PARAGON TRADE BRANDS INC, 10-Q, 1998-11-12

PARAGON TRADE BRANDS INC
10-Q, 1998-11-12
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<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the thirteen week period ended September 27, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ______________________ to _____________________

Commission File No. 1-11368

PARAGON TRADE BRANDS, INC.
(Exact name of registrant as specified in its charter)

Delaware 91-1554663
- --------------------------------- -----------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

180 Technology Parkway
Norcross, Georgia 30092
----------------------------------------
(Address of principal executive offices)

(678) 969-5000
(Registrant's telephone number, including area code)

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
--- ---

The number of shares outstanding of the registrant's common stock was
11,941,134 shares ($.01 par value) as of September 27, 1998.

Page 1 of 34
Exhibit Index on Page 32

-1-
<PAGE> 2

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q FILING
FOR THE THIRTEEN WEEK PERIOD ENDED SEPTEMBER 27, 1998

Page No.
----------------
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements 3-14
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Financial Statements 6

Item 2. Management's Discussion and Analysis of Financial Condition and Results of 15
Operations

PART II. OTHER INFORMATION

Item 1. Legal Proceedings 25
Item 2. Changes in Securities (not applicable)
Item 3 Defaults in Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders (not applicable)
Item 5. Other Information (not applicable)
Item 6. Exhibits and Reports on Form 8-K 28

Signature Page 31

Exhibit Index 32

Exhibits 35
</TABLE>

-2-
<PAGE> 3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
(NOTE 2)

Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------

Sept. 27, 1998 Sept. 28, 1997 Sept. 27, 1998 Sept. 28, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>

Sales, net of discounts and allowances ..... $136,993 $154,066 $402,281 $425,570
Cost of sales .............................. 109,081 125,465 322,224 345,202
-------- -------- -------- --------
Gross profit ............................... 27,912 28,601 80,057 80,368
Selling, general and administrative expense. 22,003 20,175 60,955 58,557
Research and development expense ........... 913 1,336 3,444 3,242
-------- -------- -------- --------
Operating profit ........................... 4,996 7,090 15,658 18,569
Equity in earnings of unconsolidated
subsidiaries ...................... 590 800 2,108 859
Dividend income from unconsolidated
subsidiary ........................ -- 1,055 -- 1,055
Interest expense(1) ........................ 51 1,354 341 3,445
Other income ............................... 687 564 1,730 1,490
-------- -------- -------- --------
Earnings before income taxes and bankruptcy
costs ............................. 6,222 8,155 19,155 18,528
Bankruptcy costs ........................... 1,724 -- 4,530 --
Provision for income taxes ................. 474 2,394 1,226 6,313
-------- -------- -------- --------
Net earnings ............................... $ 4,024 $ 5,761 $ 13,399 $ 12,215
======== ======== ======== ========

Basic earnings per common share ............ $ .34 $ .48 $ 1.12 $ 1.03
======== ======== ======== ========
Diluted earnings per common share .......... $ .34 $ .48 $ 1.12 $ 1.02
======== ======== ======== ========
Dividends paid ............................. $ -- $ -- $ -- $ --
======== ======== ======== ========

(1)Contractual Interest .................... $ 1,449 $ 4,348
======== ========
</TABLE>

See Accompanying Notes to Financial Statements

-3-
<PAGE> 4

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(NOTE 2)

September 27, 1998 December 28, 1997
------------------ -----------------
<S> <C> <C>
ASSETS
Cash and short-term investments....................... $ 35,676 $ 991
Receivables........................................... 74,054 70,616
Inventories........................................... 47,507 48,257
Current portion of deferred income taxes.............. 2,384 1,800
Prepaid expenses...................................... 3,177 697
------------ ------------
Total current assets......................... 162,798 122,361
Property and equipment................................ 103,406 118,383
Construction in progress.............................. 19,510 11,154
Assets held for sale.................................. 11,570 11,073
Investment in unconsolidated subsidiary, at cost...... 22,743 19,964
Investment in and advances to unconsolidated
subsidiaries, at equity...................... 61,582 53,844
Goodwill 33,299 34,739
Other assets.......................................... 13,021 4,624
------------ ------------
Total assets .............................. $ 427,929 $ 376,142
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities not subject to compromise:
Short-term borrowings........................ $ 176 $ 14,185
Checks issued but not cleared................ 8,411 9,375
Accounts payable............................. 34,114 40,305
Accrued liabilities.......................... 36,481 32,392
Accrued loss contingency..................... - 200,000
------------ ------------
Total current liabilities.................... 79,182 296,257
Liabilities subject to compromise (Note 8)............ 327,373 -
Long-term debt........................................ - 70,000
Deferred income taxes................................. 4,156 3,656
Deferred compensation................................. - 1,275
------------ ------------
Total liabilities............................ 410,711 371,188
------------ ------------

Commitments and contingencies (Notes 1 and 10)

Shareholders' equity:
Preferred stock: Authorized 10,000,000 shares,
no shares issued, $.01 par value............. - -
Common stock: Authorized 25,000,000 shares, issued
12,370,711 and 12,343,324
shares, $.01 par value....................... 124 123
Capital surplus....................................... 143,893 144,368
Foreign currency translation adjustment............... (1,540) (1,066)
Retained deficit...................................... (114,977) (128,376)
Less: Treasury stock, 429,577 and 388,658 shares, at
cost......................................... (10,282) (10,095)
------------ ------------
Total shareholders' equity................... 17,218 4,954
------------ ------------
Total liabilities and shareholders' equity... $ 427,929 $ 376,142
============ ============
</TABLE>

See Accompanying Notes to Financial Statements.

-4-
<PAGE> 5

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
(NOTE 2)

Thirty-Nine Weeks Ended
-----------------------
September 27, 1998 September 28, 1997
------------------ ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.......................................... $ 13,399 $ 12,215
Non-cash charges (benefits) to earnings:
Depreciation and amortization................ 25,703 26,381
Deferred income taxes........................ (84) 9,130
Equity in (earnings) loss of subsidiaries.... (1,149) 308
Changes in operating assets and liabilities:
Accounts receivable.......................... (6,829) (8,764)
Inventories and prepaid expenses............. (1,730) (67)
Accounts payable............................. 34,316 11,169
Checks issued but not cleared................ (964) (91)
Accrued liabilities.......................... 7,606 (9,056)
Other ............................................... (3,466) (1,482)
------------ ------------
Net cash provided by operating activities.... 66,802 39,743
------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property and equipment............... (18,640) (40,472)
Proceeds from sale of property and equipment.......... 3,433 891
Investment in Grupo P.I. Mabe, S. A. de C.V........... (2,779) (3,433)
Investment in and advances to unconsolidated
subsidiaries, at equity...................... (4,474) (14,587)
Other ............................................... (7,045) (6,668)
------------ ------------
Net cash used by investing activities........ (29,505) (64,269)
------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in short-term borrowings...... (745) 32,400
Pre-petition debt payment authorized by court......... (1,867) -
Proceeds from U.S. bank credit facility............... - 15,000
Repayments of U.S. bank credit facility............... - (25,000)
Sale of common stock.................................. - 211
------------ ------------
Net cash provided (used) by financing
activities.............................. (2,612) 22,611
------------ ------------

NET INCREASE (DECREASE) IN CASH....................... 34,685 (1,915)
Cash at beginning of period........................... 991 8,297
------------ ------------
Cash at end of period................................. $ 35,676 $ 6,382
============ ============

Cash paid (refunded) during the period for:
Interest, net of amounts capitalized......... $ 1,450 $ 3,066
============ ============
Income taxes................................. $ (2,592) $ (117)
============ ============
Bankruptcy costs............................. $ 1,965 $ -
============ ============
</TABLE>

See Accompanying Notes to Financial Statements.

-5-
<PAGE> 6

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE THIRTEEN WEEK AND THIRTY-NINE WEEK PERIODS
ENDED SEPTEMBER 27, 1998

(DOLLAR AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

NOTE 1: CHAPTER 11 PROCEEDINGS

On January 6, 1998 Paragon Trade Brands, Inc. ("Paragon" or the "Company")
filed for relief under Chapter 11 of the United States Bankruptcy Code (the
"Chapter 11 filing"), in the United States Bankruptcy Court for the Northern
District of Georgia. The Company is currently operating as a debtor in
possession under the Bankruptcy Code. See "Notes 10 and 11 of the Notes to
Financial Statements" and "PART II: OTHER INFORMATION, ITEM 1: LEGAL
PROCEEDINGS."

The Company has previously disclosed that The Procter & Gamble Company ("P&G")
had filed a claim against the Company in the United States District Court for
the District of Delaware, alleging that the Company's "Ultra" disposable baby
diaper products infringe two of P&G's inner-leg gather patents. The lawsuit
sought injunctive relief, lost profit and royalty damages, treble damages and
attorneys' fees and costs. The Company denied liability under the patents and
counterclaimed for patent infringement and violation of antitrust laws by P&G.
The Company has also previously disclosed that if P&G were to prevail on its
claims, award of all or a substantial amount of the relief requested could have
a material adverse effect on the Company's financial condition and results of
operations.

On December 30, 1997, the District Court issued a Judgment and Opinion finding
two of P&G's diaper patents to be valid and infringed by the Company's
disposable diaper products, while also rejecting the Company's patent
infringement claim against P&G. The District Court had earlier dismissed the
Company's antitrust counterclaim on summary judgment. The Judgment entitles P&G
to damages based on sales of the Company's diapers containing the inner-leg
gather feature. Damages of approximately $178.4 million were entered against
Paragon by the District Court on May 28, 1998. At the same time, the District
Court entered injunctive relief agreed upon by P&G and the Company.

The amount of the Delaware Judgment resulted in violation of certain covenants
under the Company's bank loan agreements. As a result, the issuance of the
Judgment and the uncertainty it created caused an immediate and critical
liquidity issue for the Company. The Chapter 11 filing was designed to (i)
prevent P&G from placing liens on Company property; (ii) permit the Company to
appeal the Delaware District Court's decision in the P&G case in an orderly
fashion; and (iii) give the Company the opportunity to resolve liquidated and
unliquidated claims against the Company which arose prior to the Chapter 11
filing.

