PARAGON TECHNOLOGIES INC - 10-K Annual Report

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

FORM 10-K
---------

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

For the year ended: Commission file number:
December 31, 2001 1-15729

PARAGON TECHNOLOGIES, INC.
(Exact Name Of Registrant As Specified In Its Charter)

Delaware 22-1643428
-------- ----------
(State Or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation)

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

Securities registered pursuant to Section 12(b) of the Act:

Name of Exchange
Title of Class on Which Registered
- ---------------------------------------------------- -----------------------
Common Stock, Par Value $1.00 Per Share American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark 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 check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/

Aggregate market value of common stock held by non-affiliates (based on the
closing price on the New York Stock Exchange) on March 13, 2002 was
approximately $19.9 million. For purposes of determining this amount only,
Registrant has defined affiliates as including (a) the executive officers named
in Part III of this 10-K report, (b) all directors of Registrant, and (c) each
stockholder that has informed Registrant by March 13, 2002 that it is the
beneficial owner of 10% or more of the outstanding common stock of Registrant.

The number of shares outstanding of the Registrant's Common Stock, as of
March 13, 2002 was 4,221,635.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement (the "Definitive Proxy Statement") to
be filed with the Securities and Exchange Commission for the Company's 2002
Annual Meeting of Stockholders are incorporated by reference into Part III of
this report.

TABLE OF CONTENTS

Part I.........................................................................3

Item 1. Business.....................................................3
Item 2. Properties..................................................11
Item 3. Legal Proceedings...........................................11
Item 4. Submission of Matters to a Vote of Security Holders.........12

Part II.......................................................................13

Item 5. Market For The Registrant's Common Equity and Related
Stockholder Matters.....................................13
Item 6. Selected Financial Data.....................................13
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.....................14
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk.......................................26
Item 8. Financial Statements and Supplementary Data.................27
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure....................N/A

Part III......................................................................59

Item 10. Directors and Executive Officers Of The Registrant..........59
Item 11. Executive Compensation......................................62
Item 12. Security Ownership of Management and Certain
Beneficial Owners.......................................62
Item 13. Certain Relationships and Related Transactions..............62

Part IV.......................................................................63

Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K................................................63

2

PART I
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Item 1. Business
- ------- --------

Company Overview
- ----------------
Paragon Technologies, Inc. ("the Company") provides a variety of materials
handling solutions, including systems, technologies, products, and services for
material flow applications. The Company has one sales and marketing operation
and goes to market with a multiple brand, multiple channel strategy under the SI
Systems, Ermanco, and Paragon brands. The Company markets the SI Systems and
Ermanco brands and may utilize the Paragon brand to offer synergistic materials
handling solutions to its customers. The Company's capabilities include
horizontal transportation, rapid dispensing, order fulfillment, sortation, and
integrating conveyors and conveyor systems.
The Company was originally incorporated in Pennsylvania in 1958. On
December 7, 2001, upon receiving shareholder approval, the Company changed its
state of incorporation from Pennsylvania to Delaware.
The Company's Easton, Pennsylvania operations, (hereafter referred to as
"SI Systems"), is a specialized systems integrator supplying SI Systems branded
automated materials handling systems to manufacturing, order selection, and
distribution operations. The systems are marketed, designed, sold, installed,
and serviced by its own staff or agents, generally as labor-saving devices to
improve productivity, quality, and reduce costs. SI Systems also operates as a
project manager in connection with the installation, integration, and service of
its products generally utilizing subcontractors. SI Systems' branded products
are utilized to automate the movement or selection of products and are often
integrated with other automated equipment such as conveyors and robots. SI
Systems' branded integrated materials 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 materials handling needs. SI Systems' staff develops and
designs computer control programs required for the efficient operation of the
systems. SI Systems' branded products are sold to customers located primarily in
North America, including the U.S. government.
On September 30, 1999, the Company purchased all of the outstanding common
stock of Ermanco. The Company's Spring Lake, Michigan operations (hereafter
referred to as "Ermanco"), is a manufacturer of Ermanco branded light to medium
duty unit handling conveyor products, serving the materials handling industry
through local independent distributors in North America. Ermanco also provides
complete conveyor systems for a variety of applications, including distribution
and manufacture of computers and electronic products, utilizing primarily its
own manufactured conveyor products, engineering services by its own staff or
subcontractors, and subcontracted installation services.
Ermanco supplies materials handling systems and equipment to both national
and international markets. Ermanco offers services ranging from the delivery of
basic transportation conveyors to turnkey installations of complex, fully
automated work-in-process production lines and distribution centers, utilizing
sophisticated, custom-designed controls software. The systems product line of
Ermanco accounted for approximately 43% of Ermanco's total revenues in the year
ended December 31, 2001, and the balance is from resale distribution.
The Company's systems vary in configuration and capacity. Historically,
system prices across the Company's product lines have ranged from $100,000 to
several million dollars per system. Systems and aftermarket sales by brand
during the years ended December 31, 2001 and December 31, 2000, and during the
ten months ended December 31, 1999 are as follows (in thousands):

3

For the year ended December 31, 2001:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Systems sales...................... $ 14,390 29,700 44,090 86.9%
Aftermarket sales.................. 4,618 2,044 6,662 13.1%
------ ------ ------ -----
Total sales........................ $ 19,008 31,744 50,752 100.0%
====== ====== ====== =====
As a % of total sales.............. 37.5% 62.5% 100.0%

For the year ended December 31, 2000:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Systems sales...................... $ 24,887 32,857 57,744 89.8%
Aftermarket sales.................. 4,762 1,800 6,562 10.2%
------ ------ ------ -----
Total sales........................ $ 29,649 34,657 64,306 100.0%
====== ====== ====== =====
As a % of total sales.............. 46.1% 53.9% 100.0%

For the ten months ended December 31, 1999:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Systems sales...................... $ 29,288 7,287 36,575 89.0%
Aftermarket sales.................. 4,156 377 4,533 11.0%
------ ------ ------ -----
Total sales........................ $ 33,444 7,664 41,108 100.0%
====== ======= ====== =====
As a % of total sales.............. 81.4% 18.6% 100.0%

The Company's products are sold worldwide through its own sales personnel,
along with a network of distributors and licensees. Domestic and international
sales by brand during the years ended December 31, 2001 and December 31, 2000,
and during the ten months ended December 31, 1999 are as follows (in thousands):

For the year ended December 31, 2001:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Domestic sales..................... $ 18,030 27,397 45,427 89.5%
International sales................ 978 4,347 5,325 10.5%
------ ------ ------ -----
Total sales........................ $ 19,008 31,744 50,752 100.0%
====== ====== ====== =====

For the year ended December 31, 2000:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Domestic sales..................... $ 28,910 29,627 58,537 91.0%
International sales................ 739 5,030 5,769 9.0%
------ ------ ------ -----
Total sales........................ $ 29,649 34,657 64,306 100.0%
====== ====== ====== =====

For the ten months ended December 31, 1999:

% of Total
SI Systems Ermanco Total Sales
-------------- ------------- -------------- --------------

Domestic sales..................... $ 32,324 7,250 39,574 96.3%
International sales................ 1,120 414 1,534 3.7%
------ ------ ------ -----
Total sales........................ $ 33,444 7,664 41,108 100.0%
====== ======= ====== =====

4

The Company also engages in sales with the U.S. government, which is one of
the Company's major customers. Sales to the U.S. government during the years
ended December 31, 2001 and December 31, 2000, and during the ten months ended
December 31, 1999 are as follows (in thousands):

As a %
of Total Sales
--------------

For the year ended December 31, 2001........................ $ 5,219 10.3%
For the year ended December 31, 2000........................ 8,157 12.7%
For the ten months ended December 31, 1999.................. 11,565 28.1%

The Company's backlog of orders at December 31, 2001 was $13,342,000, of
which $2,910,000 was associated with projects with the U.S. government. The
Company's backlog of orders at December 31, 2000 was $22,913,000, of which
$7,795,000 was associated with projects with the U.S. government. The Company's
business is dependent upon a limited number of large contracts with a limited
number of customers. This dependence can cause unexpected fluctuations in sales
volume. Various external factors affect the customers' decision-making process
on expanding 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. Fluctuations in
the Company's sales and earnings occur with increases or decreases in major
installations, since the Company recognizes sales on a percentage of completion
basis for its systems contracts. The Company expects to fill, within its 2002
calendar year, all of the December 31, 2001 backlog of orders indicated above.

Fiscal Year Change
- ------------------
On September 30, 1999, the Board of Directors of the Company approved an
amendment to the Company's Bylaws to change the fiscal year end of the Company
from the Sunday nearest to the last day of February to December 31. For the year
ended December 31, 1999, the fiscal year consisted of ten months.

Products
--------

SI Systems' Branded Products -- Automated Materials Handling Systems Segment
- ----------------------------------------------------------------------------

SI Systems' branded products encompass the horizontal transport and order
picking, fulfillment, and replenishment families of products.

Horizontal Transport
- --------------------

Lo-Tow(R). Lo-Tow(R) is an in-floor towline conveyor. It is the platform of
------
the towline conveyor systems utilized in the automation of manufacturing, unit
load handling, and large roll delivery systems. This simple, tough component
design allows for a variety of configurations well suited for numerous
applications. It provides reliable and efficient transportation for unit loads
of all types in progressive assembly or distribution applications. Because SI
Systems' Lo-Tow(R) tow chain used with the system operates at a depth of
approximately three inches, systems can be installed in existing one-story and
multi-story buildings as well as newly constructed facilities. The Company
believes that SI Systems is the world's largest supplier of in-floor towline
systems. A typical Lo-Tow(R) system requires approximately six months to
engineer, manufacture, and install. Lo-Tow(R) sales as a percent of total sales
were 18.1%, 22.3%, and 37.3% for the years ended December 31, 2001 and December
31, 2000, and for the ten months ended December 31, 1999, respectively.

5

Cartrac(R). Cartrac(R) spinning tube conveyor systems are used in the
-------
automation of production, manufacturing, and assembly operations throughout
various industries. Some of these industries are automotive, aerospace,
appliance, electronics, machine tools, radiation chambers, castings,
transportation, and foundries. As part of a fully computerized manufacturing
system, Cartrac(R) offers zero pressure accumulation capabilities that are well
suited for the manufacturing environment where high volume product rate and
short cycle time are critical.
Cartrac(R) sales, as a percent of total sales, were 0.7%, 3.4%, and 4.6%
for the years ended December 31, 2001 and December 31, 2000, and for the ten
months ended December 31, 1999, respectively.

SI-Egemin
---------
On July 15, 1999, the Company and Egemin N.V. ("Egemin") of Schoten,
Belgium formed a joint venture, SI-Egemin N.V. ("SI-Egemin"). SI-Egemin drew
upon the automated materials handling systems experience of the Company and
Egemin to provide automated materials handling systems worldwide. Since
inception, each member company contributed $494,000 in capital to fund the joint
venture. The Company accounted for its investment in the joint venture on the
equity basis.
The Company divested of its investment in the SI-Egemin joint venture at
the end of calendar year 2001 and received $125,000 as a return of capital for
its investment in the joint venture.

Order Picking, Fulfillment, and Replenishment Systems
- -----------------------------------------------------

Dispen-SI-matic(TM) and Automated Picking/Replenishment Solutions
-----------------------------------------------------------------
Automation of the order selection process to pick customers' orders with
accuracy, speed, and minimum human interface has been a challenge facing the
materials handling industry for quite some time. Dispen-SI-matic(TM) offers an
ideal solution for reducing inefficiencies, labor-intensive methods, and
long-time deliveries where high volume of small orders must be picked and
fulfilled.
SI Systems' branded products include a variety of Dispen-SI-matic(TM)
models for automated order selection, where volume, speed, accuracy, and
efficiency are of the essence. The Pick-to-Belt, Totes Through, and Buckets
Through are solutions that provide ultra-high throughput for loose-pick
individual items. Additionally, the Dispen-SI-matic(TM) allows a package to be
dispensed directly into a tote, thus achieving accuracy of order picking and
fulfillment every time.
The "P4"(TM) automated, single unit order picking system, is an additional
product offering. An advantage of P4(TM) is its ability to pick and convey
products in a single file with consistent orientation to a downstream secondary
process. The system can be configured for different package sizes.
SI Systems' capabilities also include gantry picking, which involves the
fulfillment of orders utilizing automated gantry technology. Certain customer
applications are well suited for this solution.
SI Systems' branded technologies include automated picking and
replenishment solutions that complement Dispen-SI-matic(TM), thus offering the
Company's customers a comprehensive solution in order picking and fulfillment
where volume of orders are processed with a high degree of accuracy. These
highly sophisticated systems require customization tailored to each individual
customer's requirements. SI Systems personnel are well known for their
creativity, innovation, and understanding customers' needs in order to achieve
the ultimate solution.
A typical Dispen-SI-matic(TM) and automated picking and replenishment
system requires approximately six to nine months to engineer, manufacture, and
install.
Dispen-SI-matic(TM) and the related order picking, fulfillment, and
replenishment systems sales (including sales of Automated Pharmacy Systems to
the SI/BAKER, INC. ("SI/BAKER") joint venture), as a percent of total sales,
were 9.2%, 12.4%, and 27.0%, for the years ended December 31, 2001 and December
31, 2000, and for the ten months ended December 31, 1999, respectively.

6

SI/BAKER, INC. (Automated Pharmacy Systems)
------------------------------------------
On March 1, 1993, the Company and Automated Prescription Systems, Inc. of
Pineville, Louisiana formed a joint venture, SI/BAKER, INC. On September 29,
1998, McKesson HBOC, Inc. [NYSE:MCK], a healthcare supply management company,
announced the completion of its acquisition of Automated Prescription Systems,
Inc. Automated Prescription Systems, Inc. was renamed McKesson Automated Systems
Inc. ("McKesson Automation"). SI/BAKER draws upon the automated materials
handling systems experience of the Company and the automated pill counting and
dispensing products of McKesson Automation to provide automated pharmacy
systems.
SI/BAKER, was formed to address the rapidly evolving automation needs of
managed care pharmacy operations which fill prescriptions by mail for the
clients of health care provision plans. The demographics of the aging population
in the United States and the emphasis on reduced health care costs, of which
prescription costs are a major part, is the driving force behind the automation
of mail order and the growing, central fill pharmacy operations. SI/BAKER
focuses on providing technologically advanced, automated prescription filling
systems to this growing market. Information pertaining to the SI/BAKER joint
venture is included in Note 11 of Notes to Consolidated Financial Statements.
See also Contingencies in Note 8 of Notes to Consolidated Financial Statements.
See also Schedule A for SI/BAKER's Financial Statements and Independent
Auditors' Report thereon.

Sortation
---------
SI Systems' branded robotic Gantry Sorter allows companies with large
volumes of mailings to take advantage of substantial postal savings by
automating their small parcel and letter sorting capability. The Gantry Sorter
has a PC-based control system, accommodates weighing and manifesting, can be
expanded with additional sorting modules, and is flexible in design.
A typical sortation system requires approximately six to nine months to
engineer, manufacture, and install.
Sortation sales, as a percent of total sales, were 0.3%, 0.5%, and 1.7% for
the years ended December 31, 2001 and December 31, 2000, and for the ten months
ended December 31, 1999, respectively.

Ermanco Branded Products -- Conveyor Systems Segment
- ----------------------------------------------------

Conveyor Systems
- ----------------
Ermanco branded products encompass the conveyor systems segment of the
business.
The results of the Company for the years ended December 31, 2001 and
December 31, 2000 include the operations of Ermanco for the entire year;
however, results for the ten months ended December 31, 1999 included the
operating results of Ermanco from October 1, 1999 through December 31, 1999
only.
Ermanco supplies materials handling systems and equipment to both national
and international markets. Ermanco offers services ranging from the delivery of
basic transportation conveyors to turnkey installations of complex, fully
automated work-in-process production lines and distributions centers, utilizing
sophisticated, custom-designed controls software. Ermanco often combines various
components of its technologies as part of a total system solution.
Ermanco branded technologies and expertise encompass products in two main
families: line shaft-driven live roller conveyor known as XenoROL(R) and
belt-driven live roller conveyor known as AccuROL(R). Within each of these drive
concepts, there are conveyors, accessories, and options of varying capacities to
satisfy a wide range of applications for transportation, accumulation, and
sortation products. Ermanco also offers conveyor technology outside these two
product lines, including belt and gravity conveyors, sortation, and special
equipment. Since its introduction in 1980, Ermanco's XenoPRESSURE technology has
provided true non-contact zero-pressure accumulation to the materials handling
industry. IntelliROL(TM), a self-powered roller technology, is a very popular
offering for unique applications. Ermanco branded sales as a percent of total
sales were 62.5%, 53.9%, and 18.6% for the years ended December 31, 2001 and
December 31, 2000, and for the ten months ended December 31, 1999, respectively.

7

Product Warranty
----------------
The Company's products are warranted against defects in materials and
workmanship for a specified period. The Company provides an accrual for
estimated future warranty costs and potential product liability claims based
upon a percentage of cost of sales and warranty experience.

Sales and Marketing
-------------------
The Company has one sales and marketing operation and goes to market with a
multiple brand, multiple channel strategy under the SI Systems, Ermanco, and
Paragon brands. The Company markets the SI Systems and Ermanco brands, and may
utilize the Paragon brand to offer synergistic materials handling solutions to
its customers.
Sales of SI Systems' branded products in the United States and Canada are
made through SI Systems' internal sales personnel. The systems are sold on a
fixed-price basis. Generally, contract terms provide for progress payments and a
portion of the purchase price is withheld by the customer until the system has
been accepted. Customers include major manufacturers, technology organizations,
and distributors of a wide variety of products, as well as the U.S. government.
In the year ended December 31, 2001, the U.S. government accounted for revenues
of $5,219,000 or 10.3%, of which the U.S. Postal Service accounted for revenues
of $5,038,000 or 9.9%. In the year ended December 31, 2000, Brandt & Hill Inc.
accounted for revenues of $10,979,000 or 17.1%, and the U.S. government
accounted for revenues of $8,157,000 or 12.7%, of which the U.S. Postal Service
accounted for revenues of $7,425,000 or 11.5%. A significant amount of business
is derived from existing customers through the sale of additional systems,
additions to existing systems, plus parts and service. The Company is not
substantially dependent upon any one customer, however, the Company's business
is dependent upon a limited number of customers.
Ermanco branded products are sold primarily through a worldwide network of
approximately 100 experienced materials handling equipment distributors and
licensees. The distributors locate opportunities that they may fulfill
themselves by purchasing products and/or services from Ermanco and take the
order in their name, acting as the system integrator, or they may elect to have
Ermanco assume the role of system integrator. In the latter case, Ermanco will
negotiate the contract with the end user and assume total system responsibility,
providing the distributor with a "finder's fee." Approximately ninety percent of
Ermanco's volume is orders processed by distributors, and ten percent of the
volume is orders processed with the end user. Depending upon the distribution
channel that is used, the typical number of competitors on any particular
project varies. As Ermanco branded products and services expand, the quality and
size of the distributors that pursue opportunities on behalf of Ermanco is
increasing, bringing better and larger opportunities to the Company's attention.
Licensees are located in India, Japan, and the Republic of South Africa, with
global affiliates in Brazil, Canada, Ireland, Netherlands, and United Kingdom.
Ermanco branded products and services are sold on a fixed-price basis. In the
year ended December 31, 2001, no one Ermanco branded customer accounted for
revenues in excess of 10% of total revenues. Generally, contract terms are net
30 days for product and parts sales, with progress payments for system-type
projects.

Competition
-----------
The materials handling industry includes many products, devices, and
systems competitive with those of the Company.
SI Systems' Cartrac(R) system competes with various alternative materials
handling technologies, including automated guided vehicle systems, automatic
dispatch cart, electrified monorail and pallet skid systems, power and free
conveyor systems, and belt and roller conveyor systems. Two principal
competitors supply equipment similar to the Cartrac(R) system. However, the
Company believes that the Cartrac(R) system's advantages, such as controlled
acceleration and deceleration, high speed, individual carrier control, and right
angle turning, are significant distinctive features providing competitive
advantages.
There are four principal competitors supplying equipment similar to the
Lo-Tow(R) system. Competition in the automatic dispatch cart field is primarily
in the areas of price, experience, and product performance.

8

The Dispen-SI-matic(TM) system competes primarily with manual picking
methods, and it also competes with similar devices provided by two other system
manufacturers, along with various alternative picking technologies, such as
general purpose "broken case" automated order selection systems that have been
sold for picking items of non-uniform configuration. The Company believes that
the Dispen-SI-matic(TM) system provides greater speed and accuracy than manual
methods of collection and reduces damage, pilferage, and labor costs.
The 2001-2002 Conveyor Equipment Manufacturers Association yearbook
includes 32 companies in the list of members in the Unit Handling Conveyors
(Light to Medium) classification (SIC 353501). Thirty members report statistics
on a monthly basis in this category, with booked sales of $1.46 billion in 2001.
Many companies are involved in more than this one category. Many of these
companies pursue opportunities with a direct sales force. Ermanco branded
products are sold primarily through a distributor network of independently owned
and operated companies as its primary channel. There are approximately 1,000
companies listed under the Conveying and Conveying Equipment - Wholesale
classification (SIC 508410); however, this includes those companies involved in
bulk material handling and unit conveyor handling.
As in the case of other technically oriented companies, there is a risk
that the Company's business may be adversely affected by technological advances
made by its competitors. However, the Company believes that its competitive
advantages include its reputation in the materials handling field and proven
capabilities in the markets in which it concentrates. Its disadvantages include
its relatively small size as compared to certain of its larger competitors.

