurchase program. All shares of common stock that were repurchased by the
Company since the inception of the program were subsequently retired.

Item 3. Defaults Upon Senior Securities
------- -------------------------------

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders
------- ---------------------------------------------------

Not applicable.

Item 5. Other Information
------- -----------------

Not applicable.

Item 6. Exhibits
------- --------

31.1 Certification by Chief Executive Officer pursuant to
Rule 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 signed by
Joel L. Hoffner, President and CEO (filed herewith).

31.2 Certification by Chief Financial Officer pursuant to
Rule 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 signed by
Ronald J. Semanick, Chief Financial Officer and Vice
President - Finance and Treasurer (filed herewith).

32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 signed by Joel L. Hoffner, President and
CEO (filed herewith).

32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 signed by Ronald J. Semanick, Chief
Financial Officer and Vice President - Finance and
Treasurer (filed herewith).

SIGNATURES
----------

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

PARAGON TECHNOLOGIES, INC.

/s/ Joel L. Hoffner
-----------------------------------------------
Joel L. Hoffner
President & CEO

/s/ Ronald J. Semanick
-----------------------------------------------
Ronald J. Semanick
Chief Financial Officer

Dated: May 12, 2006
-----------------------

EXHIBIT INDEX
-------------

Exhibits
--------

31.2 Certification by Chief Financial Officer pursuant to Rule
13a-14(a) and 15d-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 signed by Ronald J.
Semanick, Chief Financial Officer and Vice President -
Finance and Treasurer (filed herewith).

32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 signed by Joel L. Hoffner, President and CEO
(filed herewith).

32.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 signed by Ronald J. Semanick, Chief Financial
Officer and Vice President - Finance and Treasurer (filed
herewith).