Substantially all liabilities outstanding as of the date of the Chapter 11
filing are subject to resolution under a plan of reorganization to be voted
upon by the Company's creditors and shareholders and confirmed by the
Bankruptcy Court. Schedules were filed by the Company on March 3, 1998 with the
Bankruptcy Court setting forth the unaudited, and in some cases estimated,
assets and liabilities of the Company as of the date of the Chapter 11 filing,
as shown by the Company's accounting records. The bar date for the filing of
proofs of claim by creditors was June 5, 1998. P&G filed alleged claims ranging
from approximately $2.3 billion (without trebling) to $6.4 billion (with
trebling), which included a claim of $178.4 million for the Delaware judgment.
The remaining claims include claims for alleged patent infringement by the
Company in foreign countries where it has operations. The Company has reviewed
such additional claims and believes them to be without merit.

Kimberly-Clark Corporation ("K-C") filed alleged claims ranging from
approximately $893 million (without trebling) to $2.3 billion (with trebling),
including claims related to the litigation in the Dallas District Court
described herein. See "Note 10 of the Notes to Financial Statements" and "PART
II: OTHER INFORMATION, ITEM I: LEGAL PROCEEDINGS." K-C's claims in the
Bankruptcy case include an attempt to recover alleged lost profits for
infringement of the patents asserted in the Dallas District Court, despite the
fact that a lost profits theory of damages was not pursued by K-C in the Dallas
District Court. The Company continues to believe that it does not infringe any
valid claim of the asserted K-C patents. The Company further believes that K-C's
attempt to inflate its bankruptcy claims well beyond its claims in the Dallas
District Court is inconsistent with applicable law and procedure. See "Note 10
of the Notes to Financial Statements."

-6-
<PAGE> 7

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

On October 19, 1998, the Company, P&G, K-C and the Creditors' Committee
stipulated to an extension of the Company's exclusivity period to November 18,
1998 and for an additional thirty (30) days to December 18, 1998 unless any of
the parties files an objection to such additional extension by November 12,
1998.

On November 2, 1998, the U.S. Trustee appointed a Committee of Equity Security
Holders in the Company's Chapter 11 case.

The Company continues to pursue settlement of the K-C and P&G claims as an
alternative to litigation. As of early November, the Company believes
considerable progress has been made. If settlement is reached, the terms of
each such settlement will be subject to Bankruptcy Court approval.

The Chapter 11 filing did not include the Company's wholly owned subsidiaries
including Paragon Trade Brands (Canada) Inc., Paragon Trade Brands
International, Inc., Paragon Trade Brands FSC, Inc. and Changing Paradigms,
Inc. The following information summarizes the combined results of operations
for the thirteen and thirty-nine weeks ended September 27, 1998 and September
28, 1997, as well as the combined balance sheets as of September 27, 1998 and
December 28, 1997 for these subsidiaries. This information has been prepared on
the same basis as the consolidated financial statements.

Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------

Sept. 27, 1998 Sept. 28, 1997 Sept. 27, 1998 Sept. 28, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Sales, net of discounts and allowances....... $ 15,754 $ 13,154 $ 43,657 $ 39,979
Gross profit................................. 3,168 1,927 7,641 6,451
Earnings before income taxes................. 2,503 1,081 5,817 2,668
Net earnings................................. 1,837` 1,194 4,407 2,301
</TABLE>

September 27, 1998 December 28, 1997
------------------ -----------------
<S> <C> <C>
Current assets........................................ $ 17,983 $ 14,782
Non-current assets.................................... $ 52,607 $ 48,840
Current liabilities................................... $ 6,970 $ 8,424
Non-current liabilities............................... $ 9,960 $ 8,873
</TABLE>

NOTE 2: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING AND
REPORTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of Paragon Trade
Brands, Inc. and its wholly-owned subsidiaries. All significant intercompany
transactions and accounts are eliminated.

The accompanying consolidated balance sheet as of December 28, 1997, which has
been derived from audited financial statements, and the unaudited interim
consolidated financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
note disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to those rules and regulations, although the Company believes
that the disclosures made are adequate to make the information presented not
misleading. It is suggested that these consolidated financial statements be
read in conjunction with the financial statements and the notes thereto
included in the Company's latest annual report on Form 10-K.

In the opinion of management, all adjustments necessary for a fair statement of
the results of the interim periods have been included. All such interim
adjustments are of a normal recurring nature except for the bankruptcy-related
costs. The results of operations for the thirteen and thirty-nine week periods
ended September 27, 1998 should not be regarded as necessarily indicative of
the results that may be expected for the full year.

The financial statements have been prepared on the going concern basis of
accounting, which contemplates continuity of operations and realization of
assets and liquidation of liabilities in the ordinary course of business.

-7-
<PAGE> 8

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

Reclassifications

Certain reclassifications have been made to the prior years' financial
statements to conform them to the current year's presentation.

New Accounting Standards

Effective December 29, 1997, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which requires the display of comprehensive income and
its components in the financial statements. See "Note 5 of the Notes to
Financial Statements."

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," effective for
fiscal years beginning after June 15, 1999. The Statement establishes
accounting and reporting standards requiring that every derivative instrument
be recorded in the balance sheet as either an asset or liability measured at
its fair value. The Statement requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. The Company has not determined the timing of or method of
adoption of Statement 133. As the Company currently does not utilize
derivatives, adoption of Statement 133 is not expected to have any impact on
the financial statements.

NOTE 3: BANKRUPTCY COSTS

Bankruptcy costs were directly associated with the Company's Chapter 11
reorganization proceedings and consisted of the following:

Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------
Sept. 27, 1998 Sept. 27, 1998
-------------- --------------
<S> <C> <C>
Professional fees..................................... $ 2,006 $ 4,819
Amortization of DIP credit facility deferred financing
costs........................................ 211 611
Other................................................. 12 122
Interest Income....................................... (505) (1,022)
------------- -------------
$ 1,724 $ 4,530
============= =============
</TABLE>

NOTE 4: INCOME TAXES

Income tax expense for the subsidiaries not included in the Chapter 11 filing
and filing separate tax returns was $474 and $1,226 during the thirteen and
thirty-nine week periods ended September 27, 1998, respectively. The Company
recorded income tax expense of approximately $1,200 and $4,000 during the
thirteen and thirty-nine week periods ended September 27, 1998, respectively,
which was offset by a reduction in its deferred tax asset valuation allowance.

NOTE 5: COMPREHENSIVE INCOME

The following are the components of comprehensive income:

Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------

Sept. 27, 1998 Sept. 28, 1997 Sept. 27, 1998 Sept. 28, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income..................................... $ 4,024 $ 5,761 $ 13,399 $ 12,215
Foreign currency translation adjustment........ (212) (32) (474) (181)
------------- ------------ ------------- -------------
Comprehensive income........................... $ 3,812 $ 5,729 $ 12,925 $ 12,034
============= ============ ============= =============
</TABLE>

-8-
<PAGE> 9

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 6: INVENTORIES

Inventories consist of the following:

September 27, 1998 December 28, 1997
------------------ -----------------
<S> <C> <C>
LIFO:
Raw materials - pulp......................... $ 253 $ 381
Finished goods............................... 24,176 25,770

FIFO:
Raw materials - other........................ 8,899 8,561
Materials and supplies....................... 21,163 20,942
----------- ------------
54,491 55,654

Reserve for excess and
obsolete items........................... (6,984) (7,397)
------------ ------------

Net inventories....................................... $ 47,507 $ 48,257
=========== ============
</TABLE>

NOTE 7: ACCRUED LIABILITIES

Accrued liabilities are as follows:

September 27, 1998 December 28, 1997
------------------ -----------------
<S> <C> <C>
Payroll - wages and salaries, incentive awards,
retirement, vacation and severance pay...... $ 16,316 $ 10,375
Coupons outstanding................................... 3,862 3,824
Other................................................. 16,303 18,193
------------- ---------------
Total................................................. $ 36,481 $ 32,392
============= ===============
</TABLE>

NOTE 8: LIABILITIES SUBJECT TO COMPROMISE

Liabilities subject to compromise under the Company's reorganization
proceedings include substantially all current and long-term unsecured debt as
of the date of the Chapter 11 filing. Pursuant to the Bankruptcy Code, payment
of these liabilities may not be made except pursuant to a plan of
reorganization or Bankruptcy Court order while the Company continues to operate
as a debtor in possession. The Company has received approval from the
Bankruptcy Court to pay or otherwise honor certain of its pre-petition
obligations including a portion of short-term borrowings and employee wages,
benefits and expenses.

Liabilities subject to compromise are comprised of the following:

September 27, 1998 December 28, 1997
------------------ -----------------
<S> <C> <C>
Accrued loss contingency.............................. $ 200,000 $ -
Bank debt............................................. 81,397 -
Accounts payable...................................... 40,507 -
Accrued liabilities .................................. 4,179 -
Deferred compensation................................. 1,290 -
------------- -----------
$ 327,373 $ -
============= ===========
</TABLE>

-9-
<PAGE> 10

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

NOTE 9: EARNINGS PER COMMON SHARE

Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------
Sept. 27, 1998 Sept. 28, 1997 Sept. 27, 1998 Sept. 28, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net earnings.......................... $ 4,024 $ 5,761 $ 13,399 $ 12,215
=============== =============== =============== ===============

Weighted average number of common
shares used in basic EPS (000's) .. 11,938 11,947 11,933 11,900
Effect of dilutive securities:
Stock options (000's).............. - 42 1 60
--------------- --------------- --------------- ---------------

Weighted number of common shares and
dilutive potential common stock in
dilutive EPS (000's).............. 11,938 11,989 11,934 11,960
=============== =============== =============== ===============

Basic earnings per common share $ .34 .48 $ 1.12 $ 1.03
=============== =============== =============== ===============
Diluted earnings per common share $ .34 $ .48 $ 1.12 $ 1.02
=============== =============== =============== ===============
</TABLE>

Options to purchase 712,989 and 706,989 shares of common stock outstanding
during the thirteen and thirty-nine week periods ended September 27, 1998,
respectively, were not included in the calculation because their effect was
anti-dilutive. Options to purchase 503,862 shares of common stock outstanding
during the thirteen and thirty-nine week periods ended September 28, 1997, were
not included in the calculation because their effect was anti-dilutive.