Raw Materials
-------------
The Company has not been adversely affected by energy or raw materials
shortages. Its plants use natural gas for heating and electricity to operate its
machinery. The principal raw material purchased by the Company is steel, which
the Company purchases from various suppliers. The Company also purchases
components from various suppliers that are incorporated into the Company's
finished products.

Patents And Licenses
--------------------
The Company seeks patents, trademarks and other intellectual property
rights to protect and preserve its proprietary technology and its rights to
capitalize on the results of research and development activities. The Company
also relies on trade secrets, know-how, technological innovations, and licensing
opportunities to provide it with competitive advantages in its market and to
accelerate new product introductions. Significant design features of the
Cartrac(R), Lo-Tow(R), Sortation, and Dispen-SI-matic(TM) systems are covered by
patents or patent applications in the United States.
The Company holds approximately 46 patents, of which 36 have been issued in
the United States, with lives that expire through May 2019, and the Company has
4 pending patent applications.
The significant patents pertain mainly to the following areas: vehicles and
carrier design, loading and unloading products, speed and precision control,
track design and assembly, accumulation of vehicles, and simultaneous order
requests processing equipment. Cartrac(R), Robolite(R), Robodrive(R), Lo-Tow(R),
Switch-Cart(R), Mini-Cartrac(R), Ordermatic(R), Accupic(R), Roborail(R),
XenoROL(R), EWX100(R), Command Systems Software (CSS)(R), ERS(R), ESA60(R),
LightWORX(R), MCN2000(R), MTN 2000(R), NBS(R), XcelSORT(R), XenoPRESSURE(R),
XenoSORT(R), XenoTRACTION(R), NBS 30(R), NBS 90(R), and AccuROL(R) are
registered trademarks of the Company. Roborail(TM), IntelliROL(TM),
Dispen-SI-matic(TM), NBS 90-SP(TM), and "P4"(TM) are trademarks of the Company.
During the fiscal year ended March 3, 1991, the Company entered into a
10-year licensing agreement with Robotrac, Inc. (a subsidiary of Heico, Inc.) of
Lisle, Illinois whereby SI Systems markets and manufactures Robotrac products,
systems, and services along with the Company's complete line of materials
handling solutions. Under the terms of the licensing agreement, the Company paid
royalties to Robotrac, Inc. based on net sales of Cartrac(R) products and
services. Prior to termination of the license agreement on November 1, 2000, SI
Systems exercised its option to purchase the assets licensed and is no longer
required to pay royalties to Robotrac on future sales of Cartrac(R)

9

products and services. Royalty expense relating to the licensing agreements for
the years ended December 31, 2001 and December 31, 2000, and for the ten months
ended December 31, 1999, was $0, $185,000, and $146,000, respectively.
During the fiscal year ended February 25, 1990, the Company entered into a
renewable five-year licensing agreement with Knapp to acquire the exclusive
right to sell, engineer, manufacture, and install the Dispen-SI-matic(TM)
product throughout North America. The licensing agreement was amended on April
29, 1997. The amendment, also with a term of five years and automatically
renewable for additional one-year terms, retains many of the salient features of
the original licensing agreement with the exception of a change from an
exclusive right to a non-exclusive right and a reduction in royalties due Knapp
for sales of the Dispen-SI-matic(TM) product by the Company. Under terms of the
licensing agreement, which was automatically renewed through April 29, 2003, the
Company pays royalties to Knapp based on the number of dispensers per system
with a minimum payment applicable to each system. Royalty expense relating to
the Knapp licensing agreement for the years ended December 31, 2001 and
December 31, 2000, and for the ten months ended December 31, 1999, was $16,000,
$47,000, and $8,000, respectively.
Ermanco currently has license agreements with three foreign companies.
These agreements typically permit the licensee to manufacture conveyors using
Ermanco branded technology. Royalties are received based on sales volume.
Royalty income received from the license agreements in the years ended December
31, 2001 and December 31, 2000, and for the ten months ended December 31, 1999,
was approximately $66,000, $108,000, and $33,000, respectively.
It is the Company's policy to require its professional and technical
employees and consultants to execute confidentiality agreements at the time that
they enter into employment or consulting relationships with the Company. These
agreements provide that all confidential information developed by, or known to,
the individual during the course of the individual's relationship with the
Company, is to be kept confidential and not disclosed to third parties except in
specific circumstances. In the case of employees, the agreement provides that
all inventions conceived by the employee during his tenure at the Company will
be the exclusive property of the Company.

Product Development
-------------------
Product development costs, including patent expense, were
$456,000, $175,000, and $301,000 for the years ended December 31, 2001 and
December 31, 2000, and for the ten months ended December 31, 1999, respectively.
Development programs in the year ended December 31, 2001 included
enhancements to the Company's NBS 30(R), NBS 90(R), and NBS 90-SP(TM) narrow
belt sorters and to the Order Picking, Fulfillment, and Replenishment product
line.
Development programs in the year ended December 31, 2000 included
enhancements to the Company's Order Picking, Fulfillment, and Replenishment
product line and new products which were introduced in February 2001. The new
products, NBS 30(R) and NBS 90(R), are narrow belt sorters that contain
high-friction divert wheels that raise between the belts, enabling product to be
diverted at a 30 or 90 degree angle.
Development programs in the ten months ended December 31, 1999 included
enhancements to the Lo-Tow(R) and Order Picking, Fulfillment, and Replenishment
product lines.
The Company aggressively pursues continual research of new product
development opportunities, with a concentrated effort to improve existing
technologies that improve customer efficiency. The Company also develops new
products and integration capabilities that are financed through customer
projects.

10

Employees
---------
As of December 31, 2001, the Company's Easton, Pennsylvania operation
employed 45 office employees, including salespersons, draftspersons, and
engineers. During the second quarter of 2001, the Company restructured its
business operations. In conjunction with the restructuring plan, the Company
reduced the number of office employees and discontinued production operations at
its Easton, Pennsylvania facility. All production employees working in the
Easton, Pennsylvania manufacturing plant were laid off by the end of November
2001. Prior to the restructuring, the Company employed approximately twenty
production employees, with an additional 27 individuals on an extended layoff.
SI Systems also operates as a project manager in connection with the
installation, integration, and service of its products generally utilizing
subcontractors.
As of December 31, 2001, the Company's Spring Lake, Michigan operation
employed 175 persons, including 72 office employees and 103 manufacturing
employees. All manufacturing employees are collective bargaining personnel. The
current collective bargaining agreement expires on May 31, 2003.
The Company currently employs five executive officers.
The Company provides life insurance, major medical insurance, retirement
programs, and paid vacation and sick leave benefits, and considers its relations
with employees to be satisfactory.

Item 2. Properties and Leases
- ------- ---------------------

SI Systems' principal office is located in a 173,000 square foot concrete,
brick, and steel facility in Easton, Pennsylvania. The Company holds the deed to
its Easton, Pennsylvania facility and the 20-acre site on which it is located.
The Company's Easton, Pennsylvania facility was designed to operate at a higher
capacity than is currently being experienced, and the Company is currently
marketing the property for sale.
Ermanco's principal office and manufacturing facility are located in a
113,000 square foot steel building in Spring Lake, Michigan. The building is
leased from an organization that is affiliated with the Company through a common
director and officer of the Company, Messrs. Shulman and Kirschner. The leasing
agreement requires fixed monthly rentals of $32,858 (with annual increases of
2.5%) which includes a variable portion based on the lessor's borrowing rate and
the unpaid mortgage balance. The terms of the lease require payment by Ermanco
of all taxes, insurance, and other ownership-related costs of the property. This
operating lease expires on September 30, 2004.
The Company believes that its Spring Lake, Michigan facility is adequate
for its current operations. Due to the timing and receipt of new orders, the
Company's operations experience fluctuations in workload due to the timing of
customer job completion requirements. Currently, the Company's facilities are
adequate to handle these fluctuations. In the event of an unusual demand in
workload, the Company supplements its internal operations with outside
subcontractors that perform services for the Company in order to complete
contractual requirements for its customers. The Company will continue to utilize
internal personnel and its own facilities and, when necessary and/or cost
effective, outside subcontractors to complete contracts in a timely fashion in
order to address the needs of its customers.
In order to obtain a line of credit and term loan to complete the
acquisition of Ermanco, the Company granted its principal bank a security
interest in all personal property, including, without limitation, all accounts,
deposits, documents, equipment, fixtures, general intangibles, goods,
instruments, inventory, letters of credit, money, securities, and a first
mortgage on all real estate owned.

Item 3. Legal Proceedings
- ------- -----------------

The Company is from time to time a party to litigation arising in the
ordinary course of its business. The Company is not currently party to any
material litigation.

11

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

The Company held a Special Meeting of Shareholders on December 6, 2001 to
approve and adopt an Agreement and Plan of Merger providing for the merger of
the Company into a wholly-owned subsidiary formed under the laws of the state of
Delaware for the purpose of changing the state of incorporation of the Company
from Pennsylvania to Delaware.
Details of the proposal were provided to shareholders in the form of a
Notice of Special Meeting and Proxy Statement dated November 7, 2001 and mailed
on November 8, 2001, with such solicitation being in accordance with Section 14
of the Securities and Exchange Act of 1934, as amended, and the regulations
promulgated thereunder. The proposal was duly approved by the shareholders of
the Company. The Company completed the reincorporation from Pennsylvania to
Delaware on December 7, 2001.
The voting results on the proposal were as follows:

Votes For Votes Against Abstentions Non-Voting
--------- ------------- ----------- ----------

3,322,727 96,283 14,398 778,301

12

PART II
-------

Item 5. Market For The Registrant's Common Stock And Related Security
- ------- -------------------------------------------------------------
Holder Matters
--------------

On March 9, 2000, the Company's common stock began trading on the American
Stock Exchange (Amex) under the symbol "PTG." Prior to this date, the Company's
common stock was traded on The Nasdaq Stock MarketSM under the symbol "SIHS."
The high and low sales prices for the years ended December 31, 2001 and December
31, 2000 are as follows:

For the Year Ended For the Year Ended
December 31, 2001 December 31, 2000
------------------------------ ------------------------------
High Low High Low
-------------- -------------- -------------- --------------

First Quarter........................... 10.00 7.45 10.13 4.63
Second Quarter.......................... 8.05 7.00 7.75 5.38
Third Quarter........................... 7.60 7.10 7.63 6.13
Fourth Quarter ......................... 8.75 7.35 8.00 6.38

The Company did not pay any cash dividends during the years ended December
31, 2001 and December 31, 2000, and the Company has no present intention to
declare cash dividends. In accordance with the terms and conditions of the
Company's line of credit and term loan with its principal bank, the Company is
restricted from paying dividends in excess of 15% of net earnings.

The number of beneficial holders of the Company's common stock at December
31, 2001 was approximately 1,113.

The closing market price of the Company's common stock on March 13, 2002
was $8.65.

Item 6. Selected Financial Data
- ------- -----------------------
The following table sets forth the Company's selected consolidated
financial information for the five years in the year ended December 31, 2001.
The selected consolidated financial data presented below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and our Consolidated Financial Statements and Notes
thereto included in this report. The historical results presented herein may not
be indicative of future results. The information presented below is in
thousands, except per share amounts.

For the Ten For the Fiscal
For the Years Ended Months Ended Years Ended
---------------------------- ------------------------- -------------------------
12/31/98
12/31/01 12/31/00 12/31/99 (Unaudited) 2/28/99 3/01/98
-------------- ------------- ------------ ------------ ----------- --------------

Net sales................ $ 50,752 64,306 41,108 31,603 39,573 47,631
Net earnings (loss)...... (62) 3,480 (2,780) 779 1,378 2,612
Basic earnings (loss)
per share............. (.01) .83 (.72) .21 .37 .70
Diluted earnings (loss)
per share............. (.01) .82 (.73) .21 .36 .70
Total assets............. 41,343 45,917 45,406 23,941 23,580 22,219
Long-term liabilities.... 11,074 13,744 15,670 233 228 216
Cash dividends per
share................. - - .10 .10 .10 .07

13

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Liquidity And Capital Resources
- -------------------------------

The Company's cash and cash equivalents decreased to $6,114,000 at December
31, 2001 from $7,925,000 at December 31, 2000. The decrease resulted from the
repayment of long-term debt of $2,096,000 and purchases of capital equipment of
$692,000. Partially offsetting the decrease in cash and cash equivalents from
these uses was cash provided by operating activities totaling $934,000. Funds
provided by operating activities during the year ended December 31, 2000 were
$5,071,000. Funds provided by operating activities during the year ended
December 31, 2001 as compared to funds provided by operating activities during
the year ended December 31, 2000 declined primarily due to the net loss
experienced by the Company during the year ended December 31, 2001 and a
reduction in current liabilities. Funds provided by operating activities during
the ten months ended December 31, 1999 were $8,369,000.

Acquisition of Modular Automation Corp.
- --------------------------------------
On April 13, 1999, the Company acquired all of the outstanding common stock
of Modular Automation Corp. ("MAC") of Greene, New York for $1,957,000. The
acquisition required a net cash outlay of $928,000. The purchase price of the
acquisition was allocated to the assets acquired based on fair value with the
remainder representing goodwill. The acquired Automated Guided Vehicle ("AGV")
products and personnel were integrated into the SI Systems operation. However,
as of December 31, 1999, the AGV product line associated with the MAC
acquisition was abandoned. The write-off of certain long-lived assets, including
goodwill, totaling $561,000 has been recognized in the Consolidated Statement of
Operations for the ten months ended December 31, 1999 in accordance with the
criteria set forth by SFAS No. 121.

Acquisition of Ermanco Incorporated
- -----------------------------------
On September 30, 1999, the Company acquired of all of the outstanding
common stock of Ermanco. Under the terms of the Stock Purchase Agreement, the
Company acquired all of the outstanding common stock of Ermanco for a purchase
price of $22,801,000 consisting of $15,301,000 in cash, of which $1,551,000 was
held in escrow ($801,000 was released in January 2000 and $750,000 was released
in March 2001), $3,000,000 in promissory notes payable to the fourteen
stockholders of Ermanco, and 481,284 shares of the Company's common stock with a
value of $4,500,000 based on the average closing price of $9.35 of the Company's
common stock for the five trading days immediately preceding the date of the
Stock Purchase Agreement, August 6, 1999.
In 2000, the Company paid additional costs of $45,000 in connection with
the acquisition, and $186,000 to satisfy a purchase price adjustment
contingency. There are no remaining contingent arrangements that may result in
additional payments by the Company under the Stock Purchase Agreement. The
acquisition required a net cash outlay of $2,264,000.
In connection with the acquisition of Ermanco, the Company entered into
employment agreements with four employees of Ermanco. Leon C. Kirschner and
Steven Shulman, both principal stockholders of Ermanco, joined the Board of
Directors of the Company.
In order to complete the Ermanco acquisition, the Company obtained
financing from its principal bank. The Company entered into a three-year line of
credit facility which may not exceed the lesser of $6,000,000 or an amount based
on a borrowing base formula tied principally to accounts receivable, inventory,
fair market value of the Company's property and plant, and liquidation value of
equipment. This amount will be reduced by the unpaid principal balance of the
term loan described below. The line of credit facility is to be used primarily
for working capital purposes. As of December 31, 2001, the Company did not have
any borrowings under the line of credit facility.

14

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Acquisition of Ermanco Incorporated (Continued)
- -----------------------------------
The Company financed $14,000,000 of the acquisition through a seven-year
term loan from its bank. During the first two years of the term loan, the
Company was obligated to repay equal quarterly payments of $312,500 plus accrued
interest. After September 30, 2001, the Company commenced making equal quarterly
payments of $575,000, plus interest continuing until the loan is fully repaid.
The interest rate on the term loan is variable at a rate equal to the
three-month LIBOR Market Index Rate plus three percent (4.90% as of December 31,
2001). The Company also entered into an interest rate swap agreement for a
portion of the term loan to hedge the floating interest rate. The seven-year
interest rate swap for $5,462,000 is at a fixed rate of 9.38%. As of December
31, 2001, the liability associated with the fair value of the cash flow hedge
was approximately $412,000.
During the second quarter of fiscal 2001, the Company prepaid, without
penalty, $575,000 of the term loan. Also, during the third quarter of fiscal
2000, the Company prepaid, without penalty, $1,150,000 of the term loan.
Therefore, since the inception of the term loan, the Company prepaid, without
penalty, $1,725,000 of the term loan.
To obtain the line of credit and term loan, the Company granted the bank a
security interest in all personal property, including, without limitation, all
accounts, deposits, documents, equipment, fixtures, general intangibles, goods,
instruments, inventory, letters of credit, money, securities, and a first
mortgage on all real estate. The line of credit facility and term loan contain
various restrictive covenants relating to additional indebtedness, asset
acquisitions or dispositions, investments, guarantees, payment of dividends, and
maintenance of certain financial ratios. As of December 31, 2001, the Company
was in compliance with all covenants, as amended (see Note 3 of Notes to
Consolidated Financial Statements).
On September 30, 1999, the Company also issued promissory notes to fourteen
stockholders of Ermanco, two of which are directors of the Company, in the
aggregate principal amount of $3,000,000. The notes have a term of seven years
and bear interest at an annual rate of ten percent through September 30, 2002,
twelve percent from October 1, 2002 through September 30, 2004, and fourteen
percent from October 1, 2004 through September 30, 2006. The weighted average
interest rate on the promissory notes is 11.714% over the term of the notes.
Interest shall be payable quarterly, in cash, or under certain conditions, in
the Company's common stock upon approval of the Company's Board of Directors.
The promissory notes may be prepaid prior to the end of the seven-year term
provided that there is no debt outstanding under the Company's line of credit
facility and term loan. Since July 1, 2001, the Company has been and will be
prohibited from making any cash payments of subordinated debt and interest until
the Company is in full compliance with all the financial covenants as originally
set forth in the term loan agreement with the Company's principal bank. However,
the bank waived the restriction from paying interest on the subordinated debt in
the form of cash for the fourth quarter ended December 31, 2001 and the first
quarter ended March 31, 2002. The Company intends to satisfy its quarterly
interest obligations with the issuance of the Company's common stock in the
event the Company's principal bank does not grant waivers regarding the making
of cash payments of interest on subordinated debt.

Commitments and Contingencies
- -----------------------------
Ermanco's operations are located in an 113,000 square foot steel building
in Spring Lake, Michigan. The building is leased from an organization that is
affiliated with the Company through a common director and officer of the
Company, Messrs. Shulman and Kirschner. The leasing agreement requires fixed
monthly rentals of $32,858 (with annual increases of 2.5%) which includes a
variable portion based on the lessor's borrowing rate and the unpaid mortgage
balance. The terms of the lease require the payment of all taxes, insurance, and
other ownership related costs of the property. The lease expires on September
30, 2004.

15

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Liquidity And Capital Resources
- -------------------------------

Commitments and Contingencies (Continued)
- -----------------------------
The Company also leases certain automobiles and office equipment, office
space, computer equipment, and software under various operating leases with
terms extending through July 2005.
Financing agreements related to the lease of computer software have been
recorded as capital leases. These agreements had a total initial contract value
of $36,000. As of December 31, 2001, the contract value of the agreements is
approximately $5,000.
On March 4, 1996, SI/BAKER established a $3,000,000 line of credit facility
(the "Facility") with its principal bank (the "bank"). Under the terms of the
Facility, SI/BAKER's parent companies, Paragon Technologies, Inc. and McKesson
Automation Systems Inc., have each provided a limited guarantee and surety in an
amount not to exceed $1,000,000 for a combined guarantee of $2,000,000 to the
bank for the payment and performance of the related note, including any further
renewals or modifications of the facility. As of December 31, 2001, SI/BAKER did
not have any borrowings under the Facility, and the Facility expires effective
August 31, 2002.
Future contractual obligations and commercial commitments at December 31,
2001 as noted above are as follows:

Payments Due by Period
---------------------------------------------------------------------------------
Less Than
Total 1 Year 2 Years 3 Years 4 Years 5 Years
----- ------ ------- ------- ------- -------

Contractual
obligations:
Term loan...... 9,200,000 2,300,000 2,300,000 2,300,000 1,438,000 862,000

Cash flow
hedge......... 412,000 - - - - 412,000

Subordinated
notes
payable....... 3,000,000 - - - - 3,000,000

Capital lease
obligations... 5,000 5,000 - - - -

Operating
leases........ 1,567,000 558,000 537,000 412,000 60,000 -
---------- --------- --------- --------- --------- ---------

Total......... $ 14,184,000 2,863,000 2,837,000 2,712,000 1,498,000 4,274,000
========== ========= ========= ========= ========= =========

Amount of Commitment
Expiration Per Period
----------------------------------------------------------------
Total Amounts Less Than
Committed 1 Year 2 Years 3 Years 4 Years 5 Years
--------- ------- ------- ------- ------- -------

Other
commercial
commitments:
Guarantees..... $ 1,000,000 1,000,000 - - - -
Line of credit. - - - - - -

16

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Other Liquidity and Capital Resource Matters
- --------------------------------------------
On June 7, 1999, the Board of Directors of the Company authorized
management to purchase up to 10,000 shares of the Company's common stock through
open market transactions or negotiated transactions at prices not to exceed
prevailing market prices. During the second quarter ended August 29, 1999, the
Company expended $105,000 on purchases of 10,000 shares of common stock through
open market transactions.
The Company anticipates that its financial resources, consisting of
borrowings under its credit facility and cash generated from operations will be
adequate to satisfy its future cash requirements through the next fiscal year.
Due to the unpredictability of future contract sales, the dependence upon a
limited number of large contracts with a limited number of customers, sales
volume, as well as cash liquidity, may experience fluctuations. For these
reasons, cash liquidity beyond a twelve-month period is difficult for the
Company to forecast with reasonable accuracy.
The Company plans to consider all strategic alternatives to increase
shareholder value, including expansion opportunities as they arise, although the
ongoing operating results of the Company, the restrictive covenants associated
with the financing obtained from the Company's principal bank, the economics of
the expansion, and the circumstances justifying the expansion will be key
factors in determining the amount of resources the Company will devote to
further expansion.