NOTE 10: LEGAL PROCEEDINGS

The Procter & Gamble Company v. Paragon Trade Brands, Inc. - P&G filed a claim
in January 1994 in the District Court for the District of Delaware that the
Company's "Ultra" disposable baby diaper products infringe two of P&G's
inner-leg gather patents. The lawsuit sought injunctive relief, lost profit and
royalty damages, treble damages and attorneys' fees and costs. The Company
denied liability under the patents and counterclaimed for patent infringement
and violation of antitrust laws by P&G. In March 1996, the District Court
granted P&G's motion for summary judgment to dismiss the Company's antitrust
counterclaim. The trial was completed in February 1997, the parties submitted
post-trial briefs and closing arguments were conducted on October 22, 1997.
Legal fees and costs for this litigation have been and will continue to be
significant.

On December 30, 1997, the Delaware District Court issued a Judgment and Opinion
finding that P&G's patents are valid and infringed, while at the same time
finding the Company's patent to be invalid, unenforceable and not infringed by
P&G's products. Judgment was entered on January 6, 1998. Damages of
approximately $178.4 million were entered against Paragon by the District Court
on June 2, 1998. At the same time, the District Court entered injunctive relief
agreed upon by P&G and the Company.

The Company had previously filed with the District Court a motion under Rule 59
for a new trial or to alter or amend the Judgment. The District Court denied
Paragon's motion by order entered August 4, 1998. The District Court also
denied a motion by P&G seeking to recover attorneys' fees it expended in
defending itself against Paragon's patent infringement counterclaim. On August
4, 1998, the Company filed with the Federal Circuit Court of Appeals its
amended notice of appeal, appealing of the Delaware District Court's December
30, 1997 Judgment, money judgment, injunction and denial of Paragon's Rule 59
motion. The appeal has now been fully briefed; argument has not yet been
scheduled.

-10-
<PAGE> 11

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

On September 22, 1998, P&G filed a motion in the Delaware District Court
seeking to have the Court find Paragon in contempt of the injunction entered in
the case on account of Paragon's manufacture and sale of its new, single-cuff
diaper product. P&G asserts in its claim that Paragon's new diaper design (i)
is no more than just colorably different from the design found to infringe the
P&G patents at issue in the case and (ii) also infringes such patents. The
Company has opposed P&G's motion. Based on the advice of counsel, the Company
believes that P&G's motion is without merit and intends to vigorously contest
it. If the motion was granted, however, the Company would be forced to
discontinue the manufacture and sale of the new design. In addition, P&G has
asked that the Court order the Company to send letters to all of its customers
advising them that the continued resale by them of the new design would also
constitute patent infringement. Consequently, the Company believes that if the
motion was granted, it would have a material adverse effect on the Company's
financial condition and results of operations and would seriously jeopardize
the Company's future viability.

The Judgment has had a material adverse effect on the Company's financial
position and its results of operations. As a result of the District Court's
Judgment, the Company filed for relief under Chapter 11 of the Bankruptcy Code,
11 U.S.C. Section 101 et seq., in the United States Bankruptcy Court for the
Northern District of Georgia (Case No. 98-60390) on January 6, 1998. See "--In
Re Paragon Trade Brands, Inc.," below.

P&G has asserted alleged claims against the Company regarding similar patent
claims on diaper products sold in other countries. The Company has reviewed
such claims and believes them to be without merit. See "--In Re Paragon Trade
Brands, Inc." below.

The Company continues to pursue settlement of the P&G claim as an alternative
to litigation. As of early November, the Company believes considerable progress
has been made. If settlement is reached, the terms of such settlement will be
subject to Bankruptcy Court approval.

Kimberly-Clark Corporation v. Paragon Trade Brands, Inc. -- On October 26,
1995, K-C filed a lawsuit against the Company in U.S. District Court in Dallas,
Texas, alleging infringement by the Company's products of two K-C patents
relating to inner-leg gathers. The lawsuit seeks injunctive relief, royalty
damages, treble damages and attorneys' fees and costs. The Company denied
liability under the patents and counterclaimed for patent infringement and
violation of antitrust laws by K-C. Several pre-trial motions were filed by
each party, including a motion for summary judgment filed by K-C with respect
to the Company's antitrust counterclaim and a motion for summary judgment filed
by the Company on one of the patents asserted by K-C. In addition, K-C sued the
Company on another patent issued to K-C which is based upon a further
continuation of one of the K-C patents asserted in the case. That action was
consolidated with the pending action. The Court appointed a special master to
rule on the various pending motions. Legal fees and costs in connection with
this litigation have been and will be significant.

As a result of the Company's Chapter 11 filing, the proceedings in the K-C
litigation have been stayed. The Bankruptcy Court issued an order on April 10,
1998 permitting, among other things, a partial lifting of the stay to allow the
issuance of the special master's report on the items under his consideration.
K-C filed with the Bankruptcy Court a motion for reconsideration of the
Bankruptcy Court's April 10 order, which was denied on June 15, 1998. K-C has
appealed this denial of reconsideration to the Federal District Court for the
Northern District of Georgia. The Company objected to K-C's Appeal and has
sought to have it dismissed. K-C has also filed a motion, now pending, with the
District Court in Atlanta to withdraw the reference of its proof of claim from
the jurisdiction of the Bankruptcy Court. On October 27, 1998, the District
Court dismissed without prejudice the appeal, the withdrawal of the reference
and the Company's motion to dismiss the appeal and instructed the parties to
refile their respective pleadings in sixty days if the parties had not by then
resolved their dispute. See "--In Re Paragon Trade Brands, Inc." below.

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<PAGE> 12

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

held to the narrow interpretation of its patent applied by Judge Dwyer in the
Western District of Washington in earlier litigation between P&G and K-C on the
patent. In addition, the special master also recommended that the Company's
antitrust counterclaim and any discovery-related matters in connection
therewith be dismissed.

Effective September 1, 1998, the K-C case was reassigned to Judge Lindsey, a
newly-appointed judge on the Dallas Federal District Court bench. Judge Lindsey
has asked the parties to report on the status of the case and the likelihood of
settlement, and has indicated that he will set a trial date shortly if
settlement does not appear likely.

Should K-C prevail on its claims, award of all or a substantial portion of the
relief requested by K-C could have a material adverse effect on the Company's
financial condition and its results of operations. Based on the advice of
patent counsel, the Company believes that the Company's products do not
infringe any valid patent asserted by K-C.

K-C filed alleged claims ranging from approximately $893 million (without
trebling) to $2.3 billion (with trebling). The Company continues to believe
that it does not infringe any valid claim of any K-C patent. The Company
further believes that K-C's attempt to inflate its bankruptcy claims well
beyond its claims in the Dallas District Court is inconsistent with applicable
law and procedure. See "--In Re Paragon Trade Brands, Inc.," below.

The Company continues to pursue settlement of the K-C claim as an alternative
to litigation. As of early November, the Company believes considerable progress
has been made. If settlement is reached, the terms of such settlement will be
subject to Bankruptcy Court approval.

In Re Paragon Trade Brands, Inc. -- As described above, on December 30, 1997,
the Delaware District Court issued a Judgment and Opinion in the Company's
lawsuit with P&G which found, in essence, two of P&G's diaper patents to be
valid and infringed by the Company's "Ultra" disposable baby diapers, while
also rejecting the Company's patent infringement claim against P&G. Judgment
was entered on January 6, 1998. While a final damages number was not
adjudicated by the District Court at that time, the Company estimated that the
damages were approximately $200 million. The amount of the damages award
resulted in violation of certain covenants under the Company's bank loan
agreements. As a result, the entry of the Judgment and the uncertainty it
created caused an immediate and critical liquidity issue for the Company which
necessitated the Chapter 11 filing.

Subsequently, damages of approximately $178.4 million were entered against
Paragon by the District Court on June 2, 1998. At the same time, the District
Court entered injunctive relief agreed upon by P&G and the Company. See "--The
Procter & Gamble Company v. Paragon Trade Brands, Inc.," above.

The Chapter 11 filing prevented P&G from placing liens on the Company's assets
and affords the Company the opportunity to resolve liquidated and unliquidated
claims against the Company which arose prior to the Chapter 11 filing, thereby
protecting all stakeholders' interests. The Company is currently operating as a
debtor in possession under the Bankruptcy Code. The bar date for the filing of
proofs of claim (apparently excluding administrative claims) by creditors was
June 5, 1998. P&G filed alleged claims ranging from approximately $2.3 billion
(without trebling) to $6.4 billion (with trebling), which included a claim of
$178.4 million for the Delaware judgment. See "--The Procter & Gamble Company
v. Paragon Trade Brands, Inc.," above. The remaining claims include claims for
alleged patent infringement by the Company in foreign countries where it has
operations. The Company has reviewed such additional claims and believes them
to be without merit.

K-C filed alleged claims ranging from approximately $893 million (without
trebling) to $2.3 billion (with trebling), including claims related to the
litigation in the Dallas District Court described above. See "--Kimberly-Clark
Corporation v. Paragon Trade Brands, Inc.," above. K-C's claims in the
Bankruptcy case include an attempt to recover alleged lost profits for
infringement of the patents asserted in the Dallas District Court, despite the
fact that a lost profits theory of damages was not pursued by K-C in the Dallas
District Court. The Company continues to believe that it does not infringe any
valid claim of the asserted K-C patents. The Company further believes that
K-C's attempt to inflate its bankruptcy claims well beyond its claims in the
Dallas District Court is inconsistent with law and procedure.

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<PAGE> 13

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

On November 2, 1998, the U.S. Trustee appointed a Committee of Equity Security
Holders in the Company's Chapter 11 case.

On January 30, 1998, the Company received Bankruptcy Court approval of a $75
million financing facility with The Chase Manhattan Bank. This facility
supplements the Company's cash on hand and operating cash flow and permits the
Company to continue to operate its business in the ordinary course. Legal fees
and costs in connection with the Chapter 11 filing will be significant. See
"Note 11 of the Notes to Financial Statements."

The Company is unable to predict at this time when it will emerge from Chapter
11 protection.

Other -- The Company is also a party to other legal activities generally
incidental to its activities. Although the final outcome of any legal
proceeding or dispute is subject to a great many variables and cannot be
predicted with any degree of certainty, the Company presently believes that any
ultimate liability resulting from any or all legal proceedings or disputes to
which it is a party, except for the Chapter 11 filing and the P&G and K-C
matters discussed above, will not have a material adverse effect on its
financial condition or results of operations.