Results of Operations - For The Year Ended December 31, 2001 Compared To The
- ----------------------------------------------------------------------------
Year Ended December 31, 2000
- ----------------------------
The Company's net loss for the year ended December 31, 2001 was $62,000
compared to net earnings of $3,480,000 for the year ended December 31, 2000.
Contributing to the net loss for the year ended December 31, 2001 was a
reduction in sales volume, restructuring charges of $1,538,000, severance
charges of $259,000, and $310,000 of charges related to a strategic transaction
that was not completed.

Net Sales and Gross Profit on Sales
- -----------------------------------
Net sales of $50,752,000 for the year ended December 31, 2001 decreased
21.1% compared to net sales of $64,306,000 for the year ended December 31, 2000.
The sales decrease of $13,554,000 was primarily attributable to a lower volume
of orders associated with the current economic slowdown and competitive pricing
pressures. The sales decrease for the year ended December 31, 2001 was primarily
experienced by the Company's SI Systems' brand, which encountered an equivalent
reduction in sales among all of its product lines, when compared to the year
ended December 31, 2000. The Company's business is dependent upon a limited
number of large contracts with a limited number of customers. This dependence
can cause unexpected fluctuations in sales volume. Along with sales recognized
on the percentage of completion accounting method, the monthly rate of new
orders can also vary substantially, causing fluctuations in the current backlog
of orders and future revenue recognition. Various external factors affect the
customers' decision-making process on expanding and upgrading their current
production or distribution sites. The customers' timing and placement of new
orders is often affected by factors such as the current economy, current
interest rates, and future expectations.
Gross profit as a percentage of sales was 24.5% for the year ended December
31, 2001 compared to 28.1% for the year ended December 31, 2000. Gross profit on
sales for the year ended December 31, 2001 was favorably impacted by
approximately 1.9% as a result of the reversal of $960,000 in previously
established contract accruals due to changes in cost estimates. Approximately
3.5% of the decrease in the gross profit percentage for the year ended December
31, 2001 was primarily attributable to the prior year gross profit percentage
being impacted by the favorable performance on several contracts. Also
contributing to the decrease in the gross profit percentage for the year ended
December 31, 2001 was an underabsorption of overhead costs due to a decline in
sales volume that accounted for a 1.6% reduction in the gross profit percentage.
Gross profit on sales for the year ended December 31, 2000 was impacted by the
favorable

17

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2001 Compared To The
- ----------------------------------------------------------------------------
Year Ended December 31, 2000
- ----------------------------

Net Sales and Gross Profit on Sales (Continued)
- -----------------------------------
performance on several contracts, from principally the Company's higher margin
proprietary product lines, initiated in the prior fiscal year that were
completed or nearing completion during the year ended December 31, 2000.
Partially offsetting the impact of the favorable performances on several
contracts was the recognition of additional losses, primarily during the second
quarter of fiscal 2000, on a major contract where significant cost overruns,
resulting in losses, were experienced.

Selling, General, and Administrative Expenses
- ---------------------------------------------
Selling, general and administrative expenses of $10,161,000 were lower by
$740,000 for the year ended December 31, 2001 than in the year ended December
31, 2000. The decrease of $740,000 was comprised of a reduction in compensation
expense of $999,000 based on revenue and profit performance, and costs savings
of $316,000 attributable to the Company's restructuring of its business
operations and continued emphasis on cost reduction. Partially offsetting the
aforementioned decline in expenses were charges of approximately $310,000
related to a strategic transaction that was not completed, and $259,000 of
expenses pertaining to the reduction of associates due to the economic slowdown.

Product Development Costs
- -------------------------
Product development costs, including patent expense, of $456,000 were
higher by $281,000 for the year ended December 31, 2001 than in the year ended
December 31, 2000. Development programs in the year ended December 31, 2001
included enhancements to the Company's NBS 30(R), NBS 90(R), and NBS 90-SP(TM)
narrow belt sorters and to the Order Picking, Fulfillment, and Replenishment
product line. Development programs in the year ended December 31, 2000 included
enhancements to the Company's Order Picking, Fulfillment, and Replenishment
product line, and new products which were introduced in February 2001. The new
products, NBS 30(R) and NBS 90(R), are narrow belt sorters that contain
high-friction divert wheels that raise between the belts, enabling product to be
diverted at a 30 or 90 degree angle.

Amortization of Goodwill
- ------------------------
Amortization of goodwill represented costs associated with the acquisition
of Ermanco, totaling approximately $468,000 for the year ended December 31,
2001, as compared to $469,000 for the year ended December 31, 2000.

Restructuring Expenses
- ----------------------
During the second quarter of 2001, the Company restructured its business
operations and recorded a charge of $1,538,000 for restructuring costs. In
conjunction with the restructuring plan, the Company reduced the number of
office employees by fourteen and discontinued production operations at its
Easton, Pennsylvania facility. All production employees working in the Easton,
Pennsylvania manufacturing plant were laid off by the end of November 2001.
Prior to the restructuring, the Company employed approximately twenty production
employees, with an additional 27 individuals on an extended layoff. The
restructuring charges included costs of $678,000 for severance and other
personnel costs, $562,000 for pension expense associated with the curtailment of
the defined benefit plan for the Company's Easton, Pennsylvania collective
bargaining personnel, and $298,000 for plant closure and professional service
fees relating to the restructuring. The restructuring charges were determined
based on formal plans approved by the Company's management and the Board of
Directors. This restructuring action is expected to result in approximately
$1,100,000 in annual cost savings to the Company.

18

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2001 Compared To The
- ----------------------------------------------------------------------------
Year Ended December 31, 2000
- ----------------------------

Restructuring Expenses (Continued)
- ----------------------
Restructuring expenses of $337,000 for the year ended December 31, 2000
were associated with a restructuring initiative, whereby the Company reduced the
number of employees by sixteen. No material liability remained for this
restructuring initiative as of December 31, 2001.

Interest Expense and Interest Income
- ------------------------------------
Interest expense of $1,298,000 was lower by $335,000 in the year ended
December 31, 2001 than in the year ended December 31, 2000. The decrease in
interest expense was primarily attributable to the reduced level of term debt
due to principal repayments and lower interest rates.
Interest income of $252,000 was lower by $145,000 in the year ended
December 31, 2001 compared to the year ended December 31, 2000. The decrease in
interest income was attributable to a reduction in the level of funds available
for short-term investments and lower interest rates

Equity in Income of Joint Ventures
- ----------------------------------
Equity in income of joint ventures represents the Company's proportionate
share of its investments in the SI/BAKER and SI-Egemin joint ventures that are
being accounted for under the equity method. The net favorable variance of
$207,000 in the equity in income of joint ventures for the year ended December
31, 2001 as compared to the year ended December 31, 2000 was comprised of
increased earnings of approximately $97,000 attributable to the SI/BAKER joint
venture and decreased losses of approximately $110,000 attributable to the
SI-Egemin joint venture.
The favorable variance of $97,000 for the year ended December 31, 2001 in
the equity in income of the SI/BAKER joint venture was attributable to an
improvement in the gross profit percentage by approximately 6% due to favorable
performance on several contracts initiated in prior fiscal years that were
completed during the year ended December 31, 2001 plus a reduction of $80,000 in
revenue-based royalty costs due to the parent companies. The favorable variance
of $110,000 for the year ended December 31, 2001 in the equity in income of the
SI-Egemin joint venture was primarily attributable to a reduction in operating
expenses of the joint venture. The Company divested of its investment in the
SI-Egemin joint venture at the end of calendar year 2001.

Other Income, Net
- -----------------
The unfavorable variance of $55,000 in other income, net, for the year
ended December 31, 2001 as compared to the year ended December 31, 2000 was
primarily attributable to a reduction of revenue-based royalty income from the
Company's SI/BAKER joint venture and license agreements related to international
conveyor system sales.

Income Tax Expense (Benefit)
- ---------------------------
The Company recognized an income tax benefit of $257,000 during the year
ended December 31, 2001 compared to the incurrence of income tax expense of
$2,233,000 during the year ended December 31, 2000. The income tax benefit
recognized for the year ended December 31, 2001 represented the carryback of
losses experienced during the year ended December 31, 2001 against prior year
income plus the recognition of a tax benefit of approximately $140,000
associated with divestment of the SI-Egemin joint venture. Income tax expense
for the year ended December 31, 2000 was generally recorded at statutory federal
and state tax rates.

19

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2001 Compared To The
- ----------------------------------------------------------------------------
Year Ended December 31, 2000 (Continued)
- ----------------------------

Backlog of Orders
- -----------------
The total backlog of orders at December 31, 2001 was approximately
$13,342,000. During the year ended December 31, 2001, the Company received
orders totaling approximately $41,181,000.

Results of Operations - For The Year Ended December 31, 2000 Compared To The
- ----------------------------------------------------------------------------
Ten Months Ended December 31, 1999
- ----------------------------------

On September 30, 1999, the Board of Directors of the Company approved an
amendment to the Bylaws to change the fiscal year end from the Sunday nearest to
the last day of February to December 31. The year ended December 31, 2000
consisted of twelve months, while the fiscal year ended December 31, 1999
consisted of ten months.
On September 30, 1999, the Company concluded the acquisition of all of the
outstanding common stock of Ermanco Incorporated. The results for the ten months
ended December 31, 1999 include the operations of Ermanco from October 1, 1999
through December 31, 1999. See Note 12 of Notes to Consolidated Financial
Statements for further information.
The Company's net earnings for the year ended December 31, 2000 was
$3,480,000 compared to a net loss of $2,780,000 for the ten months ended
December 31, 1999. Contributing to the net earnings for the year ended December
31, 2000 was the inclusion of Ermanco operations for the entire twelve months,
compared to the inclusion of the Ermanco operations for only three months during
the ten months ended December 31, 1999. Contributing to the net loss for the ten
months ended December 31, 1999 were cost overruns of $3,000,000 associated with
four contracts, severance charges of $323,000, and the write-off of $561,000 of
certain long-lived assets.

Net Sales and Gross Profit on Sales
- -----------------------------------
Net sales of $64,306,000 for the year ended December 31, 2000 increased
56.4% compared to net sales of $41,108,000 for the ten months ended December 31,
1999. The sales increase of $23,198,000 was comprised of an increase in
Ermanco's contribution to product sales approximating $26,993,000, offset by a
decrease in SI Systems' sales of approximately $3,795,000 for the year,
principally in the Order Picking, Fulfillment, and Replenishment product line,
when compared to the ten months ended December 31, 1999. Since Ermanco was
purchased on September 30, 1999, Ermanco sales recorded in the ten months ended
December 31, 1999 consisted of sales from October 1, 1999 through December 31,
1999 only. SI Systems' business is dependent upon a limited number of large
contracts with a limited number of customers. This dependence can cause
unexpected fluctuations in sales volume. Along with sales recognized on the
percentage of completion accounting method, the monthly rate of new orders can
also vary substantially, causing fluctuations in the current backlog of orders
and future revenue recognition. 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.
Although SI Systems sales declined in the year ended December 31, 2000 as
compared to the ten months ended December 31, 1999, gross profit on sales for
the year ended December 31, 2000 increased compared to the ten months ended
December 31, 1999.

20

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2000 Compared To The
- ----------------------------------------------------------------------------
Ten Months Ended December 31, 1999
- ----------------------------------

Net Sales and Gross Profit on Sales (Continued)
- -----------------------------------
Gross profit as a percentage of sales was 28.1% for the year ended December
31, 2000 compared to 10.0% for the ten months ended December 31, 1999. The
increase in the gross profit percentage for the year ended December 31, 2000 was
primarily attributable to effective business controls relative to pricing
practices and favorable performance on several contracts, principally for SI
Systems' higher margin proprietary products, initiated in the prior fiscal year
that were completed or nearing completion during the year ended December 31,
2000. Offsetting the impact of the favorable performance on several contracts
was the recognition of an additional loss in the second quarter of fiscal 2000
on a major contract, which experienced additional cost overruns. Gross profit on
sales for the ten months ended December 31, 1999 was unfavorably impacted by
significant cost overruns on four projects, competitive pricing pressures, as
well as to first time inefficiencies associated with the development of enhanced
Order Picking, Fulfillment, and Replenishment products related to these
projects. The cost overruns associated with these contracts resulted in
approximately $8,700,000 in sales with $11,700,000 in related cost of sales
during the ten months ended December 31, 1999. As of December 31, 1999, SI
Systems had accrued the estimated costs to completion for the four projects
incurring cost overruns. Estimates relative to loss contracts, which the Company
experienced to an unusual extent in the period ended December 31, 1999, were
inherently more difficult to make than those in which the contracts proceed
according to original expectations. During 2000, SI Systems had $1,491,000 of
revenue associated with these contracts, with an additional loss of $743,000. By
December 31, 2000, the Company had obtained customer acceptance for 96% of these
contracts which are now in their warranty periods, which periods continue
through various dates, concluding in the second quarter of 2002. The Company
believes that its warranty accruals and previously established remaining
contract accruals for these projects will be adequate to meet any related
remaining obligation of the Company.

Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses of $10,901,000 were higher by
$4,095,000 in the year ended December 31, 2000 than in the ten months ended
December 31, 1999. The increase of $4,095,000 was comprised of additional cost
of operations totaling approximately $3,450,000 related to Ermanco, and an
increase in SI Systems' selling, general and administrative expenses of
approximately $645,000 for the year when compared to the ten months ended
December 31, 1999. Since Ermanco Incorporated was purchased on September 30,
1999, there were selling, general and administrative expenses associated with
the Ermanco operation only for October through December 1999 included in the ten
months ended December 31, 1999.

Product Development Costs
- -------------------------
Product development costs, including patent expense, of $175,000 were lower
by $126,000 for the year ended December 31, 2000 than in the ten months ended
December 31, 1999. Development programs in the year ended December 31, 2000
included enhancements to the Company's Order Picking, Fulfillment, and
Replenishment product line, and new products which were introduced in February
2001. The new products, NBS 30(R) and NBS 90(R), are narrow belt sorters that
contain high-friction divert wheels that raise between the belts, enabling
product to be diverted at a 30 or 90 degree angle. Development programs in the
ten months ended December 31, 1999 included enhancements to the Lo-Tow(R) and
Order Picking, Fulfillment, and Replenishment product lines.

21

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2000 Compared To The
- ----------------------------------------------------------------------------
Ten Months Ended December 31, 1999 (Continued)
- ----------------------------------

Amortization of Goodwill
- ------------------------
Amortization of goodwill represented costs associated with the acquisition
of Ermanco, totaling approximately $469,000 for the year ended December 31,
2000, as compared to $116,000 for the ten months ended December 31, 1999, which
included only three months of amortization due to the timing of the acquisition
in 1999. During the ten months ended December 31, 1999, the Company also
incurred goodwill amortization expense of $93,000 associated with the
acquisition of the Modular Automation Corp.

Goodwill and Other Asset Impairment
- -----------------------------------
Goodwill and other asset impairment of $561,000 for the ten months ended
December 31, 1999 represented the write-off of certain long-lived assets,
primarily goodwill, associated with the elimination of the Automated Guided
Vehicle product line related to the acquisition of Modular Automation Corp.

Restructuring Expenses
- ----------------------
Restructuring expenses of $337,000 represented a restructuring initiative
whereby approximately sixteen engineering and administrative employees were
separated from the Company in the year ended December 31, 2000, as compared to
restructuring expenses of $323,000 whereby approximately ten executive,
engineering, and administrative employees were separated from the Company in the
ten months ended December 31, 1999. No material liability remains for these
restructuring activities.

Interest Expense and Interest Income
- ------------------------------------
Interest expense of $1,633,000 was higher by $1,189,000 in the year ended
December 31, 2000 than in the ten months ended December 31, 1999. The increase
in interest expense was primarily attributable to the term debt and subordinated
notes issued in connection with the Ermanco acquisition which was completed on
September 30, 1999.
Interest income of $397,000 was higher by $267,000 in the year ended
December 31, 2000 compared to the ten months ended December 31, 1999. The
increase in interest income was attributable to the higher level of funds
available for short-term investments.

Equity in Income of Joint Ventures
- ----------------------------------
Equity in income of joint ventures represents the Company's proportionate
share of its investments in the SI/BAKER and SI-Egemin joint ventures that are
being accounted for under the equity method. The net favorable variance of
$205,000 for the year ended December 31, 2000 in the equity in income of joint
ventures was comprised of a favorable variance of $316,000 attributable to the
SI/BAKER joint venture and an unfavorable variance of $111,000 attributable to
the SI-Egemin joint venture. The favorable variance of $316,000 for the year
ended December 31, 2000 in the equity in income of SI/BAKER joint venture was
attributable principally to increased sales of approximately $3,644,000 and an
increase in the gross profit percentage of 2%. The increase in sales for the
year ended December 31, 2000 compared to the ten months ended December 31, 1999
was primarily due to expanded product offerings released to market in late 1999.
The unfavorable variance of $111,000 for the year ended December 31, 2000 in the
equity in income of the SI-Egemin joint venture was attributable to additional
start-up costs. The SI-Egemin joint venture was initiated in July 1999.

22

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Results of Operations - For The Year Ended December 31, 2000 Compared To The
- ----------------------------------------------------------------------------
Ten Months Ended December 31, 1999 (Continued)
- ----------------------------------------------

Other Income, Net
- -----------------
The favorable variance of $354,000 in other income, net, for the year ended
December 31, 2000 as compared to the ten months ended December 31, 1999 was
primarily attributable to an increase of revenue-based royalty income from the
Company's SI/BAKER joint venture and license agreements related to international
conveyor system sales.

Income Tax Expense (Benefit)
- ---------------------------
The Company recognized income tax expense of $2,233,000 during the year
ended December 31, 2000 compared to the income tax benefit of $1,394,000 during
the ten months ended December 31, 1999. Income tax expense for the year ended
December 31, 2000 was generally recorded at statutory federal and state tax
rates. The income tax benefit recognized for the ten months ended December 31,
1999 represented the carryback of losses experienced during the ten months ended
December 31, 1999 against prior year income. The income tax benefit recognized
for the ten months ended December 31, 1999 was negatively impacted by the
write-off of goodwill of Modular Automation Corp., which was not deductible.

Backlog of Orders
- -----------------
The total backlog of orders at December 31, 2000 was approximately
$22,913,000. During the year ended December 31, 2000, the Company received
orders totaling approximately $63,534,000.

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

Critical Accounting Policies
- ----------------------------
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 accounting principles generally accepted in the
United States. 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 related disclosure of commitments and
contingencies at the date of our financial statements. Actual results may differ
from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. We believe that
our critical accounting policies are limited to those described below. For a
detailed discussion on the application of these and other accounting policies,
see Note 1 of Notes to Consolidated Financial Statements.

Revenue Recognition
- -------------------
Revenues on sales 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. Installation
is an integral part of most systems sold by the Company and is not sold or
billed separately. As some of these contracts may extend over one or more years,
generally no more than two 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.

23

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Revenue Recognition (Continued)
- -------------------
The Company believes that it has the ability to reasonably estimate the
total costs and applicable gross profit margins at the inception of the contract
for all of its sales contracts, including both typical and more complex systems.
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, as occurred in 1999 when the Company
determined that it had significantly underestimated the costs involved
principally in four major contracts. The cost overruns associated with these
contracts resulted in approximately $8,700,000 in sales with $11,700,000 in
related cost of sales during the ten months ended December 31, 1999. During
2000, the Company had $1,491,000 of revenue associated with these contracts,
with an additional loss of $743,000.
Revenues on other sales of parts or equipment are recognized when title
transfers pursuant to shipping terms. There are no installation or customer
acceptance aspects of these sales.
The Company's business is dependent upon a limited number of large
contracts with a limited number of customers. This dependence can cause
unexpected fluctuations in sales volume. Along with sales recognized on the
percentage of completion accounting method, the monthly rate of new orders can
also vary substantially, causing fluctuations in the current backlog of orders
and future revenue recognition. 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.

Warranty
- --------
The Company's products are warranted against defects in materials and
workmanship for a specified period. The Company provides an accrual for
estimated future warranty costs and potential product liability claims based
upon a percentage of cost of sales and warranty experience. 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.

Inventories
- -----------
Inventories are valued at the lower of average cost or market. Inventories
primarily consist of materials purchased or manufactured for stock. The Company
does not defer general and administrative costs or initial startup costs. The
Company provides an inventory reserve determined by a specific identification of
individual slow moving items and a general reserve to cover other inventory
items based on historical experience. The reserve is considered to be a
write-down of inventory to a new cost basis. Upon disposal of inventory, the
cost and related inventory reserve are removed from the accounts. Historically,
the level of inventory reserve has been appropriate based on management's
assessment of estimated future inventory disposals.

Restructuring
- -------------
During the second quarter of 2001, the Company restructured its business
operations and recorded a charge of $1,538,000 for restructuring costs. In
conjunction with the restructuring plan, the Company reduced the number of
office employees by fourteen and discontinued production operations at its
Easton, Pennsylvania facility. The restructuring charges included costs of
$678,000 for severance and other personnel costs, $562,000 for pension expense
associated with the curtailment of the defined benefit plan for the Company's
Easton, Pennsylvania production employees, and $298,000 for plant closure and
professional service fees relating to the restructuring. The determination of
the
24

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Restructuring (Continued)
- -------------
amount of the restructuring charge involved a number of estimates. However, the
remaining restructuring accrual is deemed appropriate based on management's
assessment of estimated future cash payments.

Allowance for Doubtful Accounts
- -------------------------------
The Company provides an allowance for doubtful accounts determined by a
specific identification of individual accounts and a general reserve to cover
other accounts based on historical experience. The Company writes off
receivables upon determination that no further collections are probable.
Historically, receivable write offs have not had a material impact on the
Company's financial statements.

Asset Impairments
- -----------------
The Company reviews the recovery of the net book value of long-lived assets
in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," for impairment whenever
events and circumstances indicate that the net book value of an asset may not be
recoverable from the estimated undiscounted future cash flows expected to result
from its use and eventual disposition. In cases where undiscounted expected
future cash flows are less than the net book value, an impairment loss is
recognized equal to an amount by which the net book value exceeds the fair value
of assets.

New Accounting Pronouncements
- -----------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations." SFAS No. 141 requires that all business
combinations be accounted for by the purchase method and adds disclosure
requirements related to business combination transactions. SFAS No. 141 also
establishes criteria for the recognition of intangible assets apart from
goodwill. This Statement applies to all business combinations for which the
acquisition date was July 1, 2001 or later. The Company had no acquisitions
during 2001. The Company intends to implement the provisions of SFAS No. 141 in
any future business combinations.
On June 30, 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which establishes guidelines for the financial accounting
and reporting of acquired goodwill and other intangible assets. With the
adoption of SFAS No. 142, goodwill is no longer subject to amortization; rather,
it will be subject to at least an annual assessment for impairment by applying a
fair value based test. The Company is required to adopt the provisions of this
pronouncement no later than the beginning of 2002, however, goodwill and other
intangible assets acquired after June 30, 2001, are subject immediately to the
amortization provisions of this statement. The Company had no acquisitions of
goodwill or other intangibles in the second half of 2001. The Company will adopt
the amortization provisions of SFAS No. 142 beginning in the first quarter of
2002. During the years ended December 31, 2001 and December 31, 2000, and the
ten months ended December 31, 1999, goodwill and other intangible amortization
was $508,000, $558,000, and $252,000, respectively. The Company has not yet
determined the final impact of adopting SFAS No. 142.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Statement also supersedes APB No. 30 provisions
related to the accounting and reporting for the disposal of a segment of a
business. This Statement establishes a single accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sale. The Statement retains most of the requirements in SFAS No. 121 related
to the recognition of impairment of long-lived assets to be held and used. The
Statement is effective for years beginning after December 15, 2001. The Company
is evaluating the potential impact of adopting SFAS No. 144.

25

Item 7. Management's Discussion And Analysis Of Financial Condition And
- ------- ---------------------------------------------------------------
Results Of Operations
---------------------

Cautionary Statement
- --------------------
Certain statements contained herein are not based on historical fact and
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 or by the Securities and Exchange Commission
rules, regulations, and releases. The Company intends that such forward-looking
statements be subject to the safe harbors created thereby. Among other things,
they regard the Company's acquisition activities, earnings, liquidity, financial
condition, and certain operational matters. Words or phrases denoting the
anticipated results of future events, such as "anticipate," "believe,"
"estimate," "expect," "may," "will," "will likely," "are expected to," "will
continue," "should," "project," and similar expressions that denote uncertainty,
are intended to identify such forward-looking statements. The Company's actual
results, performance, or achievements could differ materially from the results
expressed in, or implied by, such "forward-looking statements" as a result of
the factors set forth in Exhibit 99.

Item 7a. Quantitative and Qualitative Disclosures about Market Risk
- -------- ----------------------------------------------------------
The Company's primary interest rate market risk exposure is from changes in
interest rates. The Company's policy is to manage interest rate exposure through
the use of a combination of fixed and floating rate debt instruments, and since
September 30, 1999, an interest rate swap agreement. Generally, the Company
seeks to match the terms of its debt with its purpose. The Company uses a
variable rate line of credit facility to provide working capital for operations.
In the ten months ended December 31, 1999, the Company entered into an interest
rate swap agreement for 50% of its new term loan from its principal bank to
effectively convert half of the term loan from a variable rate note to a fixed
rate note. A standard interest rate swap agreement involves the payment of a
fixed rate times a notional amount by one party in exchange for a floating rate
times the same notional amount from another party. The counterpart to the swap
agreement is the Company's principal bank.
The Company does not believe that its exposures to interest rate risk or
foreign currency exchange risk, risks from commodity prices, equity prices and
other market changes that affect market risk sensitive instruments, including
the interest rate swap agreement, are material to its results of operations.

26

Item 8. Consolidated Financial Statements and Supplementary Data
- ------- --------------------------------------------------------

I N D E X

o Independent Auditors' Report.

o Consolidated Financial Statements:
Consolidated Balance Sheets, December 31, 2001 and December 31, 2000.

Consolidated Statements of Operations for the years ended December 31,
2001 and December 31, 2000, and for the ten months ended December 31,
1999.

Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2001 and December 31, 2000, and for the ten months ended
December 31, 1999.

Consolidated Statements of Cash Flows for the years ended December 31,
2001 and December 31, 2000, and for the ten months ended December 31,
1999.

Notes to Consolidated Financial Statements.

o Financial Statement Schedule for the years ended December 31, 2001 and
December 31, 2000, and for the ten months ended December 31, 1999:

II - Valuation and qualifying accounts

o All other schedules are omitted as the required information is inapplicable
or the information is presented in the consolidated financial statements or
related notes.

27

Independent Auditors' Report

The Board of Directors and Stockholders
Paragon Technologies, Inc.

We have audited the consolidated financial statements of Paragon Technologies,
Inc. and subsidiary as listed in the accompanying index. In connection with our
audits of the consolidated financial statements, we also have audited the
financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit 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 Paragon
Technologies, Inc. and subsidiary as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for the years ended December
31, 2001 and 2000, and for the ten months ended December 31, 1999, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

/S/ KPMG LLP

Philadelphia, PA
March 8, 2002

28

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 2001 and December 31, 2000
(In Thousands, Except Share Data)

December 31, December 31,
2001 2000
------------------- ------------------

Assets
- ------

Current assets:
Cash and cash equivalents.......................... $ 6,114 7,925
------ ------

Receivables:
Trade (net of allowance for doubtful
accounts of $74 as of December 31,
2001 and $54 as of December 31, 2000........... 7,093 7,040
Notes and other receivables...................... 630 301
------ ------
Total receivables.............................. 7,723 7,341
------ ------

Costs and estimated earnings in excess of
billings............................................ 244 1,665
------ ------

Inventories:
Raw materials...................................... 1,731 2,198
Work-in-process.................................... 254 340
Finished goods..................................... 408 508
------ ------
Total inventories................................ 2,393 3,046
------ ------

Deferred income tax benefits.......................... 2,077 2,326
Prepaid expenses and other current assets............. 649 547
------ ------

Total current assets............................. 19,200 22,850
------ ------

Property, plant and equipment, at cost:
Land............................................... 27 27
Buildings and improvements......................... 3,727 3,746
Machinery and equipment............................ 5,059 6,341
------ ------
8,813 10,114
Less: accumulated depreciation.................... 6,112 7,334
------ ------
Net property, plant and equipment................ 2,701 2,780
------ ------

Investments in joint ventures......................... 1,667 2,000
Excess of cost over fair value of net assets
acquired, less amortization of $1,053 as of
December 31, 2001 and $585 as of December 31, 2000. 17,657 18,125
Other assets, at cost less accumulated amortization
of $94 as of December 31, 2001 and $210 as of
December 31, 2000.................................. 118 162
------ ------

Total assets..................................... $ 41,343 45,917
====== ======

See accompanying notes to consolidated financial statements.

29

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 2001 and December 31, 2000
(In Thousands, Except Share Data)

December 31, December 31,
2001 2000
----------------- -----------------

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

Current liabilities:
Current installments of long-term debt................ $ 2,305 1,521
Accounts payable...................................... 3,319 4,412
Customers' deposits and billings in excess of costs
and estimated earnings for completed and
uncompleted contracts............................... 3,345 4,446
Accrued salaries, wages, and commissions.............. 676 2,130
Income taxes payable.................................. 46 369
Accrued royalties payable............................. 92 253
Accrued product warranties............................ 863 857
Accrued pension and retirement
savings plan liabilities............................ 1,122 688
Accrued restructuring expenses........................ 494 -
Accrued other liabilities............................. 1,126 517
------ ------
Total current liabilities......................... 13,388 15,193
------ ------

Long-term liabilities:
Long-term debt, excluding current installments:
Term loan........................................... 6,900 9,775
Subordinated notes payable.......................... 3,000 3,000
Other............................................... - 5
------ ------
Total long-term debt.............................. 9,900 12,780
Other long-term liability............................. 412 -
Deferred income taxes payable......................... 628 823
Deferred compensation................................. 134 141
------ ------
Total long-term liabilities....................... 11,074 13,744
------ ------

Stockholders' equity:
Common stock, $1 par value; authorized
20,000,000 shares; issued and outstanding
4,221,635 shares as of December 31, 2001
and 4,194,869 shares as of December 31,
2000................................................ 4,222 4,195
Additional paid-in capital............................ 7,071 6,882
Retained earnings..................................... 5,841 5,903
Accumulated other comprehensive loss.................. (253) -
------ ------
Total stockholders' equity........................ 16,881 16,980
------ ------

Total liabilities and stockholders' equity........ $ 41,343 45,917
====== ======

See accompanying notes to consolidated financial statements.

30

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Statements Of Operations
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(In Thousands, Except Share and Per Share Data)

December 31, December 31, December 31,
2001 2000 1999
---------------- ---------------- ----------------

Net sales................................. $ 50,752 64,306 41,108
Cost of sales............................. 38,327 46,248 36,982
------ ------ ------
Gross profit on sales.................. 12,425 18,058 4,126
------ ------ ------

Selling, general and administrative expenses 10,161 10,901 6,806
Product development costs................. 456 175 301
Amortization of goodwill.................. 468 469 209
Goodwill and other asset
impairment............................. - - 561
Restructuring expenses.................... 1,538 337 323
Interest expense.......................... 1,298 1,633 444
Interest income........................... (252) (397) (130)
Equity in income of joint ventures........ (542) (335) (130)
Other income, net......................... (383) (438) (84)
------ ------ ------
12,744 12,345 8,300
------ ------ ------

Earnings (loss) before income
taxes.................................. (319) 5,713 (4,174)
Income tax expense (benefit).............. (257) 2,233 (1,394)
------ ------ ------
Net earnings (loss).................... $ (62) 3,480 (2,780)
====== ====== ======

Basic earnings (loss) per share........... $ (.01) .83 (.72)
====== ====== ======

Diluted earnings (loss) per share......... $ (.01) .82 (.73)
====== ====== ======

Weighted average shares
outstanding............................ 4,210,819 4,189,874 3,835,718
Dilutive effect of stock options.......... - 1,885 -
Dilutive effect of phantom stock
units.................................. - 15,885 16,493
--------- --------- ---------
Weighted average shares
outstanding assuming dilution.......... 4,210,819 4,207,644 3,852,211
========= ========= =========

See accompanying notes to consolidated financial statements.

31

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Statements Of Stockholders' Equity
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(In Thousands, Except Share And Per Share Data)

Accumulated
Additional Other Total
Common Paid-In Retained Comprehensive Stockholders' Comprehensive
Stock Capital Earnings Loss Equity Income (Loss)
------------ ------------- ------------ --------------------------------------------------

Balance at February 28, 1999.............. $ 3,705 2,767 5,675 - 12,147

Net loss and comprehensive loss........... - - (2,780) - (2,780) (2,780)
======
Dividends declared-- $.10 per share
cash dividend.......................... - - (371) - (371)
Common stock repurchases.................. (11) (9) (101) - (121)
Stock options and awards exercised........ 10 40 - - 50
Shares issued in connection with
Ermanco acquisition.................... 481 4,019 - - 4,500
------ ----- ----- ----- ------
Balance at December 31, 1999.............. 4,185 6,817 2,423 - 13,425

Net earnings and comprehensive
income................................. - - 3,480 - 3,480 3,480
=====
Issuance of common shares as
interest payment on subordinated
notes.................................. 10 65 - - 75
------ ----- ----- ----- ------
Balance at December 31, 2000.............. 4,195 6,882 5,903 - 16,980

Net loss.................................. - - (62) - (62) (62)
Cash flow hedge, net of tax............... - - - (253) (253) (253)
----
Comprehensive loss........................ (315)
====
Stock options and awards
exercised.............................. 17 124 - - 141
Issuance of common shares as
interest payment on subordinated
notes.................................. 10 65 - - 75
------ ----- ----- ----- ------
Balance at December 31, 2001.............. $ 4,222 7,071 5,841 (253) 16,881
====== ===== ===== ===== ======

See accompanying notes to consolidated financial statements.

32

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Statements Of Cash Flows
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999 (In thousands)

December 31, December 31, December 31,
2001 2000 1999
----------------- ----------------- -----------------

Cash flows from operating activities:
Net earnings (loss).......................... $ (62) 3,480 (2,780)
Adjustments to reconcile net
earnings (loss) to net cash provided
by operating activities:
Depreciation of plant and
equipment............................ 706 648 369
Amortization of intangibles............ 508 558 252
Loss (gain) on disposition
of equipment......................... 52 (2) (3)
Equity in income of joint ventures..... (542) (335) (130)
Write-off of intangible assets......... - - 561
Issuance of common shares
as interest payment on
subordinated notes................... 75 75 -
Issuance of common shares
as payment of employee's bonus....... 111 - -
Cash dividend received from
joint venture........................ 750 - -
Change in operating assets and
liabilities, net of effects of
acquisitions:
Receivables....................... (257) 435 4,752
Costs and estimated earnings
in excess of billings........... 1,421 199 7,070
Inventories....................... 653 359 366
Deferred income tax benefits,
net............................. 213 441 (1,058)
Prepaid expenses and other
current assets.................. (102) 168 211
Other noncurrent assets........... 4 (48) 94
Accounts payable.................. (1,093) (757) (1,647)
Customers' deposits and
billings in excess of costs
and estimated earnings
for completed and
uncompleted contracts........... (1,101) (708) 478
Accrued salaries, wages,
and commissions................. (1,454) 774 336
Income taxes payable.............. (323) 320 (874)
Accrued royalties payable......... (161) (31) (73)
Accrued pension and
retirement savings plan
liabilities .................... 434 225 (119)

33

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Consolidated Statements Of Cash Flows (Continued)
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999 (In thousands)

December 31, December 31, December 31,
2001 2000 1999
----------------- ----------------- -----------------

Cash flows from operating activities (Continued):
Accrued product warranties........ 6 (46) 367
Accrued restructuring
expenses........................ 494 - -
Accrued other liabilities......... 609 (606) 444
Deferred compensation............. (7) (78) (247)
----- ----- -----
Net cash provided by operating
activities ............................. 934 5,071 8,369
----- ----- -----

Cash flows from investing activities:
Investment in joint venture.................. - (266) (228)
Acquisitions, net of cash acquired........... - (231) (2,961)
Proceeds from the disposition of
land and equipment........................ 13 232 3
Additions to property, plant and
equipment (692) (395) (298)
----- ----- -----
Net cash used by investing activities........ (679) (660) (3,484)
----- ----- -----

Cash flows from financing activities:
Sale of common shares in connection
with employee incentive stock
option plan ............................. 30 - 34
Repayment of long-term debt.................. (2,096) (2,728) (30)
Dividends paid on common stock............... - - (371)
Repurchase and retirement of
common stock.............................. - - (105)
----- ----- -----
Net cash used by financing activities........ (2,066) (2,728) (472)
----- ----- -----

Increase (decrease) in cash
and cash equivalents...................... (1,811) 1,683 4,413
Cash and cash equivalents,
beginning of period....................... 7,925 6,242 1,829
----- ----- -----
Cash and cash equivalents,
end of period............................. $ 6,114 7,925 6,242
===== ===== =====

See accompanying notes to consolidated financial statements.

34

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

(1) Description of Business and Summary of Significant Accounting Policies
- --- ----------------------------------------------------------------------

Description of Business and Concentration of Credit Risk
- --------------------------------------------------------
On September 30, 1999, Paragon Technologies, Inc. ("the Company") concluded
the acquisition of all of the outstanding common stock of Ermanco Incorporated
("Ermanco"). The results for the years ended December 31, 2001 and December 31,
2000 include the operating results of Ermanco for the entire year; however,
results for the ten months ended December 31, 1999, included the operating
results of Ermanco from October 1, 1999 through December 31, 1999 only.
The Company's Easton, Pennsylvania operations (hereafter referred to as "SI
Systems") is a specialized systems integrator supplying SI Systems' branded
automated materials handling systems to manufacturing, order selection, and
distribution operations. The systems are marketed, designed, sold, installed,
and serviced by its own staff or agents, generally as labor-saving devices to
improve productivity, quality, and reduce costs. SI Systems also operates as a
project manager in connection with the installation, integration, and service of
its products generally utilizing subcontractors. SI Systems' branded products
are utilized to automate the movement or selection of products and are often
integrated with other automated equipment such as conveyors and robots. SI
Systems' branded integrated materials 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 materials handling needs. SI Systems' staff develops and
designs computer control programs required for the efficient operation of the
systems. SI Systems branded products are sold to customers located primarily in
North America, including the U.S. government.
The Company's Spring Lake, Michigan operations (hereafter referred to as
"Ermanco"), is a manufacturer of Ermanco branded light to medium duty unit
handling conveyor products, serving the materials handling industry through
local independent distributors in North America. Ermanco also provides complete
conveyor systems for a variety of applications, including distribution and
manufacture of computers and electronic products, utilizing primarily its own
manufactured conveyor products, engineering services by its own staff or
subcontractors, and subcontracted installation services. The systems product
line of Ermanco accounted for approximately 43% of Ermanco's total revenues in
the year ended December 31, 2001, and the balance is from resale distribution.
In the year ended December 31, 2001, the United States government accounted
for revenues of $5,219,000. In the year ended December 31, 2000, Brandt & Hill
Inc. accounted for revenues of $10,979,000, and the United States government
accounted for revenues of $8,157,000. In the ten months ended December 31, 1999,
the United States government accounted for revenues of $11,565,000, and Ciba
Vision Corporation accounted for revenues of $6,600,000. No other customer
accounted for over 10% of revenues.
The Company's products are sold on a fixed-price basis. Generally, contract
terms provide for progress payments and a portion of the purchase price is
withheld by the buyer until the system has been accepted. Generally, contract
terms are net 30 days for product and parts sales, with progress payments for
system-type projects. Many of Ermanco's sales are to distributors who have
non-exclusive agreements with the Company. As of December 31, 2001, one customer
owed the Company $1,242,000 in trade receivables. No other customer owed the
Company in excess of 10% in trade receivables. The Company believes that the
concentration of credit risk in its trade receivables is substantially mitigated
by the Company's ongoing credit evaluation process as well as the general
creditworthiness of its customer base.

35

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Fiscal Year
- -----------
On September 30, 1999, the Board of Directors of the Company approved an
amendment to the Company's Bylaws to change the fiscal year end of the Company
from the Sunday nearest to the last day of February to December 31. The years
ended December 31, 2001 and December 31, 2000 consisted of twelve months; while
the fiscal year ended December 31, 1999 consisted of ten months.

Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of SI Systems
and Ermanco, a wholly-owned subsidiary, after elimination of intercompany
balances and transactions.

Acquisitions
- ------------

Acquisition of Modular Automation Corp.
- --------------------------------------
On April 13, 1999, the Company acquired all of the outstanding common stock
of Modular Automation Corp. ("MAC") of Greene, New York, for $1,957,000, paid in
the form of cash. The amount of goodwill and covenant not to compete recorded at
the time of the acquisition were $616,000 and $50,000, respectively. However, as
of December 31, 1999, the Company decided to abandon the AGV product line
associated with the MAC acquisition of its Automated Materials Handling Systems
segment and the remaining $561,000 of intangible assets were written off as
impaired in 1999.