NOTE 11: BANK CREDIT FACILITIES

At December 28, 1997, the Company maintained a $150,000 revolving credit
facility with a group of nine financial institutions available through February
2001. At December 28, 1997, borrowings under this credit facility totaled
$70,000. Borrowings under this credit facility are reflected as long-term debt
in the accompanying balance sheet at December 28, 1997. Interest was at fixed
or floating rates based on the financial institution's cost of funds. The
Company was also required to maintain certain financial covenants under the
agreement. Paragon Trade Brands (Canada) Inc. has guaranteed obligations under
this revolving credit facility.

At December 28, 1997, the Company also had access to short-term lines of credit
on an uncommitted basis with several major banks. At December 28, 1997, the
Company had approximately $50,000 in uncommitted lines of credit. Borrowings
under these lines of credit totaled $12,800 at December 28, 1997. Borrowings
under these lines of credit were reflected as short-term borrowings in the
accompanying balance sheet at December 28, 1997.

The terms of the revolving credit facility and the short-term lines of credit
described above provide that a voluntary filing of a Chapter 11 petition
results in an event of default on such indebtedness. Amounts outstanding under
these facilities are reflected as Liabilities Subject to Compromise in the
accompanying balance sheet as of September 27, 1998. As a result of its Chapter
11 filing, the Company is prohibited from paying any pre-petition liabilities
without Bankruptcy Court approval. Accordingly, no interest expense has been
recorded with respect to pre-petition debt balances in the accompanying
financial statements for the period subsequent to January 6, 1998.

At December 28, 1997, Paragon Trade Brands (Canada) Inc. maintained a Cdn
$5,000 revolving term credit facility, guaranteed by the Company, available
through October 1998. At December 28, 1997, borrowings under this credit
facility totaled $1,385. The filing of a Chapter 11 petition by the Company
resulted in an event of default under this revolving credit facility.
Borrowings under this facility are reflected as short-term borrowings in the
accompanying balance sheets. Interest is at fixed or floating rates based on
the financial institution's cost of funds.

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<PAGE> 14

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

On January 30, 1998, the Bankruptcy Court entered a final order (the "Final
Order") approving the Credit Agreement (the "DIP Credit Facility") as provided
under the Revolving Credit and Guaranty Agreement dated as of January 7, 1998,
among the Company, as borrower, certain subsidiaries of the Company, as
guarantors, and The Chase Manhattan Bank, as agent ("Chase"). Pursuant to the
terms of the DIP Credit Facility, as amended by the First Amendment dated
January 30, 1998, the Second Amendment dated March 23, 1998, the Third
Amendment dated April 15, 1998, and the Fourth Amendment dated September 28,
1998, Chase and a syndicate of banks have made available to the Company a
revolving credit and letter of credit facility in an aggregate principal amount
of $75,000. The Company's maximum borrowing under the DIP Credit Facility may
not exceed the lesser of $75,000 or an available amount as determined by a
borrowing base formulation. The borrowing base formulation is comprised of
certain specified percentages of eligible accounts receivable, eligible
inventory, equipment and personal and real property of the Company. The DIP
Credit Facility has a sublimit of $10,000 for the issuance of letters of
credit. The DIP Credit Facility expires on the earlier of July 7, 1999, or the
date of entry of an order by the Bankruptcy Court confirming a plan of
reorganization.

Obligations under the DIP Credit Facility are secured by the security interest
in, pledge and lien on substantially all of the Company's assets and properties
and the proceeds thereof, granted pursuant to the Final Order under Sections
364(c)(2) and 364(c)(3) of the Bankruptcy Code. Borrowings under the DIP Credit
Facility may be used to fund working capital and for other general corporate
purposes. The DIP Credit Facility contains restrictive covenants, including
among other things, limitations on the creation of additional liens and
indebtedness, limitations on capital expenditures, limitations on transactions
with affiliates including investments, loans and advances, the sale of assets,
and the maintenance of minimum earnings before interest, taxes, depreciation,
amortization and reorganization items, as well as a prohibition on the payment
of dividends.

The DIP Credit Facility provides that advances made will bear interest at a
rate of 0.5 percent per annum in excess of Chase's Alternative Base Rate, or at
the Company's option, a rate of 1.5 percent per annum in excess of the reserve
adjusted London Interbank Offered Rate for the interest periods of one, two or
three months. The Company pays a commitment fee of 0.5 percent per annum on the
unused portion thereof, a letter of credit fee equal to 1.5 percent per annum
of average outstanding letters of credit and certain other fees.

The Company has issued a $1,300 standby letter of credit under the DIP Credit
Facility. No loans were outstanding under the DIP Credit Facility at September
27, 1998.

Paragon Trade Brands (Canada) Inc. has entered into a new $3,000 Cdn operating
credit facility with a financial institution. Borrowings under the Canadian
revolving credit facility were repaid in full with the proceeds from borrowings
under the new Canadian operating credit facility. Borrowings under this
Canadian operating credit facility are secured by substantially all of Paragon
Trade Brands (Canada) Inc.'s assets and will bear interest at a rate of 1
percent over the financial institution's prime rate. The Company does not
guaranty borrowings under the Canadian operating credit facility. The maximum
borrowings under the Canadian operating credit facility are limited to the
lesser of $3,000 Cdn or 75 percent of Paragon Trade Brands (Canada) Inc.'s
trade accounts receivable. There were $176 in borrowings outstanding against
this facility on September 27, 1998.

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<PAGE> 15

PART I. FINANCIAL INFORMATION

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION

PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES

THIRTEEN WEEKS ENDED SEPTEMBER 27, 1998 COMPARED TO THIRTEEN
WEEKS ENDED SEPTEMBER 28, 1997

CHAPTER 11 PROCEEDINGS

The Company has previously disclosed that The Procter & Gamble Company ("P&G")
had filed a claim against it in the United States District Court for the
District of Delaware, alleging that the Company's "Ultra" disposable baby
diaper products infringe two of P&G's inner-leg gather patents. The lawsuit
sought injunctive relief, lost profit and royalty damages, treble damages and
attorneys' fees and costs. The Company denied liability under the patents and
counterclaimed for patent infringement and violation of antitrust laws by P&G.
The Company has also previously disclosed that if P&G were to prevail on its
claims, award of all or a substantial amount of the relief requested by P&G
could have a material adverse effect on the Company's financial condition and
results of operations. See "PART II: OTHER INFORMATION, ITEM 1:
LEGAL PROCEEDINGS."

On December 30, 1997, the District Court issued a Judgment and Opinion finding
two of P&G's diaper patents to be valid and infringed by the Company's
disposable diaper products, while also rejecting the Company's patent
infringement claim against P&G. The District Court had earlier dismissed the
Company's antitrust counterclaim on summary judgment. The Judgment entitles P&G
to damages based on sales of the Company's diapers containing the inner-leg
gather feature. While a final damages number was not adjudicated by the
District Court, the Company estimated at that time that the damages were
approximately $200 million.

The amount of the award resulted in violation of certain covenants under the
Company's bank loan agreements. As a result, the issuance of the Judgment and
the uncertainty it created caused an immediate and critical liquidity issue for
the Company.

On January 6, 1998, the Judgment was entered on the docket in Delaware in such
a manner that P&G would have been able to begin placing liens on the Company's
assets. As a result, the Company filed for relief under Chapter 11 of the
Bankruptcy Code, 11 U.S.C. Section 101 et seq., in the United States Bankruptcy
Court for the Northern District of Georgia (Case No. 98-60390) on January 6,
1998 (the "Chapter 11 filing"). None of the Company's subsidiaries or
affiliates were included in the Chapter 11 filing. The Chapter 11 filing was
designed to (i) prevent P&G from placing liens on Company property; (ii) permit
the Company to appeal the Delaware District Court's decision on the P&G case in
an orderly fashion; and (iii) give the Company the opportunity to resolve
liquidated and unliquidated claims against the Company which arose prior to the
Chapter 11 filing.

Subsequently, damages of approximately $178.4 million were entered against
Paragon by the District Court on May 28, 1998. At the same time, the District
Court entered injunctive relief agreed upon by P&G and the Company.

The Company is currently operating as a debtor in possession under the
Bankruptcy Code. The bar date for the filing of proofs of claim by creditors
was June 5, 1998. P&G filed alleged claims ranging from approximately $2.3
billion (without trebling) to $6.4 billion (with trebling), which included a
claim of $178.4 million for the Delaware judgment. The remaining claims include
claims for alleged patent infringement by the Company in foreign countries
where it has operations. The Company has reviewed such additional claims and
believes them to be without merit.

Kimberly-Clark Corporation ("K-C") filed alleged claims ranging from
approximately $893 million (without trebling) to $2.3 billion (with trebling),
including claims related to the litigation in the Dallas District Court
described herein. See "PART II: OTHER INFORMATION, ITEM I, LEGAL PROCEEDINGS."
K-C's claims in the Bankruptcy case include an attempt to recover alleged lost
profits for infringement of the patents asserted in the Dallas District Court,
despite the fact that a lost profits theory of damages was not pursued by K-C
in the Dallas District Court. The Company continues to believe that it does not
infringe any valid claim of the asserted

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<PAGE> 16

K-C patents. The Company further believes that K-C's attempt to inflate its
bankruptcy claims well beyond its claims in the Dallas District Court is
inconsistent with applicable law and procedure.

On November 2, 1998, the U.S. Trustee appointed a Committee of Equity
Securities Holders in the Company's Chapter 11 case.

The Company is unable to predict at this time when it will emerge from Chapter
11 protection. See "Notes 1, 10 and 11 of Notes to Financial Statements" and
"PART II: OTHER INFORMATION, ITEM 1: LEGAL PROCEEDINGS" herein.