Acquisition of Ermanco Incorporated
- -----------------------------------
On September 30, 1999, the Company acquired all of the outstanding common
stock of Ermanco Incorporated ("Ermanco"). Under the terms of the Stock Purchase
Agreement, the Company acquired all of the outstanding common stock of Ermanco
for a purchase price of $22,801,000 consisting of $15,301,000 in cash, of which
$1,551,000 was held in escrow ($801,000 was released in January 2000, and
$750,000 was released in March 2001), $3,000,000 in promissory notes payable to
the fourteen stockholders of Ermanco, and 481,284 shares of the Company's common
stock with a value of $4,500,000 based on the average closing price of $9.35 of
the Company's common stock for the five trading days immediately preceding the
date of the Stock Purchase Agreement, August 6, 1999. The Company financed
$14,000,000 of the acquisition through term debt.
In 2000, the Company paid additional costs of $45,000 in connection with
the acquisition, and $186,000 to satisfy a purchase price adjustment
contingency. There are no remaining contingent arrangements that may result in
additional payments by the Company under the Stock Purchase Agreement. The
acquisition required a net cash outlay of $2,264,000.
The acquisition was accounted for as purchase and, accordingly, the
acquired assets and assumed liabilities have been recorded at their estimated
fair value at the date of acquisition. The amount of the excess of cost over
fair value of net assets acquired associated with the acquisition was
$18,710,000 and is being amortized over a period of 40 years.

36

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Acquisition of Ermanco Incorporated (Continued)
- -----------------------------------
On the basis of a pro forma consolidation of the results of operations of
Ermanco, as if the acquisition had taken place on March 1, 1999, the following
unaudited pro forma financial results for the ten months ended December 31, 1999
are as follows (in thousands, except per share amounts and unaudited):

For the Ten
Months Ended
December 31, 1999
-------------------------

Net sales........................................................... $ 60,168
======
Net earnings (loss)................................................. $ (1,755)
======
Basic earnings (loss) per share..................................... $ (.42)
======
Diluted earnings (loss) per share................................... $ (.42)
======

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

Financial Instruments
- ---------------------
The Company believes the market values of its short-term assets and
liabilities, which are financial instruments materially, approximate their
carrying values due to the short-term nature of the instruments. The carrying
amount of the Company's long-term debt appropriates market value as the debt
carries a variable interest rate.

Cash and Cash Equivalents
- -------------------------
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, cash on deposit, amounts invested on an overnight basis with a
bank, and other highly liquid debt instruments purchased with a maturity of
three months or less. The Company does not believe it is exposed to any
significant credit risk on cash and cash equivalents.

Allowance for Doubtful Accounts
- -------------------------------
The Company provides an allowance for doubtful accounts determined by a
specific identification of individual accounts and a general reserve to cover
other accounts based on historical experience. The Company writes off
receivables upon determination that no further collections are probable.

Inventories
- -----------
Inventories are valued at the lower of average cost or market. Inventories
primarily consist of materials purchased or manufactured for stock. The Company
does not defer general and administrative costs or initial startup costs.
Inventory reserves are $954,000 and $992,000 as of December 31, 2001 and
December 31, 2000, respectively.

37

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Property, Plant and Equipment
- -----------------------------
Plant and equipment generally are depreciated on the straight-line method
over the estimated useful lives of individual assets. The ranges of lives used
in determining depreciation rates for buildings and improvements and machinery
and equipment are 15-40 years and 3-7 years, respectively. Maintenance and
repairs are charged to operations; betterments and renewals are capitalized.
Upon sale or retirement of plant and equipment, the cost and related accumulated
depreciation are removed from the accounts and the resultant gain or loss, if
any, is credited or charged to earnings.

Investments in Joint Ventures
- -----------------------------
On March 1, 1993, the Company and McKesson Automated Systems Inc.
("McKesson Automation") of Pineville, Louisiana formed a joint venture,
SI/BAKER, INC. ("SI/BAKER"). SI/BAKER draws upon the automated materials
handling systems experience of the Company and the automated pill counting and
dispensing products of McKesson Automation to provide automated pharmacy
systems. Each member company contributed $100,000 in capital to fund the joint
venture. The Company accounts for its investment in the joint venture on the
equity basis.
On July 15, 1999, the Company and Egemin N.V. ("Egemin") of Schoten,
Belgium formed a joint venture, SI-Egemin N.V. ("SI-Egemin"). SI-Egemin drew
upon the automated materials handling systems experience of the Company and
Egemin to provide automated materials handling systems worldwide. Since
inception, each member Company contributed $494,000 in capital to fund the joint
venture. The Company accounted for its investment in the joint venture on the
equity basis.
The Company divested of its investment in the SI-Egemin joint venture at
the end of calendar year 2001. The divestment of the Company's investment in the
SI-Egemin joint venture did not result in a material gain or loss.

Intangibles
- -----------

Deferred Debt Issuance Costs
- ----------------------------
Deferred debt issuance costs, included in Other assets, incurred in
connection with the line of credit and term loan with the Company's principal
bank associated with the acquisition of Ermanco (see Notes 3 and 4) are
amortized over a period of 3 and 7 years, respectively.

Asset Impairments
- -----------------
The Company reviews the recovery of the net book value of long-lived assets
in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," for impairment whenever
events and circumstances indicate that the net book value of an asset may not be
recoverable from the estimated undiscounted future cash flows expected to result
from its use and eventual disposition. In cases where undiscounted expected
future cash flows are less than the net book value, an impairment loss is
recognized equal to an amount by which the net book value exceeds the fair value
of assets.

Revenue Recognition
- -------------------
Revenues on sales 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. Installation
is an integral part of most systems sold by the Company and is not sold or
billed separately. As these contracts may extend over one or more years,
generally no more than two 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.

38

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Revenue Recognition (Continued)
- -------------------
The Company believes that it has the ability to reasonably estimate the
total costs and applicable gross profit margins at the inception of the contract
for all of its sales contracts, including both typical and more complex systems.
However, in rare instances, as occurred in 1999, the Company determined that it
had significantly underestimated the costs involved, principally in four major
contracts that included enhancements to Order Picking, Fulfillment, and
Replenishment products. The cost overruns associated with these contracts
resulted in approximately $8,700,000 in sales with $11,700,000 in related cost
of sales during the ten months ended December 31, 1999. As of December 31, 1999,
the Company had accrued the estimated costs to completion for these four
projects.
During 2000, the Company had $1,491,000 of revenue associated with these
contracts, with an additional loss of $743,000. The Company obtained customer
acceptance for these contracts. Two of the contracts remain in their warranty
periods, which periods continue through various dates, concluding in the second
quarter of 2002. The Company believes that its warranty accruals and previously
established remaining contract accruals for these projects will be adequate to
meet any related remaining obligation of the Company.
Revenues on other sales of parts or equipment are recognized when title
transfers pursuant to shipping terms. There are no installation or customer
acceptance aspects of these sales.

Product Development Costs
- -------------------------
The Company expenses product development costs as incurred.

Restructuring
- -------------
During the second quarter of 2001, the Company restructured its business
operations and recorded a charge of $1,538,000 for restructuring costs. In
conjunction with the restructuring plan, the Company reduced the number of
office employees by fourteen and discontinued production operations at its
Easton, Pennsylvania facility. All production employees working in the Easton,
Pennsylvania manufacturing plant were laid off by the end of November 2001.
Prior to the restructuring, the Company employed approximately twenty production
employees, with an additional 27 individuals on an extended layoff. The
restructuring charges included costs of $678,000 for severance and other
personnel costs, $562,000 for pension expense associated with the curtailment of
the defined benefit plan for the Company's Easton, Pennsylvania production
employees, and $298,000 for plant closure and professional service fees relating
to the restructuring. The restructuring charges were determined based on formal
plans approved by the Company's management and the Board of Directors.
The liability related to the curtailment of the defined benefit plan is
recorded as accrued pension and retirement savings plan liabilities on the
consolidated balance sheet.
The major components of the restructuring charge and remaining accruals are
as follows:

Balance at Cash Balance at
June 30, 2001 Payments December 31, 2001
------------------ -------------- -------------------------

Severances $ 678,000 (404,000) 274,000
Other 298,000 ( 78,000) 220,000
------- ------- -------
$ 976,000 (482,000) 494,000
======= ======= =======

39

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Restructuring (Continued)
- -------------
Restructuring expenses of $337,000 represented a restructuring initiative
whereby approximately sixteen engineering and administrative employees were
separated from the Company in the year ended December 31, 2000. Restructuring
expenses of $323,000 resulted from ten executive, engineering, and
administrative employees being separated from the Company in the ten months
ended December 31, 1999. No liability remains for these restructuring
activities.

Warranty
- --------
The Company's products are warranted against defects in materials and
workmanship for a specified period. The Company provides an accrual for
estimated future warranty costs and potential product liability claims based
upon a percentage of cost of sales and warranty experience.

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.

Stock-Based Compensation
- ------------------------
The Company grants stock options for a fixed number of shares to employees
and non-employee directors with an exercise price equal to the fair value of the
shares at the date of grant. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and, accordingly, recognizes no compensation expense on options granted to
employees for the stock option grants. The Company recognizes compensation
expense on options granted to non-employee directors.
The Company also grants phantom stock units to its directors as deferred
compensation. Such awards are redeemable in cash or the Company's common stock
at the director's option and are accounted for in accordance with APB Opinion
No. 25 as stock appreciation rights. Expense (Income associated with the
reversal of previously recognized expense) for the phantom stock unit plan was
$8,000, ($40,000), and ($30,000) for the years ended December 31, 2001 and
December 31, 2000, and in the ten months ended December 31, 1999, respectively.
40

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

Earnings (Loss) Per Share
- -------------------------
Basic and diluted earnings (loss) per share for the years ended December
31, 2001 and December 31, 2000, and for the ten months ended December 31, 1999,
are based on the weighted average number of shares outstanding. In addition,
diluted earnings (loss) per share reflect the effect of dilutive securities
which include phantom stock units, and the shares that would be outstanding
assuming the exercise of dilutive stock options. The number of shares that would
be issued from the exercise has been reduced by the number of shares that could
have been purchased from the proceeds at the average market price of the
Company's common stock.
The following table sets forth the computation of basic and diluted
earnings (loss) per share:

Basic Earnings Effect of Dilutive Diluted Earnings
(Loss) Per Share Securities (Loss) Per Share
--------------- ---------- ---------------

For the year ended
December 31, 2001
Income (loss) numerator............. $ (62,000) - (62,000)
Shares denominator.................. 4,210,819 - 4,210,819
--------- ---------
Per share amount.................... $ (.01) (.01)
========= =========

For the year ended
December 31, 2000
Income (loss) numerator............ $ 3,480,000 (25,000) 3,455,000
Shares denominator................. 4,189,874 17,770 4,207,644
--------- ---------
Per share amount................... $ .83 .82
========= =========

For the ten months ended
December 31, 1999
Income (loss) numerator............ $ (2,780,000) (20,000) (2,800,000)
Shares denominator................. 3,835,718 16,493 3,852,211
--------- ---------
Per share amount................... $ (.72) (.73)
========= =========

Cash Flow Hedge
- ---------------
The Company is exposed to market risk from changes in interest rates, and
uses an interest rate swap to hedge this risk. The seven-year interest rate swap
has a notional amount of $5,462,500 and is classified as a cash flow hedge of
forecasted variable rate interest payments on a portion of the Company's term
loan. Gains and losses on the interest rate swap are deferred in other
comprehensive income (loss). The fair value of the interest rate swap at
December 31, 2001 was a liability of approximately $412,000.
The separate components of other comprehensive loss are as follows (in
thousands):

Gross Tax Effect Net
----- ---------- ---

Cumulative impact of
adoption of FAS 133....................... $ 165 69 96
Other comprehensive loss..................... 247 90 157
--- --- ---
Accumulated other comprehensive
loss at December 31, 2001................ $ 412 159 253
=== === ===

The Company uses derivative financial instruments as risk management tools
and not for speculative purposes.

41

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

New Accounting Standards Adopted
- --------------------------------
On January 1, 2002, the Company adopted "Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," and SFAS No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities," an amendment of SFAS No. 133. These Statements
establish accounting and reporting standards that require every derivative
instrument to be recorded on the consolidated balance sheet as either an asset
or a liability measured at its fair value. SFAS No. 133, as amended, requires
the transition adjustment resulting from adopting these Statements to be
reported in net income or accumulated other comprehensive income, as
appropriate, as the cumulative effect of change in accounting principle. On
January 1, 2001, the Company recorded the value of an interest rate swap as a
liability on the consolidated balance sheet. The transition adjustment was an
after-tax loss to accumulated other comprehensive loss.

New Accounting Pronouncements
- -----------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations." SFAS No. 141 requires that all business
combinations be accounted for by the purchase method and adds disclosure
requirements related to business combination transactions. SFAS No. 141 also
establishes criteria for the recognition of intangible assets apart from
goodwill. This Statement applies to all business combinations for which the
acquisition date was July 1, 2001 or later. The Company had no acquisitions
during 2001. The Company intends to implement the provisions of SFAS No. 141 in
any future business combinations.
On June 30, 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which establishes guidelines for the financial accounting
and reporting of acquired goodwill and other intangible assets. With the
adoption of SFAS No. 142, goodwill is no longer subject to amortization; rather,
it will be subject to at least an annual assessment for impairment by applying a
fair value based test. The Company is required to adopt the provisions of this
pronouncement no later than the beginning of 2002, however, goodwill and other
intangible assets acquired after June 30, 2001, are subject immediately to the
amortization provisions of this statement. The Company had no acquisitions of
goodwill or other intangibles in the second half of 2001. The Company will adopt
the amortization provisions of SFAS No. 142 beginning in the first quarter of
2002. During the years ended December 31, 2001 and December 31, 2000, and the
ten months ended December 31, 1999, goodwill and other intangible amortization
was $508,000, $558,000, and $252,000, respectively. The Company has not yet
determined the final impact of adopting SFAS No. 142.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Statement also supersedes APB No. 30 provisions
related to the accounting and reporting for the disposal of a segment of a
business. This Statement establishes a single accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sale. The Statement retains most of the requirements in SFAS No. 121 related
to the recognition of impairment of long-lived assets to be held and used. The
Statement is effective for years beginning after December 15, 2001. The Company
is evaluating the potential impact of adopting SFAS No. 144.

42

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

(2) Uncompleted Contracts
- --- ---------------------

Costs and estimated earnings on uncompleted contracts are as follows (in
thousands):

December 31, December 31,
2001 2000
-------------------- --------------------

Costs and estimated earnings on
uncompleted contracts............................ $ 38,255 37,778
Less: billings to date............................. 41,356 40,559
------ ------
$ (3,101) (2,781)
====== ======

Included in accompanying balance sheets under the
following captions:
Costs and estimated earnings
in excess of billings.......................... $ 244 1,665
Customers' deposits and billings in
excess of costs and estimated
earnings for completed and
uncompleted contracts.......................... (3,345) (4,446)
------ ------
$ (3,101) (2,781)
====== ======

(3) Line of Credit Loan
- --- -------------------

In order to complete the acquisition of Ermanco on September 30, 1999, the
Company obtained financing from its principal bank. The Company entered into a
three-year line of credit facility which may not exceed the lesser of $6,000,000
or an amount based on a borrowing base formula tied principally to accounts
receivable, inventory, fair market value of the Company's property and plant,
and liquidation value of equipment. This amount will be reduced by the unpaid
principal balance of the term loan. The line of credit facility is to be used
primarily for working capital purposes. Interest on the line of credit facility
is at the bank's prime rate of interest or LIBOR Market Index Rate plus 2%.
To obtain the line of credit, the Company granted the bank a security
interest in all personal property, including, without limitation, all accounts,
deposits, documents, equipment, fixtures, general intangibles, goods,
instruments, inventory, letters of credit, money, securities, and a first
mortgage on all real estate. The line of credit facility contains various
restrictive covenants relating to additional indebtedness, asset acquisitions or
dispositions, investments, guarantees, and maintenance of certain financial
ratios. In addition, the Company is restricted from paying dividends in excess
of 15% of its net earnings. The Company was in compliance with all covenants, as
amended, as of December 31, 2001. As of December 31, 2001, the Company did not
have any borrowings under the line of credit facility. The line of credit
facility has an expiration date of September 30, 2002.

43

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

(4) Long-Term Debt
- --- --------------

A summary of long-term debt follows (in thousands):

December 31, December 31,
2001 2000
----------------- ----------------

Term loan................................................ $ 9,200 11,288
Subordinated notes payable............................... 3,000 3,000
Capital lease obligations................................ 5 13
------ ------
Total.................................................... 12,205 14,301
Less: current installments of long-term debt............ 2,305 1,521
------ ------
Long-term debt........................................... $ 9,900 12,780
====== ======

The Company received $14,000,000 in the form of a seven-year term loan from
its bank to finance the acquisition of Ermanco on September 30, 1999. During the
first two years of the term loan, the Company was obligated to repay equal
quarterly payments of $312,500 plus accrued interest. After September 30, 2001,
the Company commenced making equal quarterly payments of $575,000, plus interest
continuing until the loan is fully repaid. The interest rate on the term loan is
variable at a rate equal to the three-month LIBOR Market Index Rate plus three
percent (4.90% as at December 31, 2001).
To obtain the term loan, the Company granted the bank a security interest
in all personal property, including, without limitation, all accounts, deposits,
documents, equipment, fixtures, general intangibles, goods, instruments,
inventory, letters of credit, money, securities, and a first mortgage on all
real estate. The term loan contains various restrictive covenants relating to
additional indebtedness, asset acquisitions or dispositions, investments,
guarantees, and maintenance of certain financial ratios. In addition, the
Company is restricted from paying dividends in excess of 15% of its net
earnings. The Company was in compliance with all covenants, as amended, as of
December 31, 2001.
The subordinated promissory notes issued on September 30, 1999 to the
fourteen stockholders of Ermanco, two of which are directors, totaled
$3,000,000. The notes have a term of seven years and bear interest at an annual
rate of ten percent through September 30, 2002, twelve percent from October 1,
2002 through September 30, 2004, and fourteen percent from October 1, 2004
through September 30, 2006. The weighted average interest rate on the promissory
notes is 11.714% over the term of the notes. Interest shall be payable
quarterly, in cash, or under certain conditions, in the Company's common stock
upon approval of the Company's Board of Directors. The promissory notes may be
prepaid prior to the end of the seven-year term provided that there is no debt
outstanding under the Company's line of credit facility and term loan. Since
July 1, 2001, the Company has been and will be prohibited from making any cash
payments of subordinated debt and interest until the Company is in full
compliance with all the financial covenants as originally set forth in the Loan
Agreement with the Company's principal bank. The bank waived the restriction
from paying interest on the subordinated debt in the form of cash for the fourth
quarter ended December 31, 2001 and the first quarter ended March 31, 2002. The
Company intends to satisfy its quarterly interest obligations with the issuance
of the Company's common stock in the event the Company's principal bank does not
grant waivers regarding the making of cash payments of interest on subordinated
debt.
Financing agreements related to the lease of computer software have been
recorded as capital leases. These agreements had a total initial contract value
of $36,000. The current and long-term portions of capital lease obligations are
$5,000 and $0, respectively.

44

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements

(4) Long-Term Debt (Continued)
- --- --------------
Principal payments of long-term debt (including capital leases) from
December 31, 2001 under terms of existing agreements are as follows:

2002................... $ 2,305
2003................... 2,300
2004................... 2,300
2005................... 1,438
2006................... 3,862
------
$ 12,205
======

45

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(5) Capital Stock Options
- --- ---------------------
The following is a summary of options available for grant and changes in
options outstanding under the Company's 1992 Incentive Stock Option Plan
("ISOP") and 1997 Equity Compensation Plan ("ECP") for the years ended December
31, 2001 and December 31, 2000, and for the ten months ended December 31, 1999:

1992 ISOP 1997 ECP TOTAL
---------------- --------------------------------------------------------------------------------------- --------

Option price* $ 4.36 6.33 13.33 15.25 10.88 10.00 8.25 8.00 8.94 7.06 5.88 6.63 7.50
====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ======= =======
Options out-
standing
as of February
28, 1999......... 7,264 26,400 58,800 52,748 - - - - - - - - - 145,212
Granted........ - - - - 40,000 76,772 39,000 10,000 7,000 - - - - 172,772
Exercised...... (7,039) (3,000) - - - - - - - - - - - (10,039)
Lapsed......... - (7,875)(18,900)(19,579) - - - - - - - - - (46,354)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Options out-
standing as of
December 31,
1999............. 225 15,525 39,900 33,169 40,000 76,772 39,000 10,000 7,000 - - - - 261,591
Granted........ - - - - - - - - - 106,000 10,000 236,675 - 352,675
Exercised...... - - - - - - - - - - - - - -
Lapsed......... (225) (5,700)(15,000) (10,762) - (24,242) - (10,000) (7,000) (5,000) - - - (77,929)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------- ------- -------

Options out-
standing as of
December 31,
2000............. - 9,825 24,900 22,407 40,000 52,530 39,000 - - 101,000 10,000 236,675 - 536,337
Granted........ - - - - - - - - - - - - 142,000 142,000
Exercised...... - (2,700) - - - - - - - (1,750) - - - (4,450)
Lapsed......... - (7,125)(15,150) (8,841) - (25,550) - - - (20,250) - (40,200) - (117,116)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------- ------- -------

Options out-
standing as of
December 31,
2001............. - - 9,750 13,566 40,000 26,980 39,000 - - 79,000 10,000 196,475 142,000 556,771
====== ====== ====== ====== ====== ====== ====== ====== ====== ======= ====== ======= ======= =======

*The option prices and number of options have been adjusted to reflect the three-for-two stock splits of August 11, 1995
and November 10, 1997.

46

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(5) Capital Stock Options (Continued)
- --- ---------------------

Under the Company's 1992 Incentive Stock Option Plan, officers and key
employees were granted options to purchase shares of common stock at the market
price at the date of grant. Options became exercisable in increments of 25% on
the anniversary date of the grant; thus, at the end of four years, the options
were fully exercisable. There are no options outstanding under the 1992 ISOP.
The 1992 ISOP authorizes up to 112,500 shares of common stock for issuance
pursuant to the terms of the Plan. The plan, approved in 1992, also authorizes
stock appreciation rights; however, none have been issued. The Plan will expire
in July 2002.
In July 1997, the stockholders adopted the 1997 Equity Compensation Plan
("ECP"), which will expire in July 2007. The ECP provides for grants of stock
options, restricted stock, and stock appreciation rights to selected 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 shareholders 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. The Company recognizes compensation expense
on options granted to non-employee directors. To date, the effect of options
granted to non-employee directors has been immaterial. 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. Currently, 556,771
options are outstanding under the plan, and all options have a term of five
years.
The Company has elected to continue to account for its stock-based
compensation plans under the guidelines of Accounting Principles Board Opinion
No. 25; however, additional disclosure as required under the guidelines of SFAS
No. 123, "Accounting for Stock-Based Compensation," is included below. If the
Company had elected to recognize stock-based compensation expense for options
granted to employees based on the fair value of granted options at the grant
date (as determined under SFAS No. 123), net earnings (loss) (in thousands) and
basic earnings (loss) per share for the years ended December 31, 2001 and
December 31, 2000, and for the ten months ended December 31, 1999 would have
been as follows:

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
----------------- ----------------- ----------------

Net earnings (loss) As reported...... $ (62) 3,480 (2,780)
Pro forma........ (212) 3,316 (2,865)

Basic earnings (loss) As reported...... $ (.01) .83 (.72)
per share Pro forma........ (.05) .79 (.75)

The above pro forma net earnings (loss) and basic earnings (loss) per share
were computed using the fair value of granted options at the date of grant as
calculated by the Black-Scholes option pricing method. In order to perform this
calculation, the following assumptions were made for the years ended December
31, 2001 and December 31, 2000, and for the ten months ended December 31, 1999,
respectively: dividend yields of 0%, 0%, and 1.25%; risk-free interest rates of
3.92%, 4.69%, and 6.50%; expected volatilities of 34.7%, 35.3%, and 33.6%; and
an expected holding period of four years.

47

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(6) Employee Benefit Plans
- --- ----------------------

The Company maintains defined benefit plans for employees covered by
collective bargaining agreements. Retirement benefits are based on the
employee's years of service multiplied by the appropriate monthly benefit
amount. Employee compensation does not impact pension benefits. The Company's
policy is to fund the plans in compliance with applicable laws and regulations.
Assets of the Company's defined benefit plans are primarily invested in publicly
traded common stocks, corporate and government debt securities, and cash or cash
equivalents.

The benefit obligations for the Company's defined benefit plans were (in
thousands):

September 30, September 30,
2001 2000
-------------------- ---------------------

Change in benefit obligations:
Benefit obligation at beginning of year............. $ 2,925 2,450
Service cost (excluding administrative expenses).... 124 99
Interest cost....................................... 216 190
Amendment........................................... - 374
Actuarial (gain) loss............................... 56 (105)
Benefits paid....................................... (128) (93)
----- -----
Benefit obligation at end of year................... $ 3,193 2,925
===== =====

The amendment in 2000 provided an increase in the monthly benefit amount.

The fair value of the plan assets of the Company's defined benefit plans
follows (in thousands):

September 30, September 30,
2001 2000
-------------------- ---------------------

Change in plan assets:
Fair value of plan assets at beginning of year...... $ 3,811 3,329
Actual return on plan assets........................ 357 569
Employer contribution............................... 77 54
Expenses............................................ (72) (58)
Benefits paid....................................... (128) (83)
----- -----
Fair value of plan assets at end of year............ $ 4,045 3,811
===== =====

Accrued pension liability included in the Company's balance sheets at
September 30, 2001 and September 30, 2000 were (in thousands):

September 30, September 30,
2001 2000
-------------------- ---------------------

Reconciliation to balance sheets:
Funded status:
Plan assets in excess of benefit obligation......... $ 852 886
Unrecognized net actuarial gain..................... (1,840) (1,940)
Unrecognized net obligation......................... (14) (14)
Unrecognized prior service costs.................... 6 627
----- -----
Accrued benefit cost recognized in the Company's
balance sheets.................................... $ (996) (441)
===== =====

48

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(6) Employee Benefit Plans (Continued)
- --- ----------------------

The Company uses the projected unit credit actuarial method to compute
pension expense, which includes amortization of past service costs over 30
years. The net periodic pension expense (benefit) and total pension expense for
the years ended December 31, 2001 and December 31, 2000, and for the ten months
ended December 31, 1999, includes the following components (in thousands):

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
---------------- ----------------- -----------------

Service cost-benefits earned during the
period $ 182 159 89
Interest cost on projected benefit
obligation............................ 216 190 123
Expected return on plan assets - increase (277) (231) (151)
Amortization of net asset................ (1) (21) (18)
Amortization of prior service cost....... 60 62 40
Recognized net actuarial gain............ (187) (48) (33)
----- ----- -----
Net periodic pension expense
(benefit)............................. (7) 111 50
Curtailment cost......................... 562 - -
----- ----- -----
Total pension expense.................... $ 555 111 50
===== ===== =====

The weighted average rates and actuarial assumptions used to develop the
net periodic pension expense (benefit) and the projected benefit obligation
were:

As of
---------------------------------------------------------
September 30, September 30, September 30,
2001 2000 1999
----------------- ----------------- -----------------

Discount rate........................... 7.0% - 7.25% 7.0% - 7.75% 7.0% - 7.5%
Expected long-term rate of
return on plan assets................ 8.0% - 8.50% 8.0% - 8.50% 8.0% - 8.5%

The Company operates a number of defined contribution plans for employees.
The plans contain a Company match feature and one plan also contains provisions
for profit sharing contributions in the form of cash as determined annually by
the Board of Directors. Total expense for these plans was $199,000, $386,000,
and $198,000 for the years ended December 31, 2001 and December 31, 2000, and
for the ten months ended December 31, 1999, respectively.

49

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(7) Income Taxes
- --- ------------

The provision for income tax expense (benefit) consists of the following
(in thousands):

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
------------------ ------------------ ------------------

Federal - current.................. $ (510) 1,541 (365)
- deferred................. 322 372 (777)
----- ----- -----
(188) 1,913 (1,142)
----- ----- -----

State - current.................. 32 240 27
- deferred................. (109) 69 (281)
----- ----- -----
(77) 309 (254)
----- ----- -----

Foreign - current.................. 8 11 2
----- ----- -----
$ (257) 2,233 (1,394)
===== ===== =====

The reconciliation between the U.S. federal statutory rate and the
Company's effective income tax rate is (in thousands):

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
------------------ ----------------- ------------------

Computed tax expense (benefit)
at statutory rate of 34%............ $ (108) 1,942 (1,419)
Increase (reduction) in taxes
resulting from:
State income taxes, net of
federal benefit.............. (51) 204 (167)
Equity in income of joint venture (139) 70 (58)
Change in the valuation
allowance for deferred tax
assets....................... - (102) -
Write-off of intangible assets - - 210
Miscellaneous items............ 41 119 40
----- ------ -----
$ (257) 2,233 (1,394)
===== ===== =====

50

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(7) Income Taxes (Continued)
- --- ------------

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 2001 and
December 31, 2000 are presented below (in thousands):

December 31, December 31,
2001 2000
----------------- -----------------

Deferred tax assets:
Net operating and built-in loss carryforward
expiring through 2007)............................... $ 405 307
Inventories............................................ 458 495
Accrued restructuring costs............................ 179 -
Accrued warranty costs................................. 332 331
Accrued pension costs.................................. 397 183
Accruals for other book expenses, not yet deductible
for tax purposes..................................... 1,349 1,544
----- -----
Total gross deferred tax assets.................... 3,120 2,860
----- -----

Deferred tax liabilities:
Plant and equipment, principally due to differences in
depreciation......................................... (159) (143)
Amortization........................................... (783) (443)
Investment in SI/BAKER joint venture................... (605) (652)
Other.................................................. (124) (119)
------ -----
Total gross deferred tax liabilities............... (1,671) (1,357)
----- -----
Net deferred tax assets............................ $ 1,449 1,503
===== =====

In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Based upon historical
taxable income and projections for future taxable income over the periods in
which the deferred tax assets are deductible, management believes it is more
likely than not that the Company will realize the benefits of these deductible
differences at December 31, 2001.

(8) Contingencies
- --- -------------

The Company is guarantor (not to exceed $1,000,000) of one-half of
SI/BAKER's borrowings under a line of credit which had no outstanding balance at
December 31, 2001.
The Company is presently engaged in certain legal proceedings, which
management believes present no significant risk of material loss to the Company.

51

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(9) Commitments and Related Party Transactions
- --- ------------------------------------------

Ermanco's operations are located in a 113,000 square foot steel building in
Spring Lake, Michigan. The building is leased from an organization that is
affiliated with the Company through a common director and officer, Messrs.
Shulman and Kirschner. The leasing agreement requires fixed monthly rentals of
$32,858 (with annual increases of 2.5%) which includes a variable portion based
on the lessor's borrowing rate and the unpaid mortgage balance. The terms of the
lease require the payment of all taxes, insurance, and other ownership related
costs of the property. The lease expires on September 30, 2004. The Company paid
$394,000, $374,000, and $90,000 in the years ended December 31, 2001 and
December 31, 2000, and in the ten months ended December 31, 1999, respectively,
under this leasing arrangement.
The Company also leases certain automobiles and office equipment, office
space, computer equipment, and software under various operating leases with
terms extending through July 2005.
Financing agreements related to the lease of computer software have been
recorded as capital leases. These agreements had a total initial contract value
of $36,000. As of December 31, 2001, the contract value of the agreement is
$5,000.
Total rental expense, including short-term leases, in the years ended
December 31, 2001 and December 31, 2000, and in the ten months ended December
31, 1999, approximated $584,000, $623,000, and $199,000, respectively.
Future minimum rental commitments at December 31, 2001 are as follows (in
thousands):

Capital
Leases Operating Leases
------------------- -------------------

2002................................................ $ 5 558
2003................................................ - 537
2004................................................ - 412
2005................................................ - 60
---- -----
Total minimum lease payments........................ 5 1,567
=====
Less: current portion.............................. 5
----
Long-term capital lease obligations................. $ -
====

To complete the acquisition of Ermanco, the Company issued $3,000,000 in
subordinated promissory notes to the stockholders of Ermanco. See Note 4 of the
Notes to Consolidated Financial Statements for more information on the
promissory notes issued to the fourteen stockholders of Ermanco, eleven of whom
continue to be employees, and two are directors of the Company.
The Company has employment agreements with several of the Company's
executive officers. Each of the agreements has varying expiration dates. They
provide for each party to receive annual compensation during the term of the
employment agreements, participate in bonus plans, plus usual and customary
fringe benefits associated with being an employee of the Company. Under certain
circumstances, several of the agreements provide for post termination severance
payments.
See Note 11 of Notes to Consolidated Financial Statements for transactions
related to the SI/BAKER joint venture.

52

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(10) Cash Flow Information
- ---- ---------------------

Supplemental disclosures of cash flow information for the years ended
December 31, 2001 and December 31, 2000, and for the ten months ended December
31, 1999, are as follows (in thousands, except share data):

For the For the Year For the Ten
Year Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
---------------- ----------------- ----------------

Supplemental disclosures of cash
flow information:
Cash paid for:
Interest.......................... $ 1,030 1,837 7
===== ===== ======

Income taxes...................... $ 195 1,472 1,030
===== ===== ======

Supplemental disclosures of
noncash investing and financing
activities:
Receivable associated with the
divestment of a joint venture..... $ 125 - -
===== ===== ======

Adjustment to excess of cost
over fair value of net assets
acquired due to a change in
the estimated fair value of
land acquired..................... $ - 70 -
===== ===== ======

Issuance of 2,850 common
shares in exchange for 1,943
common shares delivered to
the Company by an officer in
connection with the employee
incentive stock option plan....... $ - - 16
===== ===== ======

Issuance of 481,284 common
shares for the Ermanco
acquisition....................... $ - - 4,500
===== ===== ======

Issuance of $14,000 of term
debt for the Ermanco
acquisition....................... $ - - 14,000
===== ===== ======

Issuance of $3,000 in
subordinated notes payable
in connection with the
Ermanco acquisition............... $ - - 3,000
===== ===== ======

Additional consideration and
costs payable in connection
with the Ermanco acquisition...... $ - - 231
===== ===== ======

53

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(11) Joint Ventures
- ---- --------------

The Company has entered into various transactions with SI/BAKER as follows:

December 31, December 31,
2001 2000
----------------- ------------------

SI/BAKER, INC., 50% owned by the Company:
Balance Sheets data (in thousands):
Amount included in notes and other receivables........... $ 52 68
Amount included in costs and estimated earnings in
excess of billings..................................... - 34
Investment in SI/BAKER................................... 1,667 1,788
Amount included in accounts payable...................... - -

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
---------------- ----------------- ----------------

Statements of Operations Data
(in thousands):
Systems and services sold under
various subcontracts................ $ 876 593 237
Services purchased for resale under
various subcontracts................ - 1 60
Reimbursement for administrative and
other services provided............. 55 106 116
Royalty income........................ 243 283 210

Information pertaining to the Company's investment in the SI/BAKER joint
venture is as follows (in thousands):

Balance at February 28, 1999.........................................................$ 1,041
Equity in net earnings............................................................... 215
-----
Balance at December 31, 1999......................................................... 1,256
Equity in net earnings............................................................... 532
-----
Balance at December 31, 2000......................................................... 1,788
Equity in net earnings............................................................... 629
Cash dividends....................................................................... (750)
-----
Balance at December 31, 2001.........................................................$ 1,667
=====

Undistributed earnings of SI/BAKER (less related deferred tax expenses) at
December 31, 2001 and December 31, 2000 were $961,500, and $1,036,000,
respectively.

Summary financial information and operating results for the SI/BAKER joint
venture are set forth in the following table (in thousands):

December 31, December 31,
2001 2000
------------------ -----------------

Current assets........................................... $ 5,974 8,065
Property, plant and equipment, net....................... 118 75
Other assets............................................. - 8
Current liabilities...................................... 2,750 4,572
Long-term liabilities.................................... 9 -
----- -----
Net assets............................................... $ 3,333 3,576
===== =====

54

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(11) Joint Ventures (Continued)
- ---- --------------

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
----------------- ---------------- ------------------

Net sales.............................. $ 12,139 14,139 10,495
====== ====== ======

Net earnings........................... $ 1,257 1,063 431
====== ====== ======

Operations of the SI-Egemin joint venture were not material to the Company
during the years ended December 31, 2001 and December 31, 2000, and during the
ten months ended December 31, 1999. The Company divested of its investment in
the SI-Egemin joint venture at the end of calendar year 2001.

(12) Major Segments of Business
- ---- --------------------------

Operating segments are defined as components of an enterprise in which
separate financial information is available and evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The Company identified such segments based on both management
responsibility and types of products offered for sale.
On September 30, 1999, the Company completed the acquisition of Ermanco.
Prior to the acquisition, the Company operated in one major market segment. With
the addition of the Ermanco operations, the Company now operates in two major
market segments, and products are sold worldwide as follows (in thousands):

For the year ended Automated Materials Conveyor
December 31, 2001: Handling Systems Systems Total
- ----------------- ------------------- -------- --------

Sales........................................ $ 19,008 31,744 50,752
Earnings (loss) before interest expense,
interest income, equity in income of joint
ventures, and income taxes................. (750) 935 185
Total assets................................. 10,660 30,683 41,343
Capital expenditures......................... 128 564 692
Depreciation and amortization expense........ 363 851 1,214

For the year ended Automated Materials Conveyor
December 31, 2000: Handling Systems Systems Total
- ----------------- ------------------- -------- --------

Sales........................................ $ 29,649 34,657 64,306
Earnings before interest expense, interest
income, equity in income of joint
ventures, and income taxes................. 3,430 3,184 6,614
Total assets................................. 15,429 30,488 45,917
Capital expenditures......................... 151 244 395
Depreciation and amortization expense........ 428 778 1,206

55

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(12) Major Segments of Business (Continued)
- ---- --------------------------

For the ten months ended Automated Materials Conveyor
December 31, 1999 Handling Systems Systems Total
- ----------------- ------------------- -------- --------

Sales................................. $ 33,444 7,664 41,108
Earnings before interest expense,
interest income, equity in income
of joint ventures, and income taxes. (4,620) 629 (3,991)
Total assets.......................... 16,525 28,881 45,406
Capital expenditures.................. 206 92 298
Depreciation and amortization
expense............................. 430 191 621

Geographic segment information was as follows (in thousands):

For the year ended Europe
December 31, 2001 Domestic and Asia Canada Other Total
- ----------------- -------------- ----------- --------- ---------- ----------

Sales.................................. $45,427 3,498 1,751 76 50,752
Earnings before interest expense,
interest income, equity in income
of joint ventures, and income
taxes............................... 185 - - - 185
Total assets........................... 41,343 - - - 41,343
Capital expenditures................... 692 - - - 692
Depreciation and
amortization expense................ 1,214 - - - 1,214

Intersegment sales for the year ended December 31, 2001 totaled $0.

For the year ended Europe
December 31, 2000 Domestic and Asia Canada Other Total
- ----------------- -------------- ----------- --------- ---------- ----------

Sales.................................. $58,537 4,507 1,262 - 64,306
Earnings before interest expense,
interest income, equity in income
of joint ventures, and income
taxes............................... 6,614 - - - 6,614
Total assets........................... 45,917 - - - 45,917
Capital expenditures................... 395 - - - 395
Depreciation and
amortization expense................ 1,206 - - - 1,206

Intersegment sales for the year ended December 31, 2000 totaled $109,000.

For the year ended Europe
December 31, 1999 Domestic and Asia Canada Other Total
- ----------------- -------------- ----------- --------- ---------- ----------

Sales.................................. $39,574 864 670 - 41,108
Earnings before interest expense,
interest income, equity in income
of joint ventures, and income
taxes............................... (3,991) - - - (3,991)
Total assets........................... 45,406 - - - 45,406
Capital expenditures................... 298 - - - 298
Depreciation and
amortization expense................ 621 - - - 621

Intersegment sales for the ten months ended December 31, 1999 totaled
$30,000.

56

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY
Notes To Consolidated Financial Statements (Continued)

(13) Quarterly Financial Information (Unaudited)
- ---- -------------------------------

Selected Quarterly Financial Data
---------------------------------
(In thousands, except per share amounts)

For the Year Ended First Second Third Fourth
December 31, 2001 Quarter Quarter Quarter Quarter
----------------- ------- ------- ------- -------

Net sales ................................ $ 13,930 12,221 12,796 11,805
Gross profit on sales..................... $ 3,593 3,063 3,297 2,472
Net earnings (loss)....................... $ 126 (808) 469 151
Basic earnings (loss) per share........... $ .03 (.19) .11 .04
Diluted earnings (loss) per share......... $ .03 (.19) .11 .04

For the Year Ended First Second Third Fourth
December 31, 2000 Quarter Quarter Quarter Quarter
----------------- ------- ------- ------- -------

Net sales................................. $ 18,344 16,689 13,473 15,800
Gross profit on sales..................... $ 4,432 4,516 4,187 4,923
Net earnings.............................. $ 772 785 848 1,075
Basic earnings per share.................. $ .18 .19 .20 .26
Diluted earnings per share................ $ .17 .19 .20 .26

57

PARAGON TECHNOLOGIES, INC. AND SUBSIDIARY Schedule II
-----------
VALUATION AND QUALIFYING ACCOUNTS
Forthe Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(in thousands)

Additions Due Additions
Balance at to Acquisition Charged to
Beginning of of Ermanco Costs and Balance at
Year Incorporated Expenses Deductions End of Year
--------------- ---------------- ------------- ------------ -------------

Year ended December 31, 2001:
Reserve for inventory loss............ $ 992 - 569 607 (a) 954 (b)
Accrued product warranties............ 857 - 295 (c) 289 (d) 863
Allowance for doubtful accounts....... 54 - 40 20 74
----- ----- ----- ----- -----
$ 1,903 - 904 916 1,891
===== ===== ===== ===== =====

Year ended December 31, 2000:
Reserve for inventory loss............ $ 941 - 213 162 (a) 992 (b)
Accrued product warranties............ 903 - 130 (c) 176 (d) 857
Allowance for doubtful accounts....... 54 - 106 106 54
----- ----- ----- ----- -----
$ 1,898 - 449 444 1,903
===== ===== ===== ===== =====

Ten months ended December 31, 1999:
Reserve for inventory loss............ $ 854 79 508 500 (a) 941 (b)
Accrued product warranties............ 486 51 486 (c) 120 (d) 903
Allowance for doubtful accounts....... - 48 6 - 54
----- ----- ----- ----- -----
$ 1,340 178 1,000 620 1,898
===== ===== ===== ===== =====

(a) Inventory items disposed of, net of salvage proceeds.
(b) Allowance is reflected in the net inventory on the balance sheet.
(c) Costs include materials and incidental costs, but exclude any services.
(d) Payments of warranty costs and reversal of unused expired warranty accrual.