RESULTS OF OPERATIONS

Net earnings were $4.0 million in the third quarter of 1998 compared with net
earnings of $5.8 million in the third quarter of 1997. The decrease in profits
in the third quarter of 1998 compared to the same period in 1997 was primarily
due to lower volumes and bankruptcy costs of $1.7 million, primarily related to
professional fees. These negative impacts were partially offset by
non-operating factors related to lower taxes and lower interest expense. The
third quarter of 1998 was favorably impacted by a reduction in the deferred tax
asset valuation allowance of $1.2 million. There was $.1 million of interest
expense in the third quarter of 1998 compared to $1.4 million in the third
quarter of 1997. The decrease resulted from the suspension of interest on the
credit facilities due to the Chapter 11 filing.

Pre-tax results from operations, equity in earnings of unconsolidated
subsidiaries and dividends received from an unconsolidated subsidiary were $5.6
million in the third quarter of 1998 compared to $8.9 million in the third
quarter of 1997. Results were negatively impacted by lower volumes and prices,
higher trade merchandising expenses, higher cost product designs and higher
selling, general and administrative expenses ("SG&A"). Results in the third
quarter of 1997 also included a dividend received from Grupo P.I. Mabe, S.A. de
C.V. ("Mabesa"). These negative factors were partially offset by improved
efficiencies and lower manufacturing overhead in the baby diaper business,
favorable raw material prices, lower operating losses associated with the
feminine care business and lower packaging artwork expenses.

Basic earnings per share in the third quarter of 1998 were $.34 compared to
basic earnings per share of $.48 in the third quarter of 1997. Basic earnings
per share, excluding bankruptcy costs and adjusted to reflect an effective tax
rate of 38.5 percent and the Company's contractual interest charges, were $.25
per share in the third quarter of 1998.

Basic earnings per share of $.34 in the third quarter of 1998 included a net
loss of $.18 related to the feminine care and adult incontinence businesses.
Basic earnings per share of $.48 in the third quarter of 1997 included a net
loss of $.26 related to the feminine care and adult incontinence businesses.
Losses in the feminine care and adult incontinence businesses are expected to
continue throughout 1999.

NET SALES

Net sales were $137.0 million in the third quarter of 1998, a 11.1 percent
decrease from the $154.1 million reported in the third quarter of 1997. Diaper
unit sales decreased 14.8 percent to 866 million diapers in the third quarter
of 1998 compared to a record 1,017 million diapers in the third quarter of
1997. Volume was primarily impacted by the temporary discontinuation of
shipments to a customer due to product design issues associated with a new
product rollout. The Company believes these product design issues have been
resolved. The Company expects to resume shipments to that customer in the first
quarter of 1999. The lost sales, due to the temporary discontinuation of
shipments discussed above, should be partially offset during the fourth quarter
of 1998 by the start of shipments to a large European customer in the United
Kingdom. The decrease in baby diaper sales was partially offset by sales growth
in the feminine care, adult incontinence and household cleaning products
businesses.

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<PAGE> 17

Volume also remained under pressure from discounts and promotional allowances
by branded manufacturers and value segment competitors. These conditions are
expected to continue during the fourth quarter of 1998 and throughout 1999.
Volume, during the fourth quarter of 1998 and in 1999, could also be negatively
impacted by a prolonged Chapter 11 case.

Excluding the effect of a favorable product mix, average sales prices during
the third quarter of 1998 decreased approximately 1.5 percent compared to the
third quarter of 1997. The decrease in prices was primarily due to the use of
multiple packs by the branded manufacturers and value segment competitors,
competitive pressure from store-brand diaper competitors and price decreases in
Canada. The Company began to implement a price increase of approximately 5
percent during the third quarter of 1998 in response to increases announced by
K-C and P&G. The price increase is expected to be substantially realized during
the fourth quarter of 1998 but it is difficult to predict the timing and the
amount of final realization of this price increase.

COST OF SALES

Cost of sales in the third quarter of 1998 was $109.1 million compared to
$125.5 million in the third quarter of 1997, an 13.1 percent decrease. As a
percentage of net sales, cost of sales was 79.6 percent in the third quarter of
1998 compared to 81.4 percent in the comparable 1997 period. Costs were lower
in the third quarter of 1998 compared to the same period of 1997 primarily due
to lower raw material costs, improved baby diaper manufacturing efficiencies,
lower baby diaper overhead costs and improved operating results in the feminine
care business. These lower costs were partially offset by higher product design
costs associated with the Company's conversion to a single leg cuff diaper.

Raw material costs, including pulp and super absorbent polymer, were at lower
price levels in the third quarter of 1998 compared to the same period of 1997.
Raw material prices, including pulp, are expected to remain at similar levels
during the fourth quarter of 1998 and through the first half of 1999. Product
costs, however, are expected to remain at higher levels during the fourth
quarter of 1998 and during 1999 due to higher costs of new product designs.

Baby diaper labor costs were similar during the third quarter of 1998 compared
to the third quarter of 1997. The costs associated with the new product rollout
temporarily offset ongoing manufacturing efficiencies including the use of
automated packaging. Baby diaper overhead costs were lower during the third
quarter of 1998 compared to the same period in 1997 due to cost management
efforts. Labor and overhead costs were also lower in the feminine care business
as a result of improved operating results, cost management and the shut down of
tampon-related production equipment during the first quarter of 1998. Labor
costs are expected to remain at similar levels during the fourth quarter of
1998 and early 1999 due to inefficiencies related to new product designs and
introductions.

Depreciation costs were lower in the third quarter of 1998 compared to the
third quarter of 1997 primarily due to lower baby diaper depreciation. These
costs were partially offset by increases related to the feminine care and adult
incontinence business. Depreciation costs should remain at similar levels
during the fourth quarter of 1998.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

SG&A expenses were $22.0 million in the third quarter of 1998 compared to $20.2
million in the third quarter of 1997. As a percentage of net sales, these
expenses were 16.1 percent in 1998 compared to 13.1 percent for the same period
in 1997. The increase in costs is primarily attributable to an increase in
trade merchandising expenses, incentive-based accruals, selling expenses and
information system costs related to the Company's new information system
installation, which is part of its Year 2000 remediation project discussed
below. It is anticipated that these expenses will continue at similar levels
during the fourth quarter of 1998. These increased costs were partially offset
by lower packaging artwork and design costs. It is anticipated that packaging
costs will increase during the first half of 1999 due to new product
introductions.

RESEARCH AND DEVELOPMENT

Research and development expenses were $.9 million in the third quarter of 1998
compared to $1.3 million in the third quarter of 1997. The decrease was
primarily due to lower baby diaper and feminine care product development and
testing.

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<PAGE> 18

INTEREST EXPENSE

There was $.1 million interest expense in the third quarter of 1998 compared to
$1.4 million in the third quarter of 1997. The decrease resulted from the
suspension of interest on the credit facilities due to the Chapter 11 filing.
There were no borrowings under the DIP credit facility during the third quarter
of 1998. The third quarter of 1997 included interest on approximate average
borrowings of $86 million under the pre-petition revolving credit facility.

EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES

The equity in earnings of unconsolidated subsidiaries was $.6 million in the
third quarter of 1998 compared to $.8 million during the third quarter of 1997.
The decrease reflects inefficiencies due to product rollouts at Paragon-Mabesa
International, S.A. de C.V. ("PMI") and start up costs at Goodbaby Paragon
Hygenic Products Ltd. ("Goodbaby"), a joint venture in China.

DIVIDEND INCOME

Dividend income of $1.1 million was received during the third quarter of 1997.
The dividend represented a distribution from Mabesa, an unconsolidated
subsidiary accounted for on the cost basis.

BANKRUPTCY COSTS

Bankruptcy costs were $1.7 million during the third quarter of 1998. These
costs were primarily related to professional fees and are expected to continue
at similar levels until the Company emerges from Chapter 11 protection.

INCOME TAXES

Income tax expense for the subsidiaries not included in the Chapter 11 filing
and filing separate tax returns was $.5 million during the period ended
September 27, 1998. The Company recorded income tax expense of approximately
$1.2 million during the third quarter of 1998, which was offset by a reduction
in its deferred tax asset valuation allowance.

RAW MATERIALS

The Company's agreement with Weyerhaeuser Company ("Weyerhaeuser") whereby it
purchases 100 percent of its requirements of bleached chemical fluff pulp
expired August 31, 1998. The Company intends to continue purchasing 100 percent
of its fluff pulp requirements from Weyerhaeuser at prices as favorable as
those Weyerhaeuser charges other North American disposable diaper manufacturers
for similar grade pulp. The Company believes that at least two other sources of
supply exist for fluff pulp.

THIRTY-NINE WEEKS ENDED SEPTEMBER 27, 1998 COMPARED TO THIRTY-NINE
WEEKS ENDED SEPTEMBER 28, 1997

RESULTS OF OPERATIONS

Net earnings were $13.4 million in the first three quarters of 1998 compared
with net earnings of $12.2 million in the first three quarters of 1997. The
increase in profits in the first three quarters of 1998 compared to the same
period in 1997 was primarily due to non-operating factors related to lower
taxes and lower interest expense. The first three quarters of 1998 was
favorably impacted by a reduction in the Company's deferred tax asset valuation
allowance of $4.0 million. Interest expense in the first three quarters of 1998
was $3.1 million lower than the same period of 1997. The decrease resulted from
the suspension of interest on the credit facilities due to the Chapter 11
filing. These benefits were partially offset by bankruptcy costs of $4.5
million, primarily related to professional fees.

Pre-tax results from operations, equity in earnings of unconsolidated
subsidiaries and dividends received from an unconsolidated subsidiary were
$17.8 million in the first three quarters of 1998 compared to $20.5 million in
the first three quarters of 1997. The decrease in profits in the first three
quarters of 1998 compared to the same period in 1997 was primarily due to lower
volume and prices, higher costs of sourcing products from PMI under a supply
contract, royalties payable to P&G under a product conversion agreement, higher
product design costs associated with the breathable baby diaper product, higher
trade merchandising expenses and higher SG&A. These negative impacts were
partially offset by improved manufacturing efficiencies and lower overhead in
the

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<PAGE> 19

baby diaper business, lower raw material costs, improved results from
unconsolidated subsidiaries, lower packaging artwork expenses and lower
operating losses associated with the feminine care business.

Basic earnings per share in the first three quarters of 1998 were $1.12
compared to basic earnings per share of $1.03 in the first three quarters of
1997. Basic earnings per share, excluding bankruptcy costs and adjusted to
reflect an effective tax rate of 38.5 percent and the Company's contractual
interest charges, were $.78 per share during the first three quarters of 1998.

Basic earnings per share of $1.12 in the first three quarters of 1998 included
a net loss of $.50 related to the feminine care and adult incontinence
businesses. Basic earnings per share of $1.03 in the first three quarters of
1997 included a net loss of $.70 related to the feminine care and adult
incontinence businesses. Losses in the feminine care and adult incontinence
businesses are expected to continue throughout 1999.

NET SALES

Net sales were $402.3 million in the first three quarters of 1998, a 5.5
percent decrease from the $425.6 million reported in the first three quarters
of 1997. Diaper unit sales decreased 7.9 percent to 2,597 million diapers in
the first three quarters of 1998 compared to 2,821 million diapers in the first
three quarters of 1997. The decrease in sales was primarily due to lower
volumes in the baby diaper business during the second quarter of 1998, due to
uncertainties related to the bankruptcy and the temporary discontinuation of
shipments to a customer during the third quarter due to product design issues
associated with a new product rollout, as discussed above. The Company believes
these product design issues have been resolved. The Company expects to resume
shipments to that customer in the first quarter of 1999. The lost sales, due to
the temporary discontinuation of shipments discussed above, should be partially
offset during the fourth quarter of 1998 by the start of shipments to a large
European customer in the United Kingdom. The decrease in baby diaper volume was
partially offset by sales growth in the feminine care, adult incontinence and
household cleaning products businesses.

Volume also remained under pressure from discounts and promotional allowances
by branded manufacturers and value segment competitors and by customer losses
to a store-brand diaper competitor. Volume during the fourth quarter of 1998
and in 1999 could also be negatively impacted by a prolonged Chapter 11 case.

Excluding the effect of a favorable product mix, average sales prices during
the first three quarters of 1998 decreased approximately 2.5 percent compared
to the first three quarters of 1997. The decrease in prices was primarily due
to the use of multiple packs by the branded manufacturers and value segment
competitors, competitive pressure from store-brand diaper competitors and price
decreases in Canada. The Company began to implement a price increase of
approximately 5 percent during the third quarter of 1998 in response to
increases announced by K-C and P&G. The price increase is expected to be
substantially realized during the fourth quarter of 1998 but it is difficult to
predict the timing and the amount of final realization of this price increase.

COST OF SALES

Cost of sales in the first three quarters of 1998 was $322.2 million compared
to $345.2 million in the first three quarters of 1997, a 6.7 percent decrease.
As a percentage of net sales, cost of sales was 80.1 percent in the first three
quarters of 1998 compared to 81.1 percent in the comparable 1997 period. Costs
were lower in the first three quarters of 1998 compared to the same period in
1997, primarily due to lower raw material costs, improved baby diaper
efficiencies, lower baby diaper overhead costs and improved operating results
in the feminine care business. The lower costs were partially offset by the
sourcing of products from PMI under a supply contract and charges related to
royalties payable to P&G under a product conversion agreement. Costs were also
higher due to the product design costs associated with the Company's conversion
to a single leg cuff diaper in the third quarter of 1998.

Raw material costs, including pulp and super absorbent polymer, were at lower
price levels in the first three quarters of 1998 compared to the same period of
1997. Raw material prices, including pulp, are expected to remain at similar
levels during the fourth quarter of 1998 and through the first half of 1999.
Product costs, however, are expected to remain at higher levels during the
fourth quarter of 1998 and during 1999 due to higher costs of new product
designs.

Baby diaper labor costs were lower during the first three quarters of 1998
compared to the first three quarters of 1997. The lower costs reflect increased
manufacturing efficiencies including the use of automated packaging. Baby
diaper

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<PAGE> 20

overhead costs were lower during the first three quarters of 1998 compared to
the same period in 1997 due to cost management efforts. Labor and overhead
costs were also lower in the feminine care business as a result of improved
operating results, cost management and the shut down of tampon-related
production equipment during the first quarter of 1998. Labor costs are expected
to remain at increased levels during the fourth quarter of 1998 and early 1999
due to inefficiencies related to new product designs and introductions.

Depreciation costs were at similar levels in the first three quarters of 1998
compared to the first three quarters of 1997. Decreases in baby diaper
depreciation were offset by increases related to the feminine care and adult
incontinence businesses.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

SG&A expenses were $61.0 million in the first three quarters of 1998 compared
to $58.6 million in the first three quarters of 1996. As a percentage of net
sales, these expenses were 15.2 percent in 1998 compared to 13.8 percent for
the same period in 1997. The increase in costs is primarily attributable to an
increase in trade merchandising expenses, incentive-based accruals, selling
expenses and information system costs related to the Company's new information
system installation, which is part of the Company's Year 2000 remediation
project discussed below. It is anticipated that these expenses will continue at
similar levels during the fourth quarter of 1998. These increased costs were
partially offset by lower legal expenses and packaging artwork and design
costs. It is anticipated that the packaging costs will increase during the
first half of 1999 due to new product introductions.

RESEARCH AND DEVELOPMENT

Research and development expenses were $3.4 million in the first three quarters
of 1998 compared to $3.2 million in the first three quarters of 1997. The
increase was primarily due to baby diaper product development and testing. The
increase in baby diaper spending has been partially offset by a decrease in
feminine care and adult incontinence product development spending.

INTEREST EXPENSE

Interest expense was $.3 million in the first three quarters of 1998 compared
to $3.4 million in the first three quarters of 1997. The decrease resulted from
the suspension of interest on the credit facilities due to the Chapter 11
filing. There were no borrowings under the DIP credit facility during the first
three quarters of 1998. The first three quarters of 1997 included interest on
approximate average borrowings of $77 million under the pre-petition revolving
credit facility.

EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES

The equity in earnings of unconsolidated subsidiaries was $2.1 million in the
first three quarters of 1998 compared to $.9 million in the first three
quarters of 1997. The increase primarily reflects improved operating results at
PMI and earnings of Stronger Corporation S.A..

DIVIDEND INCOME

Dividend income of $1.1 million was received during the third quarter of 1997.
The dividend represented a distribution from Mabesa, an unconsolidated
subsidiary accounted for on the cost basis.

BANKRUPTCY COSTS

Bankruptcy costs were $4.5 million during the first three quarters of 1998.
These costs were primarily related to professional fees and are expected to
continue at similar levels until the Company emerges from Chapter 11
protection.

INCOME TAXES

Income tax expense for the subsidiaries not included in the Chapter 11 filing
was $1.2 million during the first three quarters of 1998. The Company recorded
income tax expense of approximately $4.0 million during the first three
quarters of 1998, which was offset by a reduction in its deferred tax asset
valuation allowance.

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<PAGE> 21

LIQUIDITY AND CAPITAL RESOURCES

During the first three quarters of 1998, cash flow from earnings and non-cash
charges to earnings was $37.9 million compared to $47.7 million in the same
period in 1997.

During the first three quarters of 1998, cash flow was positively impacted by
approximately $33.3 million by an increase in post-petition accounts payable
and checks issued but not cleared. Cash was also positively impacted by the
receipt of $3.4 million from previous equipment sales and by an increase in
accrued liabilities, primarily related to incentive-pay accruals. Cash flow has
been negatively impacted by an increase in receivables primarily due to an
overall slowness of payment from a few large customers. Cash was also used by
an increase in prepaid expenses, primarily prepaid insurance and deposits to
suppliers due to the bankruptcy.

The cash produced from operations supported capital expenditures of $26.0
million, including approximately $7.5 million of computer software and
consulting costs related to the Company's Year 2000 remediation efforts
discussed below, in the first three quarters of 1998 compared to $46.4 million
in the same period of 1997. The expenditures were primarily in support of the
baby diaper business, specifically new product enhancements and automated
packaging. Capital spending is expected to be approximately $39 million during
1998 and will include further expenditures for product enhancement and a
company-wide information system upgrade related to the Company's Year 2000
remediation efforts. Capital spending is expected to be approximately $60
million in 1999.

The cash produced from operations also supported the Company's acquisition of
its share of Goodbaby, a joint venture in China on December 31, 1997. The
joint venture partners are Goodbaby Group and First Shanghai Investment of Hong
Kong. Paragon maintains a 40 percent ownership position in the venture. Initial
registered capital of the venture was approved at $15 million, to be funded
over a two-year period. The Company also made an additional payment to Mabesa
as an earnout payment based on 1997 performance.

At December 28, 1997, the Company maintained a $150 million revolving credit
facility with a group of nine financial institutions available through February
2001. At December 28, 1997, borrowings under this credit facility totaled $70
million. The Company also had access to short-term lines of credit on an
uncommitted basis with several major banks. At December 28, 1997, the Company
had approximately $50 million in uncommitted lines of credit. Borrowings under
these lines of credit totaled $12.8 million at December 28, 1997. As a result
of the Chapter 11 filing, the Company is prohibited from paying any
pre-petition liabilities without Bankruptcy Court approval. The Chapter 11
filing resulted in a default under its pre-petition revolving credit facility
and borrowings under its uncommitted lines of credit. See "Note 11 of Notes to
Financial Statements."

In connection with the Chapter 11 filing, on January 30, 1998, the Bankruptcy
Court entered a final order approving the Credit Agreement (the "DIP Credit
Facility") as provided under the Revolving Credit and Guarantee Agreement dated
as of January 7, 1998, among the Company, as Borrower, the subsidiaries of the
Company, as guarantors, and a bank group led by The Chase Manhattan Bank
("Chase"). Pursuant to the terms of the DIP Credit Facility, as amended by the
First Amendment dated January 30, 1998, the Second Amendment dated March 23,
1998, the Third Amendment dated April 15, 1998, and the Fourth Amendment dated
September 28, 1998, Chase and a syndicate of banks has made available to the
Company a revolving credit and letter of credit facility in an aggregate
principal amount of $75 million. The Company's maximum borrowing under the DIP
Credit Facility may not exceed the lesser of $75 million or an available amount
as determined by a borrowing base formulation. The borrowing base formulation
is comprised of certain specified percentages of eligible accounts receivable,
eligible inventory, equipment and personal and real property of the Company.
The DIP Credit Facility has a sublimit of $10 million for the issuance of
letters of credit. The DIP Credit Facility expires on the earlier of July 7,
1999, or the date of entry of an order by the Bankruptcy Court confirming a
plan of reorganization.