58

PART III

Item 10. Directors and Executive Officers of the Registrant
- -------- --------------------------------------------------

Information concerning the Company's directors is as follows:

Name, Other Positions or Offices With The Company Director
and Principal Occupation for Past Five Years Since Age
- -------------------------------------------------------------------------------- --------- --------

L. Jack Bradt.................................................................. 1958 74
L. Jack Bradt was the founder in 1958 and for 30 years President and CEO of
SI Handling Systems, Inc., renamed Paragon Technologies, Inc. shortly
after the Company acquired Ermanco Incorporated. Mr. Bradt has
continued as a director of the Company since its inception. Mr. Bradt
served in the U.S. Marine Corps and graduated from Cornell University
with a Mechanical/Industrial Engineering Degree in 1953. After retiring
as CEO of SI Handling Systems, Inc., he taught in the MBA programs at
Lehigh and Cornell Universities. Most recently, he was director of
Human Services in Northampton County, Pennsylvania. He is active as a
director in a number of local, state, and national organizations
involved in business, education, human services, and government.

Gilman J. Hallenbeck........................................................... 2001 63
Gilman J. Hallenbeck is Chairman of the Board of Street Lighting Equipment
Corporation, a manufacturer of architectural outdoor lighting and equipment.
He has held this position since 1964. He is also a co-owner of Bolt Electric
Co., a distributor of electrical products selling to electrical contractors,
NUJA Realty Corporation, a commercial real estate holding and management
company, and Asbury Leasing Company, a lessor of capital equipment. Mr.
Hallenbeck has held these interests since 1967. From 1966 to 1997, he was
Chairman of the Board of Area Lighting Research, Inc., a manufacturer and
distributor of photoelectric controls and electrical energy savings devices.
He is a graduate of the United States Military Academy at West Point.

William R. Johnson............................................................. 1999 55
William R. Johnson is the President and Chief Executive Officer of the
Company. Mr. Johnson joined the Company as President in March 1999 and
in July 1999 was promoted to Chief Executive Officer. Before joining
the Company, Mr. Johnson was with Reliance Electric, a Rockwell
International business. He joined Reliance Electric in 1977 as Manager
of A C Engineering and, in 1979, managed Reliance's large motor
engineering efforts. In 1981, he was appointed Plant Manager of the
Kings Mountain, North Carolina facility. In 1986, he became General
Manager of the Engineered Motor Division. From 1993 to 1995, Mr.
Johnson was the former General Manager of Rockwell Automation's
Engineered Motors and Generators Business and from 1995 to 1998, he was
the Senior Vice President of Rockwell Automation's Reliance Electric
Motor Group. Mr. Johnson received his Bachelor's Degree in Electrical
Engineering from Michigan Technological University and his M.B.A. from
the College of St. Thomas. Mr. Johnson is a director of the Lehigh
Valley Partnership and has served on the boards of a number of community
organizations.

59

Name, Other Positions or Offices With The Company Director
and Principal Occupation for Past Five Years Since Age
- -------------------------------------------------------------------------------- --------- --------

Leon C. Kirschner.............................................................. 1999 61
Leon C. Kirschner is the Chief Operating Officer of the Company and
President of Ermanco Incorporated since 1983. From 1968 to 1983, Mr.
Kirschner was the Senior Vice President of W&H Systems. Mr.
Kirschner began his career in 1961 as an engineer at Celanese
Plastics, and from 1963 to 1968 he worked for P.P.G. Industries as
Plant Engineer. Mr. Kirschner received his Bachelor's Degree in
Engineering from Stevens Institute of Technology and his M.B.A. from
New York University. Mr. Kirschner is also a director of Terrace
Food Group, Inc.

Theodore W. Myers.............................................................. 2002 58
Theodore W. Myers retired from Tucker Anthony Sutro, an investment
banking firm, where he was First Vice President and Branch Manager of the
Phillipsburg, New Jersey satellite office, where he served from 1991 to 2000.
After graduating from Fairleigh Dickinson University in 1966 with a B.S. in
Marketing and Finance, he served in the Armed Forces during the Vietnam era
and subsequently returned as a National Bank Examiner for the Controller of
the Currency until he became the internal auditor for Dean Witter Reynolds in
1971. Prior to his employment with Tucker Anthony, he was a Vice President
with Prudential Bache and Vice President/Manager of the Flemington, New
Jersey office of Paine Webber from 1985 to 1991, and from 1977 to 1985, he
was an Assistant Vice President with Thompson McKinnon Securities and Dean
Witter Reynolds.

Anthony W. Schweiger........................................................... 2001 60
Anthony W. Schweiger is the Interim Chairman of the Board and the
President of The Tomorrow Group, LLC, which provides specialized financial
and management services for complex and strategic/turnaround business issues.
Since March of 2001, he has also been the Managing Principal of e-brilliance,
an IT consulting and education business. As a consultant, he has served as
the senior acting manager in a variety of businesses, including Acting COO
for WineAccess, a development stage infomediary from May 1998 to March 1999,
and Acting Chief Executive Officer for Care Systems in 1995. He was Managing
Director of the Stafford Companies, an investment banking firm, from November
1994 until April 1995. From November 1993 through August 1994, he served as
the Executive Vice President of First Advantage Mortgage Corporation, a
mortgage banking company. Prior to that, he served as the President and Chief
Executive Officer of Meridian Mortgage Corporation from 1987 until 1993, and
the Executive Vice President/Chief Operating Officer from that company's
inception in 1983. Mr. Schweiger is a graduate of the Wharton School at the
University of Pennsylvania with a Bachelor's Degree in Economics. Mr.
Schweiger is also a director of Radian Group Inc.

60

Name, Other Positions or Offices With The Company Director
and Principal Occupation for Past Five Years Since Age
- -------------------------------------------------------------------------------- --------- --------

Steven Shulman................................................................. 1999 61
Steven Shulman, an investment banker with over 30 years of experience,
began his career in 1967 with Burnham & Company. From 1970 to 1984,
Mr. Shulman was the Senior Vice President of Corporate Development at
Wheelabrator. Since 1984, Mr. Shulman has been an investment banker
through his wholly-owned company, The Hampton Group, and Latona
Associates, Inc. where he serves as Managing Director. Currently,
Mr. Shulman is a shareholder and director in a diversified group of
companies, including Transportation Technologies, Inc., Terrace Food
Group, Inc., C3i Inc., and Beacon Capital Partners, Inc. In
addition, he serves as Chairman of Terrace Food Group, Inc. Mr.
Shulman is a graduate of Stevens Institute of Technology where he
received a Bachelor's Degree in Mechanical Engineering and a Master's
Degree in Industrial Management. Mr. Shulman serves as Vice Chairman
of the Board of Stevens Institute of Technology. Mr. Shulman was
also a director of Ermanco Incorporated at the time of its
acquisition by the Company on September 30, 1999.

The names, ages, and offices with the Company of its executive officers are
as follows:

Name Age Office
---- --- ------
William R. Johnson 55 President and Chief Executive Officer, Director
Leon C. Kirschner 61 Chief Operating Officer, President - Ermanco, Director
Ronald J. Semanick 40 Vice President - Finance, Chief Financial Officer,
Treasurer and Secretary
Gordon A. Hellberg 48 Vice President - Sales
Lee F. Schomberg 55 Vice President - Marketing

Information regarding Messrs. Johnson and Kirschner is provided above.
Mr. Semanick was appointed Vice President - Finance, Chief Financial
Officer, and Treasurer of the Company on May 10, 2000, and was appointed
Secretary of the Company by the Board of Directors on July 13, 1994. Previously,
Mr. Semanick held the positions of Controller, Manager of Financial Accounting,
Senior Financial Accountant, and Financial Accountant. Prior to joining the
Company in 1985, Mr. Semanick was employed as a Certified Public Accountant by
Arthur Andersen & Company of Philadelphia, Pennsylvania. Mr. Semanick received a
Bachelor's Degree in Accounting from Moravian College and his MBA in Finance
from Wilkes University.
Mr. Hellberg was appointed Vice President - Sales of the Company on June
25, 2001, and had served Ermanco in various management positions since 1987.
After earning a B.S. in Engineering from Western Michigan University, Mr.
Hellberg was employed with Haworth, Inc., L.S.I./Rapistan Division, and psb -
Advanced Material Handling Systems, Inc. Mr. Hellberg has also completed
post-graduate studies in Business Law, Principles of Management, Project
Management, and Statistics.
Mr. Schomberg was appointed Vice President - Marketing of the Company on
June 25, 2001, and had served Ermanco in various sales and marketing positions
since 1986. Mr. Schomberg's previous employers include Seimens/Dematic (formerly
Rapistan), and FKI Logistex (formerly Matthews Conveyor). He received a B.S. in
Engineering from the University of Wisconsin. Mr. Schomberg is currently an
officer in the Conveyor Equipment Manufacturers Association (CEMA) and a
corporate representative to the Material Handling Institute of America (MHIA).
All executive officers hold office at the pleasure of the Board of
Directors.

61

The information concerning compliance with Section 16 of the Securities
Exchange Act of 1934 required by this Item is incorporated by reference to the
portion of the Definitive Proxy Statement entitled "Section 16(a) Beneficial
Ownership Reporting Compliance."

Item 11. Executive Compensation
- -------- ----------------------

Incorporated by reference to the portion of the Definitive Proxy Statement
entitled "Executive Compensation & Other Arrangements."

Item 12. Security Ownership of Certain Beneficial Owners and Management
- -------- --------------------------------------------------------------

Incorporated by reference to the portion of the Definitive Proxy Statement
entitled "Stock Ownership of Directors and Officers."

Item 13. Certain Relationships and Related Transactions
- -------- ----------------------------------------------

Incorporated by reference to the portion of the Definitive Proxy Statement
entitled "Relationships and Related Transactions with Management and Others."

62

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------- ---------------------------------------------------------------

(a) 1. Index to Consolidated Financial Statements.
Independent Auditors' Report
Consolidated Financial Statements
Consolidated Balance Sheets, December 31, 2001 and December 31, 2000
Consolidated Statements of Operations for the years ended December
31, 2001 and December 31, 2000, and for the ten months ended
December 31, 1999
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2001 and December 31, 2000, and for the ten months
ended December 31, 1999
Consolidated Statements of Cash Flows for the years ended December
31, 2001 and December 31, 2000, and for the ten months ended
December 31, 1999
Notes to Consolidated Financial Statements

2. Index to Financial Statement Schedule

II Valuation and Qualifying Accounts and Reserves

All other schedules are omitted as the required information is
inapplicable or the information is presented in the consolidated
financial statements or related notes.

3. Exhibits:
2.1 Stock Purchase Agreement dated as of August 6, 1999 among SI
Handling Systems, Inc., Ermanco Incorporated, and the
stockholders of Ermanco Incorporated (incorporated by
reference to Exhibit 2.1 to Form 10-Q for the quarterly
period ended August 29, 1999).
3.1 Articles of Incorporation of Paragon Technologies, Inc.,
a Delaware corporation (incorporated by reference to
Exhibit 3.1 on Form 8-K, filed on December 11, 2001).
3.2 Bylaws of Paragon Technologies, Inc., a Delaware
corporation (incorporated by reference to Exhibit 3.2 on
Form 8-K, filed on December 11, 2001).
4.1 Form of Subordinated Promissory Note payable to the
Stockholders of Ermanco Incorporated dated September 30,
1999 (incorporated by reference to Exhibit 4.1 to Form 8-K
filed on October 15, 1999).
10.4 1992 Incentive Stock Option Plan, Amended and Restated,
Effective as of July 16, 1997* (incorporated by reference to
Exhibit 10.4 to Form 10-Q for the quarterly period ended
August 31, 1997).
10.5 Executive Officer Incentive Plan* (incorporated by
reference to Exhibit 10.5 to Annual Report on Form 10-K
for the fiscal year ended February 26, 1995).
10.6 Directors' Deferred Compensation Plan* (incorporated
by reference to Exhibit 10.6 to the Company's Registration
Statement on Form S-8 [No. 333-10181]).
10.7 1997 Equity Compensation Plan* (incorporated by reference
to Exhibit 10.7 to the Company's Registration Statement on
Form S-8 [No. 333-36397]).

63

PART IV (Continued)
-------

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------- ---------------------------------------------------------------
(Continued)

10.8 Joint Venture Agreement and Governing Documents Relating
to SI/BAKER, INC. (incorporated by reference to Exhibit
21.1 to Annual Report on Form 10-K for the fiscal year
ended February 26, 1995).
10.9 Second Amendment to the Joint Venture Agreement Relating to
SI/BAKER, INC. (incorporated by reference to Exhibit 10.9 to
Annual Report on Form 10-K for the fiscal year ended
February 28, 1999).
10.10 Executive Employment Agreement with William R. Johnson
dated March 29, 1999* (incorporated by reference to
Exhibit 10.10 to Form 10-Q for the quarterly period ended
May 30, 1999).
10.11 Employment Agreement with Leon C. Kirschner*
(incorporated by reference to Exhibit 10.11 to Form 8-K
filed on October 15, 1999).
10.12 Line of Credit Loan Agreement entered into September 30,
1999 by and between SI Handling Systems, Inc., Ermanco
Incorporated, and First Union National Bank (incorporated by
reference to Exhibit 10.12 to Form 8-K filed on October 15,
1999).
10.13 Promissory Note related to the Line of Credit Loan Agreement
entered into September 30, 1999 by and between SI Handling
Systems, Inc., Ermanco Incorporated, and First Union
National Bank (incorporated by reference to Exhibit 10.13 to
Form 8-K filed on October 15, 1999).
10.14 Term Loan Loan Agreement entered into September 30, 1999 by
and between SI Handling Systems, Inc., Ermanco Incorporated,
and First Union National Bank (incorporated by reference to
Exhibit 10.14 to Form 8-K filed on October 15, 1999).
10.15 Promissory Note related to the Term Loan Loan Agreement
entered into September 30, 1999 by and between SI Handling
Systems, Inc., Ermanco Incorporated, and First Union
National Bank (incorporated by reference to Exhibit 10.15 to
Form 8-K filed on October 15, 1999).
10.16 Escrow Agreement entered into September 30, 1999 by and
among SI Handling Systems, Inc., the stockholders of Ermanco
Incorporated, and First Union National Bank (incorporated by
reference to Exhibit 10.16 to Form 8-K filed on October 15,
1999).
10.17 First Amendment to Term Note and Loan Agreement dated
March 30, 2000 (incorporated by reference to Exhibit 10.17
to Form 10-Q, filed on May 15, 2000).
10.18 Registration Rights Agreement (incorporated by reference to
Exhibit 10.1 to Form S-3, filed on July 5, 2000).
21 Subsidiaries of the Registrant (filed herewith).
23.1 Consent of Independent Auditors (filed herewith).
23.2 Consent of Independent Auditors relating to SI/BAKER, INC.
(filed herewith).
99 Cautionary Statement (filed herewith).

* Management contract or compensatory plan or arrangement required
to be filed as an Exhibit pursuant to Item 14(c) of this report.

64

PART IV (Continued)
-------

(b) Reports on Form 8-K.
During the quarter ended December 31, 2001, the Company filed a Form
8-K on December 11, 2001. The filing pertained to the changing of the
state of incorporation of the Company from Pennsylvania to Delaware. On
December 7, 2001, Paragon Technologies, Inc., a Pennsylvania
corporation ("Paragon") merged with and into (the "Merger") Paragon
Technologies, Inc., a Delaware corporation and a wholly-owned
subsidiary of Paragon. The surviving corporation in the Merger is
Paragon Technologies, Inc., a Delaware corporation (the "Surviving
Corporation"). The sole purpose of the Merger was to change the state
of incorporation of Paragon from the Commonwealth of Pennsylvania to
the State of Delaware. The Articles of Incorporation and the Bylaws of
the Surviving Corporation were included as part of the Form 8-K filing.

(c) Exhibits 21, 23.1, 23.2, and 99 are filed with this report.

(d) Schedule A - SI/BAKER, INC. Financial Statements and Independent
Auditors' Report Thereon.

65

Schedule A
----------

SI/BAKER, INC.

Financial Statements
December 31, 2001 and December 31, 2000

(With Independent Auditors' Report Thereon)

66

Independent Auditors' Report
----------------------------

The Board of Directors
SI/BAKER, INC.:

We have audited the accompanying balance sheets of SI/BAKER, INC. as of December
31, 2001 and 2000, and the related statements of operations, stockholders'
equity, and cash flows for the years ended December 31, 2001 and 2000, and for
the ten months ended December 31, 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit 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 financial statements referred to above present fairly, in
all material respects, the financial position of SI/BAKER, INC. as of December
31, 2001 and 2000, and the results of its operations and its cash flows for the
years ended December 31, 2001 and 2000, and for the ten months ended December
31, 1999, in conformity with accounting principles generally accepted in the
United States of America.

/S/ KPMG LLP

Philadelphia, Pennsylvania
March 8, 2002

67

SI/BAKER, INC.
Balance Sheets
December 31, 2001 and December 31, 2000
(In Thousands, Except Share Data)

December 31, December 31,
2001 2000
------------------- ------------------

Assets
- ------

Current assets:
Cash and cash equivalents.......................... $ 3,302 4,681

Receivables:
Trade............................................ 1,434 1,001
Other receivables................................ 234 65
----- -----
Total receivables.............................. 1,668 1,066
----- -----

Costs and estimated earnings in excess of billings. 498 1,873

Deferred income tax benefits....................... 379 409
Prepaid expenses and other current assets.......... 127 36
----- -----
Total current assets........................... 5,974 8,065
----- -----

Machinery and equipment, at cost...................... 207 222
Less: accumulated depreciation.................... 89 147
----- -----
Net machinery and equipment.................... 118 75
----- -----

Equipment leased to customer.......................... - 487
Less: accumulated depreciation.................... - 487
----- -----
Net equipment leased to customer............... - -
----- -----

Deferred income tax benefits.......................... - 8
----- -----

Total assets................................... $ 6,092 8,148
===== =====

See accompanying notes to financial statements.

68

SI/BAKER, INC.
Balance Sheets
December 31, 2001 and December 31, 2000
(In Thousands, Except Share Data)

December 31, December 31,
2001 2000
------------------- ------------------

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

Current liabilities:
Accounts payable:
Trade............................................... $ 276 663
Affiliated companies................................ - 56
----- -----
Total accounts payable............................ 276 719
----- -----

Customers' deposits and billings in excess of
costs and estimated earnings........................ 814 1,459
Accrued salaries, wages, and commissions.............. 443 358
Income taxes payable.................................. 38 127
Accrued royalties payable............................. 105 766
Accrued product warranties............................ 998 1,055
Accrued other liabilities............................. 76 88
----- -----
Total current liabilities......................... 2,750 4,572
----- -----

Long-term liabilities:
Deferred income taxes payable......................... 9 -
----- -----
Total long-term liabilities....................... 9 -
----- -----

Stockholders' equity:
Common stock, $1 par value; authorized 1,000
shares; issued and outstanding 200 shares........... - -
Additional paid-in capital............................ 200 200
Retained earnings..................................... 3,133 3,376
----- -----
Total stockholders' equity........................ 3,333 3,576
----- -----

Total liabilities and stockholders' equity........ $ 6,092 8,148
===== =====

See accompanying notes to financial statements.

69

SI/BAKER, INC.
Statements Of Operations
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(In thousands)

December 31, December 31, December 31,
2001 2000 1999
---------------- ---------------- ----------------

Net sales............................. $ 12,139 14,139 10,495
Cost of sales......................... 8,663 10,931 8,326
------ ------ ------
Gross profit on sales.............. 3,476 3,208 2,169
------ ------ ------

Selling, general and
administrative expenses............ 1,058 1,035 984
Product development costs............. 180 161 200
Royalty expense to parent companies... 486 566 420
Interest income....................... (166) (177) (85)
Interest expense...................... - - 4
Other income, net..................... (185) (178) (98)
------ ------ ------
1,373 1,407 1,425
------ ------ ------

Earnings before income taxes.......... 2,103 1,801 744
Income tax expense.................... 846 738 313
------ ------ ------
Net earnings..................... $ 1,257 1,063 431
====== ====== ======

SI/BAKER, INC.
Statements Of Stockholders' Equity
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(In thousands)

Additional Total
Common Paid-In Retained Stockholders'
Stock Capital Earnings Equity
----------- ----------- ----------- ----------------

Balance at February 28, 1999.......... $ - 200 1,882 2,082
Net earnings.......................... - - 431 431
--- --- ------ -----
Balance at December 31, 1999.......... - 200 2,313 2,513
Net earnings.......................... - - 1,063 1,063
--- --- ----- -----
Balance at December 31, 2000.......... - 200 3,376 3,576
Net earnings.......................... - - 1,257 1,257
Cash dividends paid................... - - (1,500) (1,500)
--- --- ----- -----
Balance at December 31, 2001.......... $ - 200 3,133 3,333
=== === ===== =====

See accompanying notes to financial statements.