Obligations under the DIP Credit Facility are secured by the security interest,
pledge and lien on substantially all of the Company's assets and properties and
the proceeds thereof, granted pursuant to the Final Order under Sections
364(c)(2) and 364(c)(3) of the Bankruptcy Code. Borrowings under the DIP Credit
Facility may be used to fund working capital and for other general corporate
purposes. The DIP Credit Facility contains restrictive covenants, including
among other things, limitations on the creation of additional liens and
indebtedness, limitations on capital expenditures, limitations on transactions
with affiliates including investments, loans and advances, the sale of assets,
and the maintenance of minimum earnings before interest, taxes, depreciation,
amortization and reorganization items, as well as a prohibition on the payment
of dividends.

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<PAGE> 22

The Company may utilize, in accordance with certain covenants, its DIP credit
facility for continued investments in its foreign subsidiaries. The DIP credit
facility in combination with internally generated funds is anticipated to be
adequate to finance these investments and the Company's 1998 capital
expenditures. See "Note 11 of Notes to Financial Statements."

YEAR 2000

The "Year 2000 issue" is generally defined as the inability of computer
hardware, software and embedded systems to properly recognize and process
date-related information for dates after December 31, 1999. The Company began
its efforts to address this problem as early as 1995. The Company's efforts
generally are separated into three areas: (i) business information systems
("Business Systems"), (ii) non-information technology systems, including real
estate facilities and manufacturing equipment ("Infrastructure Systems"), and
(iii) vendors, suppliers, customers and third party information interfaces
("Third Party Dependencies").

The Company has established a formal "Y2K Project Office" to assess, manage and
implement its Year 2000 activities. The Company has also established a formal
"Y2K Steering Committee" to oversee the Company's Year 2000 efforts, including
the efforts of the Project Office. The Company has also engaged Deloitte
Consulting/ICS to assist with implementation of certain Year 2000 related
Business Systems and the Gartner Group to assist with its Year 2000 efforts for
Infrastructure Systems and Third Party Dependencies.

The Company's State of Readiness

Most of the Year 2000 issues arising with respect to the Business Systems of
the Company are being addressed by replacement of the majority of those systems
through implementation of SAP R/3 enterprise resource planning software. The
SAP software was implemented and operating at the Company's corporate
headquarters and in its U.S. baby diaper plants in early November of 1998 and is
warranted to be Year 2000 compliant by its manufacturer. The Company currently
anticipates that the November 1998 SAP implementation should help significantly
minimize any Year 2000 related disruptions for approximately 80% of the
Company's Business Systems at those locations. Overall, the Company expects
that the November 1998 SAP implementation will address 60% of the Year 2000
exposures related to its Business Systems as a whole. The remaining systems are
being addressed and are expected to be fully assessed, remediated or replaced,
tested and implemented in a timely fashion. While there may be integration and
process issues associated with implementation of the SAP system, the Company
currently anticipates that the system will improve the Company's Business
Systems and address the majority of the Business System Year 2000 problems.
With respect to Business Systems that will not be addressed by the overall SAP
implementation, the Company is investigating certain issues with certain of its
desktop computer operating systems. While the remediation requirements are not
clearly known at this time, it may be necessary to replace such workstations.
If replacement of all possibly affected machines were necessary, the Company
does not anticipate that such replacement would have a material adverse impact
on the Company's financial position. Contingency planning, if necessary, for
the Company's non-SAP related Business Systems will be developed prior to the
end of the first quarter of 1999.

The Company has engaged The Gartner Group to evaluate and analyze the Company's
overall Year 2000 preparedness, concentrating specifically on the Company's
Infrastructure Systems and Third Party Dependencies. The Company currently
anticipates that it will receive The Gartner Group's formal report by the end
of November 1998. The Company plans, if necessary, to initiate
remediation/replacement procedures and testing and implementation of any
remediated or replaced systems after issuance of the Gartner report.
Contingency planning, if necessary, for Infrastructure Systems is currently
scheduled to begin in the first quarter of 1999, but this may change depending
on the contents of the Gartner report.

The Company is in the process of evaluating its Infrastructure Systems for Year
2000 related problems. These systems include the manufacturing capacity for the
Company's products and are therefore critical to the Company's ability to
produce products and realize revenue from sales. The manufacturing capacity of
the Company include any number of automated systems which may include embedded
chips that are difficult to identify and remediate in the event of Year 2000
related problems. Security, heating and air conditioning and

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<PAGE> 23

other commonly encountered real estate facilities and personal safety and
security systems are also among the different types of systems included in the
Company's assessment of its Infrastructure Systems.

The Company is in the process of identifying and prioritizing its material
Third Party Dependencies. Year 2000 problems with respect to certain material
customers that prevented the taking or filling of orders for products or
interfered with the collections process could have a material impact on the
Company's revenues. Approximately 80% of the Company's orders for products are
delivered via electronic data interchange facilities ("EDI"). The SAP
implementation is designed to address Year 2000 related issues for Company
systems required for these EDI exchanges, but the Company is not able to
control the EDI facilities of its customers. The Company is in the process of
surveying the EDI facilities of certain of its customers for Year 2000
preparedness. The Company is also in the process of preparing an inventory and
assessment of those vendors, service providers and raw materials suppliers
which may have a material impact on the Company in the event of Year 2000
problems. Currently, the Company anticipates that this inventory and assessment
process will be substantially completed in the first quarter of 1999. The
Company cannot predict how many of the vendors, service providers and raw
materials suppliers will respond to the survey requests or the nature of their
responses. The Company's current plan is to either resolve material Third Party
Dependency issues known to it by the end of the first quarter of 1999 or
develop a contingency plan to address problems with a particular Third Party
Dependency, as necessary.

Costs to Address the Company's Year 2000 Issues

The total costs associated with required modifications to address Year 2000
related issues for the Company is expected to be material to the Company's
financial position. The cost of the project through September 27, 1998 was
$14.7 million, all of which was related to the SAP implementation. It is not
possible to identify what portion of the total SAP cost is attributable to the
Year 2000 remediation. The Company planned to implement an enterprise resource
planning system for its Business Systems, regardless of Year 2000 issues with
respect to its former Business Systems.

The future cost of the Year 2000 project is estimated to be approximately $14
million. The Company is still in the process of assessing what, if any,
additional costs may be required to remediate or replace its remaining Business
Systems, its Infrastructure Systems or to address Third Party Dependencies. All
of the costs are expected to be funded through operating cash flow and/or bank
borrowings.

Risks Presented by Year 2000 Issues

The Year 2000 presents a number of risks and uncertainties that could affect
the Company. These include, but are not limited to, failure of the SAP
implementation to address a material issue with the Company's Business Systems,
failure of the Company to identify and address material issues associated with
non-SAP related Business Systems or with its Infrastructure Systems, failure or
inability of customers to place orders for Year 2000 related reasons, failure
of necessary raw materials manufacturers to deliver their products to the
Company in a timely fashion and the inability of either the Company to collect
its receivables or its customers to process payments for goods. In addition,
any combination of the foregoing which would not in and of itself constitute a
material adverse event may, in the aggregate, materially and adversely affect
the Company's results of operations, liquidity and overall financial position.
Moreover, problems in public utilities and infrastructure systems such as power
supply, telecommunications, transportation and other possible disturbances
related to the Year 2000 in the United States and abroad may have unexpected,
material impacts on the Company's ability to do business in the normal course
and therefore may also have a material adverse impact on the Company's results
of operations and financial position. The Company currently anticipates that
the SAP implementation and completion of the Year 2000 project as scheduled
will reduce the incidence and severity of Year 2000 related disturbances in
systems that are within the control of the Company. In addition, the Company
currently anticipates that it will be able to address those Year 2000 issues
for internal business processes not addressed by the SAP implementation which
the Company anticipates may have a material impact on the Company or its
results of operation.

RISKS AND UNCERTAINTIES

As a result of the adverse judgment in the P&G patent litigation, the Company
was required to modify its current diaper design. Pursuant to an agreement with
P&G, the Company had until July 6, 1998 to complete the conversion to a new
diaper design. The Company completed its conversion to a new diaper design in
accordance with the requirements of the conversion agreement with P&G. The
Company has been advised by independent patent counsel that the new diaper
design does not infringe any valid U.S. patent. The Company

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<PAGE> 24

also paid P&G a royalty of approximately $4.5 million, which represents 2
percent of net sales of the previous diapers manufactured during the conversion
period. This 2 percent royalty had a material adverse effect on the results of
operations during the first three quarters of 1998.

The ability of the Company to effect a successful reorganization will depend,
in significant part, upon the Company's ability to formulate a Plan of
Reorganization that is approved by the Bankruptcy Court and meets the standards
for plan confirmation under the Bankruptcy Code. In a Chapter 11 reorganization
plan, the rights of the Company's creditors and shareholders may be altered.
Investment in stock of the Company, therefore, should be regarded as highly
speculative. As a result of the Chapter 11 filing, the Company will incur
significant costs for professional fees as the reorganization plan is
developed. The Company is also required to pay certain expenses of the Official
Committee of Unsecured Creditors and the Committee of Equity Security Holders
including professional fees, to the extent allowed by the Bankruptcy Court.

The Company is unable to predict at this time when it will emerge from Chapter
11 protection.

The Company faces risks and uncertainties raised by the Year 2000 Issue with
respect to its Business Systems, Infrastructure System and Third Party
Dependencies described above under "Year 2000 - Risks Presented by Year 2000
Issues" which could have a material adverse effect on the Company if not
addressed. The Company is taking steps to address these Year 2000 Issues as
outlined above.

FORWARD-LOOKING STATEMENTS

From time to time, information provided by the Company, statements made by its
employees or information included in its filings with the Securities and
Exchange Commission (including the Annual Report on Form 10-K) may include
statements that are not historical facts, so-called "forward-looking
statements." Such statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from those expressed in
the Company's forward-looking statements. Factors which could affect the
Company's financial results, including, but not limited to: the Company's
Chapter 11 filing; patent litigation; Year 2000 issues; increased raw material
prices; new product and packaging introductions by competitors; increased price
and promotion pressure from competitors; and new competitors in the market, are
described in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission. Readers are cautioned not to place undue reliance on
the forward-looking statements contained herein, which speak only as of the
date hereof, and which are made by management pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. The Company
undertakes no obligation to publicly release the result of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.

NEW ACCOUNTING STANDARDS

Effective December 29, 1997, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which requires the display of comprehensive income and
its components in the financial statements.

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<PAGE> 25

The Company has not determined the timing of or method of adoption of Statement
133. As the Company currently does not utilize derivatives, adoption of
Statement 133 is not expected to have any impact on the financial statements.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On September 22, 1998, P&G filed a motion in the Delaware District Court
seeking to have the Court find Paragon in contempt of the injunction entered in
the case on account of Paragon's manufacture and sale of its new, single-cuff
diaper product. P&G asserts in its claim that Paragon's new diaper design (i)
is no more than just colorably different from the design found to infringe the
P&G patents at issue in the case and (ii) also infringes such patents. The
Company has opposed P&G's motion. Based on the advice of counsel, the Company
believes that P&G's motion is without merit and intends to vigorously contest
it. If the motion was granted, however, the Company would be forced to
discontinue the manufacture and sale of the new design. In addition, P&G has
asked that the Court order the Company to send letters to all of its customers
advising them that the continued resale by them of the new design would also
constitute patent infringement. Consequently, the Company believes that if the
motion was granted it would have a material adverse effect on the Company's
financial condition and results of operations and would seriously jeopardize
the Company's future viability.

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<PAGE> 26

On May 26, 1998, the special master issued his report on the majority of the
motions pending before him. His report included a finding, among other things,
that Paragon, as the successor-in-interest to the disposable diaper business of
Pope & Talbot, Inc. ("Pope & Talbot"), has a fully paid-up license to one of
the three asserted K-C inner-leg gather patents, which license runs from the
date of the acquisition by the Company of Pope & Talbot. Pope & Talbot had
previously obtained the license from K-C. The special master also found that
K-C should be held to the narrow interpretation of its patent applied by Judge
Dwyer in the Western District of Washington in earlier litigation between P&G
and K-C on the patent. In addition, the special master also recommended that
the Company's antitrust counterclaim and any discovery-related matters in
connection therewith be dismissed.

Effective September 1 1998, the K-C case was reassigned to Judge Lindsey, a
newly-appointed judge on the Dallas Federal District Court bench. Judge Lindsey
has asked the parties to report on the status of the case and the likelihood of
settlement, and has indicated that he will set a trial date shortly if
settlement does not appear likely.

K-C filed alleged claims ranging from approximately $893 million (without
trebling) to $2.3 billion (with trebling). The Company continues to believe
that it does not infringe any valid claim of any K-C patent. The Company
further believes that K-C's attempt to inflate its bankruptcy claims well
beyond its claims in the Dallas District Court is inconsistent with law and
procedure. See "--In Re Paragon Trade Brands, Inc.," below.

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<PAGE> 27

On November 2, 1998, the U.S. Trustee appointed a Committee of Equity Security
Holders in the Company's Chapter 11 case.

The Company is unable to predict at this time when it will emerge from Chapter
11 protection.

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<PAGE> 28

ITEM 3. DEFAULTS IN SENIOR SECURITIES

At December 28, 1997, the Company maintained a $150 million revolving credit
facility with a group of nine financial institutions available through February
2001. At December 28, 1997, borrowings under this credit facility totaled $70
million. The Company also had access to short-term lines of credit on an
uncommitted basis with several major banks. At December 28, 1997, the Company
had approximately $50 million in uncommitted lines of credit. Borrowings under
these lines of credit totaled $12.8 million at December 28, 1997. The Chapter
11 filing resulted in a default under its pre-petition revolving credit
facility and borrowings under its uncommitted lines of credit. See "Note 11 of
Notes to Financial Statements."

<TABLE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<S> <C> <C>
(a) Exhibits

Exhibit 3.1 Certificate of Incorporation of Paragon Trade
Brands, Inc.(4)

Exhibit 3.2 By-Laws of Paragon Trade Brands, Inc., as
amended through July 31, 1995(5)

Exhibit 4.1 Certificate of Incorporation of Paragon Trade
Brands, Inc. (see Exhibit 3.1)

Exhibit 10.1 Asset Transfer Agreement, dated as of January
26, 1993, by and between Weyerhaeuser and
Paragon(1)

Exhibit 10.2 Intellectual Property Agreement, dated as of
February 2, 1993, between Weyerhaeuser and
Paragon(1)

Exhibit 10.3 License, dated as of February 2, 1993, between
Weyerhaeuser and Paragon(1)

Exhibit 10.4 Sublicense, dated as of February 2, 1993,
between Weyerhaeuser and Paragon(1)

Exhibit 10.5 Technology Agreement, dated as of October 15,
1987, by and between Weyerhaeuser and Johnson
and Johnson, as amended(1)

Exhibit 10.6 Critical Supply Agreement, dated as of February
2, 1993, between Weyerhaeuser and Paragon(1)

Exhibit 10.6.1 Letter Supply Agreement between Weyerhaeuser
and Paragon dated as of October 22, 1997(9)

Exhibit 10.7* Stock Option Plan for Non-Employee Directors(1)

Exhibit 10.8* Annual Incentive Compensation Plan(1)

Exhibit 10.9* 1993 Long-Term Incentive Compensation Plan(1)

Exhibit 10.10* Employment Agreement, dated as of August 11,
1998, between Paragon and Bobby V. Abraham

Exhibit 10.11* Employment Agreement, dated as of August 11,
1998, between Paragon and David W. Cole

Exhibit 10.12* Employment Agreement, dated as of August 11,
1998, between Paragon and Alan J. Cyron

</TABLE>

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<PAGE> 29
<TABLE>
<S> <C>

Exhibit 10.13* Employment Agreement, dated as of August 11,
1998, between Paragon and Arrigo D. (Rick)
Jezzi

Exhibit 10.14* Employment agreement, dated as of August 11,
1998, between Paragon and Robert E. McClain

Exhibit 10.15* Employment Agreement, dated as of August 11
1998, between Paragon and Catherine O.
Hasbrouck

Exhibit 10.16* Employment Agreement, dated as of August 11,
1998, between Paragon and Kevin P. Higgins

Exhibit 10.17* 1995 Incentive Compensation Plan(5)

Exhibit 10.18* Paragon Trade Brands, Inc. Confirmation
Retention Plan for Top Eight Executives and
Summary Plan Description

Exhibit 10.19 Amended and Restated Credit Agreement, dated as
of February 6, 1996(7)

Exhibit 10.19.1 Amendment Agreement, dated December 13, 1996,
to Amended and Restated Credit Agreement, dated
as of February 6, 1996(8)

Exhibit 10.20 Revolving Credit and Guaranty Agreement Among
Paragon Trade Brands, Inc., a
Debtor-in-Possession, as Borrower, the
Subsidiaries of the Borrower Named Herein, as
Guarantors, the Banks Party hereto, and Chase
Manhattan Bank, as Agent, dated as of January
7, 1998, as Amended (Conformed to Reflect the
First Amendment to the Revolving Credit and
Guaranty Agreement dated as of January 30,
1998, the Third Amendment to the Revolving
Credit and Guaranty Agreement dated as of March
23, 1998, and the Third Amendment to Revolving
Credit and Guaranty Agreement dated as of April
15, 1998)(10)

Exhibit 10.21 Security and Pledge Agreement, dated as of
January 7, 1998(10)

Exhibit 10.22 Revolving Canadian Credit Facility and Parent
Guarantee(2)

Exhibit 10.23 Indemnification Agreements, dated as of
February 2, 1993, between Weyerhaeuser and
Bobby V. Abraham and Gary M. Arnts(1)

Exhibit 10.24 Rights Agreement dated December 14, 1994
between Paragon Trade Brands, Inc. and Chemical
Bank, as Rights Agent(3)

Exhibit 10.25 Asset Purchase Agreement dated December 11,
1995 by and among Paragon Trade Brands, Inc.,
PTB Acquisition Sub, Inc., Pope & Talbot, Inc.
and Pope & Talbot, Wis., Inc. (6)

Exhibit 10.26** Sales Contract, dated as of January 30, 1996,
between Hoechst Celanese Corporation and
Paragon Trade Brands, Inc.(7)

Exhibit 10.26.1** Sales Contract, dated as of April 30,
1998, between Clariant Corporation and Paragon
Trade Brands, Inc.(11)

Exhibit 10.27 Lease Agreement between Cherokee County, South
Carolina and Paragon Trade Brands, Inc., dated
as of October 1, 1996(8)

Exhibit 11 Computation of Per Share Earnings (See Note 9
to Financial Statements)

Exhibit 27 Financial Data Schedule (for SEC use only)
</TABLE>
29
<PAGE> 30

(b) No reports on Form 8-K were filed during the quarter ended September 27,
1998.

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

*Management contract or compensatory plan or arrangement.
**Confidential treatment has been requested as to a portion of this document.

(1) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report
on Form 10-K for the fiscal year ended December 26, 1993.

(2) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended June 26, 1994.

(3) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report
on Form 8-K, dated as of December 14, 1994.

(4) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report
on Form 10-K for the fiscal year ended December 25, 1994.

(5) Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended June 25, 1995.

(6) Incorporated by reference from Paragon Trade Brands, Inc.'s Current Report
on Form 8-K, dated as of February 8, 1996.

(7) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report
on Form 10-K for the fiscal year ended December 31, 1995.

(8) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual Report
on Form 10-K for the fiscal year ended December 29, 1996.

(9) Incorporated by reference from Paragon Trade Brands, Inc.'s Annual report
on From 10-K for the fiscal year ended December 28, 1997.

(10)Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended March 29, 1998.

(11)Incorporated by reference from Paragon Trade Brands, Inc.'s Quarterly
Report on Form 10-Q for the quarter ended June 28, 1998.

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<PAGE> 31

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

PARAGON TRADE BRANDS, INC.

By /s/ Alan J. Cyron
------------------------
Alan J. Cyron
Chief Financial Officer

November 12, 1998

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<PAGE> 32

EXHIBIT INDEX

EXHIBIT DESCRIPTION
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<S> <C>
Exhibit 3.1 Certificate of Incorporation of Paragon Trade
Brands, Inc.(4)