70

SI/BAKER, INC.
Statements Of Cash Flows
For the Years Ended December 31, 2001 and December 31, 2000, and for the Ten
Months Ended December 31, 1999
(In thousands)

December 31, December 31, December 31,
2001 2000 1999
------------------ -------------------- ------------------

Cash flows from operating activities:
Net earnings........................... $ 1,257 1,063 431
Adjustments to reconcile net
earnings to net cash provided
by operating activities:
Depreciation of machinery
and equipment and leased
equipment........................ 34 46 123
Changes in operating assets and
liabilities:
Receivables........................ (602) 421 409
Costs and estimated earnings
in excess of billings............ 1,375 286 357
Deferred income taxes.............. 47 (4) (104)
Prepaid expenses and other
current assets................... (91) 17 83
Other assets....................... - - 95
Accounts payable................... (443) (84) 278
Customers' deposits and
billings in excess of costs
and estimated earnings........... (645) (655) 1,010
Accrued salaries, wages, and
commissions...................... 85 111 156
Income taxes payable............... (89) (16) 143
Accrued royalties payable.......... (661) 405 152
Accrued product warranties......... (57) 213 182
Accrued other liabilities.......... (12) 11 67
Deferred compensation.............. - - (123)
----- ----- -----
Net cash provided by
operating activities........... 198 1,814 3,259
----- ----- -----

Cash flows from investing activities:
Additions to machinery and
equipment............................ (77) (28) (18)
----- ----- -----

Cash flows from financing activities:
Dividends paid on common stock......... (1,500) - -
Repayment of notes payable to
bank................................. - - (500)
----- ----- -----
Net cash used by
financing activities........... (1,500) - (500)
----- ----- -----

Increase (decrease) in cash
and cash equivalents................... (1,379) 1,786 2,741
Cash and cash equivalents,
beginning of year...................... 4,681 2,895 154
----- ----- -----
Cash and cash equivalents,
end of year............................ $ 3,302 4,681 2,895
===== ===== =====

Supplemental disclosure of cash
flow information:
Cash paid during the year for:
Income taxes....................... $ 956 759 2
===== ===== =====
Interest........................... $ - - 3
===== ===== =====

See accompanying notes to financial statements.

71

SI/BAKER, INC.
Notes To Financial Statements

Note 1: Organization, Description of Business, and Summary of
- ------- -----------------------------------------------------
Significant Accounting Policies
-------------------------------

Organization, Description of Business, and Concentration of Credit Risk
- -----------------------------------------------------------------------
On March 1, 1993, Paragon Technologies, Inc. and Automated Prescription
Systems, Inc. formed a joint venture, SI/BAKER, INC. (the "Company" or "joint
venture"). On September 29, 1998, McKesson HBOC, Inc. [NYSE:MCK], a healthcare
supply management company, announced the completion of its acquisition of
Automated Prescription Systems, Inc. Automated Prescription Systems, Inc. was
renamed McKesson Automation Systems Inc. ("McKesson Automation"). The joint
venture draws upon the automated materials handling systems experience of
Paragon Technologies, Inc. and the automated pill counting and dispensing
products of McKesson Automation to provide automated pharmacy systems. Each
member company contributed $100,000 in capital to fund the joint venture.
The Company designs and installs computer controlled, fully automated,
integrated systems for managed care and central fill pharmacy operations. The
Company's systems are viewed as labor saving devices which address the issues of
improved productivity and cost reduction. Systems can be expanded as customers'
operations grow and they may be integrated with a wide variety of components to
meet specific customer needs.
Although the Company is not dependent on any single customer, much of its
revenue is derived from contracts to design and install systems for managed care
and central fill pharmacy operations for North American corporations and the
federal government. In the year ended December 31, 2001, four customers
accounted for revenues of $1,974,000, $1,706,000, $1,544,000, and $1,484,000,
respectively. In the year ended December 31, 2000, three customers accounted for
revenues of $4,024,000, $3,045,000, and $2,175,000, respectively. In the ten
months ended December 31, 1999, two customers accounted for revenues of
$3,608,000 and $2,700,000, respectively. No other customer accounted for over
10% of revenues.
The Company's systems are sold on a fixed-price basis. Contract terms
provide for progress payments and a portion of the purchase price is withheld by
the buyer until the system has met contractual specifications. As of December
31, 2001, two customers owed the Company $651,000 and $254,000, respectively.
The Company believes that the concentration of credit risk in its trade
receivables is substantially mitigated by the Company's ongoing credit
evaluation process as well as the general creditworthiness of its customer base.

Fiscal Year
- -----------
On November 4, 1999, the Board of Directors of the Company approved an
amendment to the Company's Bylaws to change the fiscal year end from the last
day of February to December 31. The years ended December 31, 2001 and December
31, 2000 consisted of twelve months. For the year ended December 31, 1999, the
fiscal year consisted of ten months.

Use of Estimates
- ----------------
The preparation of the financial statements, in conformity with 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 warranty reserve and revenue
recognition.

72

SI/BAKER, INC.
Notes To Financial Statements

Financial Instruments
- ---------------------
The Company believes that the market values of its short-term assets and
liabilities, which are financial instruments materially, approximate their
carrying values due to the short-term nature of the instruments.

Cash and Cash Equivalents
- -------------------------
For the purpose of reporting cash flows, cash and cash equivalents include
cash on deposit, amounts invested on an overnight basis with a bank, and other
highly liquid debt instruments purchased with a maturity of three months or
less. The Company does not believe it is exposed to any significant credit risk
on cash and cash equivalents.

Machinery and Equipment
- -----------------------
Machinery and equipment are depreciated on the straight-line method over
the estimated useful lives of individual assets. The range of lives used in
determining depreciation rates for machinery and equipment is 3-7 years.
Maintenance and repairs are charged to operations; betterments and renewals are
capitalized. Upon sale or retirement of equipment, the cost and related
accumulated depreciation are removed from the accounts and the resultant gain or
loss, if any, is credited or charged to earnings.

Revenue Recognition
- -------------------
Revenues on sales 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. Installation
is an integral part of most systems sold by the Company and is not sold or
billed separately. As these contracts may extend over one or more years,
generally no more than two 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.
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 sales contracts, including both typical and more complex systems.

Warranty
- --------
The Company's products are warranted against defects in materials and
workmanship for a specified period. The Company provides an accrual for
estimated future warranty costs based upon a percentage of net sales and
warranty experience.

Product Development Costs
- -------------------------
The Company expenses product development costs as incurred.

Royalty Arrangement
- -------------------
During the fiscal year ended February 28, 1995, an amendment to the joint
venture investment agreement was adopted to compensate each member company at a
rate of 2% of gross sales for marketing and sales efforts on behalf of SI/BAKER,
INC. The expense is included as royalty expense to parent companies in the
Company's Statements of Operations.

73

SI/BAKER, INC.
Notes To Financial Statements

Royalty Arrangement (Continued)
- -------------------
The Company receives a royalty from McKesson Automation based on the
monthly lease rates for all cells, counters, cassettes, and any other McKesson
Automation equipment leased to customers in the Company's defined market segment
since the inception of SI/BAKER on March 1, 1993. The royalty received by the
Company is included in other income.

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.

New Accounting Pronouncements
- -----------------------------
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Statement also supersedes APB No. 30 provisions
related to the accounting and reporting for the disposal of a segment of a
business. This Statement establishes a single accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sale. The Statement retains most of the requirements in SFAS No. 121 related
to the recognition of impairment of long-lived assets to be held and used. The
Statement is effective for years beginning after December 15, 2001. The Company
is evaluating the potential impact of adopting SFAS No. 144.

Note 2: Uncompleted Contracts
- ------- ---------------------

Costs and estimated earnings on uncompleted contracts are as follows at
December 31, 2001 and December 31, 2000 (in thousands):

December 31, December 31,
2001 2000
------------------ ------------------

Costs incurred on uncompleted contracts................... $ 9,203 24,770
Estimated earnings........................................ 3,854 7,041
------ ------
13,057 31,811
Less: billings to date................................... 13,373 31,397
------ ------
$ (316) 414
====== ======

Included in accompanying balance sheets
under the following captions:
Costs and estimated earnings in excess
of billings.......................................... $ 498 1,873
Customers' deposits and billings in excess
of costs and estimated billings...................... (814) (1,459)
------ ------
$ (316) 414
====== ======

74

SI/BAKER, INC.
Notes To Financial Statements

Note 3: Short-Term Bank Borrowings and Compensating Balances
- ------- ----------------------------------------------------

On March 4, 1996, the Company established a Line of Credit Facility (the
"Facility") with its principal bank (the "Bank"). Under terms of the $3,000,000
Facility, the Company's parent companies have each provided a limited guarantee
and surety in the amount not to exceed $1,000,000 for a combined guarantee of
$2,000,000 to the Bank for the payment and performance of the related note,
including any further renewals or modifications of the Facility. The Facility
contains various covenants and requires the maintenance of a net worth ratio.
The Company was in compliance with all covenants during the year ended December
31, 2001. The Facility has an expiration date of August 31, 2002.
As of December 31, 2001, there was no debt outstanding under the Facility.
Interest on the Facility is at the Bank's prime rate of interest minus one
percent (3.75% as of December 31, 2001) or the LIBOR-based rate plus one and
three-quarters percent.

Note 4: Employee Benefit Plan
- ------- ---------------------

The Company has a multi-faceted defined contribution Retirement Savings
Plan. Employees age 21 and above with at least one year of service are eligible
to participate in the Plan. Under the 401(k) feature of the Plan, the Company
contributes 2% of base pay to each eligible salaried employee's account and, in
addition, matches 50% of the first 4% of pay which the employee contributes to
the Plan. The Plan also contains provisions for profit sharing contributions
determined annually by the Board of Directors. Total expense for the Retirement
Savings Plan was $55,000, $48,000, and $67,000, for the years ended December 31,
2001 and December 31, 2000, and for the ten months ended December 31, 1999,
respectively.

Note 5: Income Taxes
- ------- ------------

The provision for income tax expense (benefit) consists of the following
(in thousands):

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
------------------ ------------------ ------------------

Federal - current.................. $ 637 594 322
- deferred................. 37 (3) (83)
--- --- ---
674 591 239
--- --- ---

State - current.................. 163 148 95
- deferred................. 9 (1) (21)
--- --- ---
172 147 74
--- --- ---
$ 846 738 313
=== === ===

A reconciliation between the U. S. federal statutory rate and the Company's
effective income tax rate is (in thousands):

75

SI/BAKER, INC.
Notes To Financial Statements

Note 5: Income Taxes (Continued)
- ------- ------------

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
2001 2000 1999
------------------ ----------------- ------------------

Computed tax expense at statutory
rate of 34%...................... $ 715 612 253
Increase in taxes resulting from:
State income taxes,
net of federal benefit......... 114 97 49
Miscellaneous items.............. 17 29 11
--- --- ---
$ 846 738 313
=== === ===

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 2001 and
December 31, 2000 are presented below (in thousands):

December 31, December 31,
2001 2000
------------------ -------------------

Deferred tax assets:
Accruals of book costs, not yet
deductible for tax purposes...................... $ 395 420
Machinery and equipment, principally
due to differences in depreciation............... - 9
--- ---
Total gross deferred tax assets................ 395 429
--- ---

Deferred tax liabilities:
Other.............................................. (16) (12)
Machinery and equipment, principally
due to differences in depreciation............... (9) -
--- ---
Total gross deferred tax liabilities........... (25) (12)
--- ---
Net deferred tax assets........................ $ 370 417
=== ===

In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment. Based upon historical
taxable income and projections for future taxable income over the periods in
which the deferred tax assets are deductible, management believes it is more
likely than not that the Company will realize the benefits of these deductible
differences at December 31, 2001.

Note 6: Royalties
- ------- ---------

In April 1996, a competitor filed suit against the Company and its parents,
alleging that certain of the products of the Company infringed a patent held by
the competitor.
On December 20, 1996, a Settlement Agreement was reached between the
Company, its parents, and the competitor. The competitor dismissed the action
and granted a license to the Company for certain of its products. In exchange
for the license, the Company agreed to dismiss its counterclaims and pay the
competitor a per system royalty. On December 31, 1996, the Company satisfied a
$600,000 liability under the Settlement Agreement relative to systems installed
to date.

76

SI/BAKER, INC.
Notes To Financial Statements

Note 6: Royalties (Continued)
- ------- ---------

The term of the Settlement Agreement continues until the expiration of the
competitor's patent; however, the Company's status as sole licensee remained in
effect until December 31, 2000, and all orders related to licensed products
received by the Company after December 31, 2000 are not subject to royalty
payments.

Note 7: Commitments

Total rental expense, including short-term leases, for the years ended
December 31, 2001 and December 31, 2000, and for the ten months ended December
31, 1999, approximated $107,000, $88,000, and $74,000, respectively.
Future minimum rental commitments at December 31, 2001 under operating
leases for office space is as follows:
2002........................... $ 72,000
2003........................... 42,000
2004........................... 32,000

77

SI/BAKER, INC.
Notes To Financial Statements (Continued)

Note 8: Related Party Transactions
- ------- --------------------------

The Company has entered into various transactions with affiliated entities
as follows (in thousands):

(a) McKesson Automation
Systems Inc.(50% Stockholder):

December 31, December 31,
Balance Sheets Data 2001 2000
------------------- -------------------

Amount included in trade receivables........... $ 75 6
Amount included in other receivables.......... 49 45
Amount included in costs and estimated
earnings in excess of billings.............. 12 179
Amount included in accounts payable........... - 22
Amount included in accrued royalties payable.. 52 68
Amount included in accrued other liabilities.. - 27

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
Statements of Operations Data 2001 2000 1999
------------------ ------------------ -------------------

Sales of systems and services..... $ 1,204 (55) 216
Systems and services purchased
for resale under various
subcontracts................... 84 265 115
Royalty expense to parent
companies...................... 243 283 210
Other income - royalty income.... 188 172 95

(b) Paragon Technologies, Inc.
(50% Stockholder):

December 31, December 31,
Balance Sheets Data 2001 2000
------------------- -------------------

Amount included in accounts payable............ $ - 34
Amount included in accrued royalties
payable..................................... 52 68

For the Year For the Year For the Ten
Ended Ended Months Ended
December 31, December 31, December 31,
Statements of Operations Data 2001 2000 1999
------------------ ------------------- -----------------

Systems and services purchased for
resale under various subcontracts $ 876 593 237
Systems and services sold under
various subcontracts........... - 1 60
Purchase of administrative and
other services................. 55 106 116
Royalty expense to parent companies 243 283 210

78

SIGNATURES

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

PARAGON TECHNOLOGIES, INC.

Dated: April 1, 2002 By /s/ Anthony W. Schweiger
------------------------------------------
Anthony W. Schweiger
Interim Chairman of the Board of Directors

Dated: April 1, 2002 By /s/ William R. Johnson
------------------------------------------
William R. Johnson
President and Chief Executive Officer

79

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. This Annual Report
may be signed in multiple identical counterparts, all of which taken together,
shall constitute a single document.

Dated: April 1, 2002 /s/ Anthony W. Schweiger
--------------------------------------------
Anthony W. Schweiger
Interim Chairman of the Board of Directors

Dated:
--------------------------------------------
William R. Johnson
President & Chief Executive Officer, Director

Dated: April 1, 2002 /s/ Ronald J. Semanick
--------------------------------------------
Ronald J. Semanick
Vice President-Finance, Chief Financial
Officer and Treasurer, and Secretary
(Principal Accounting and Financial Officer)

Dated: April 1, 2002 /s/ Leon C. Kirschner
--------------------------------------------
Leon C. Kirschner
Chief Operating Officer, and
President of Ermanco Incorporated, Director

Dated: April 1, 2002 /s/ L. Jack Bradt
--------------------------------------------
L. Jack Bradt
Director

Dated: April 1, 2002 /s/ Gilman J. Hallenbeck
--------------------------------------------
Gilman J. Hallenbeck
Director

Dated: April 1, 2002 /s/ Theodore W. Myers
--------------------------------------------
Theodore W. Myers
Director

Dated: April 1, 2002 /s/ Steven Shulman
--------------------------------------------
Director

80

EXHIBIT INDEX

2.1 Stock Purchase Agreement dated as of August 6, 1999 among SI Handling
Systems, Inc., Ermanco Incorporated, and the stockholders of Ermanco
Incorporated (incorporated by reference to Exhibit 2.1 to Form 10-Q for
the quarterly period ended August 29, 1999).
3.1 Articles of Incorporation of Paragon Technologies, Inc., a Delaware
corporation (incorporated by reference to Exhibit 3.1 on
Form 8-K, filed on December 11, 2001).
3.2 Bylaws of Paragon Technologies, Inc., a Delaware corporation
(incorporated by reference to Exhibit 3.2 on Form 8-K, filed on
December 11, 2001).
4.1 Form of Subordinated Promissory Note payable to the Stockholders
of Ermanco Incorporated dated September 30, 1999
(incorporated by reference to Exhibit 4.1 to Form 8-K filed on
October 15, 1999).
10.4 1992 Incentive Stock Option Plan, Amended and Restated, Effective
as of July 16, 1997* (incorporated by reference to Exhibit
10.4 to Form 10-Q for the quarterly period ended August 31, 1997).
10.5 Executive Officer Incentive Plan* (incorporated by reference to
Exhibit 10.5 to Annual Report on Form 10-K for the fiscal
year ended February 26, 1995).
10.6 Directors' Deferred Compensation Plan* (incorporated by reference to
Exhibit 10.6 to the Company's Registration Statement on
Form S-8 [No. 333-10181]).
10.7 1997 Equity Compensation Plan* (incorporated by reference to
Exhibit 10.7 to the Company's Registration Statement on Form
S-8 [No. 333-36397]).
10.8 Joint Venture Agreement and Governing Documents Relating to
SI/BAKER, INC. (incorporated by reference to Exhibit 21.1 to
Annual Report on Form 10-K for the fiscal year ended February
26, 1995).
10.9 Second Amendment to the Joint Venture Agreement Relating to
SI/BAKER, INC. (incorporated by reference to Exhibit 10.9 to
Annual Report on Form 10-K for the fiscal year ended February 28,
1999).
10.10 Executive Employment Agreement with William R. Johnson dated
March 29, 1999* (incorporated by reference to Exhibit 10.10 to
Form 10-Q for the quarterly period ended May 30, 1999).
10.11 Employment Agreement with Leon C. Kirschner* (incorporated by
reference to Exhibit 10.11 to Form 8-K filed on October 15,
1999).
10.12 Line of Credit Loan Agreement entered into September 30, 1999 by and
between SI Handling Systems, Inc., Ermanco Incorporated, and First
Union National Bank (incorporated by reference to Exhibit 10.12 to Form
8-K filed on October 15, 1999).
10.13 Promissory Note related to the Line of Credit Loan Agreement entered
into September 30, 1999 by and between SI Handling Systems, Inc.,
Ermanco Incorporated, and First Union National Bank (incorporated by
reference to Exhibit 10.13 to Form 8-K filed on October 15, 1999).
10.14 Term Loan Loan Agreement entered into September 30, 1999 by and between
SI Handling Systems, Inc., Ermanco Incorporated, and First Union
National Bank (incorporated by reference to Exhibit 10.14 to Form 8-K
filed on October 15, 1999).
10.15 Promissory Note related to the Term Loan Loan Agreement entered into
September 30, 1999 by and between SI Handling Systems, Inc., Ermanco
Incorporated, and First Union National Bank (incorporated by reference
to Exhibit 10.15 to Form 8-K filed on October 15, 1999).
10.16 Escrow Agreement entered into September 30, 1999 by and among SI
Handling Systems, Inc., the stockholders of Ermanco Incorporated, and
First Union National Bank (incorporated by reference to Exhibit 10.16
to Form 8-K filed on October 15, 1999).
10.17 First Amendment to Term Note and Loan Agreement dated March 30,
2000 (incorporated by reference to Exhibit 10.17 to Form
10-Q, filed on May 15, 2000).
10.18 Registration Rights Agreement (incorporated by reference to Exhibit
10.1 to Form S-3, filed on July 5, 2000).

EXHIBIT INDEX (Continued)
-------------

21 Subsidiaries of the Registrant (filed herewith).
23.1 Consent of Independent Auditors (filed herewith).
23.2 Consent of Independent Auditors relating to SI/BAKER, INC.
(filed herewith).
99 Cautionary Statement (filed herewith).

*Management contract or compensatory plan or arrangement required to be
filed as an Exhibit pursuant to Item 14(c) of this report.