Selected Financial Data (1)
(In thousands, except per share data)
<TABLE>
<CAPTION>


Year Ended November 30                 1998          1997         1996 (2)        1995          1994          1993          1992    
-------------------------------       --------      --------      --------      --------      --------      --------      -------- 
<S>                                   <C>           <C>           <C>           <C>           <C>           <C>           <C>      
Operations
Net sales                             $619,002      $601,296      $508,976      $328,345      $331,306      $284,325      $236,476 
Cost of products sold                  379,641       373,015       321,748       219,899       214,809       189,111       152,480 
Gross margin percentage                   38.7%         38.0%         36.8%         33.0%         35.2%         33.5%         35.5%
Selling, general and
     administrative expenses           146,763       139,467       112,361        59,874        61,498        53,319        50,128 
Research and development expenses       20,567        18,680        17,294        13,184        12,982        12,325        11,030 
Operating income                        72,031        70,134        57,573        35,388        42,017        29,570        22,838 
Operating income percentage               11.6%         11.7%         11.3%         10.8%         12.7%         10.4%          9.7%
Interest expense, net                   16,919        18,967        13,938         1,487         2,465         1,568         1,245 
Income taxes                            22,867        23,068        11,039        13,510        16,350        11,784         9,201 
Effective income tax rate                 42.0%         45.1%         45.0%         40.0%         41.2%         42.2%         42.0%
Net income                              31,579        28,095        24,060        20,264        23,302        16,155        12,706 
EBITDA(3)                               91,389        92,120        73,233        43,435        51,082        36,394        29,944 
EBITDA interest coverage(4)                5.4           4.9           5.3          29.2          20.7          23.2          24.1 

Per Share Data(5)

Net income, diluted                       1.35          1.20          1.04           .88          1.00           .70           .55 
Cash dividends                             .32           .32           .32           .31           .27           .24           .22 
Book value                                7.15          6.16          5.36          4.86          4.38          3.60          3.16 
Price range of common stock        24 5/8-14 3/8   24 1/8-16 3/4  19 3/4-12 1/4    15-11      18-11 3/4   15 7/8-9 3/8   9 3/4-5 5/8

Other Data

Total assets                           516,485       501,795       521,860       183,582       190,252       167,044       117,049 
Working capital                         50,071        52,126        50,579        35,505        41,604        33,270        27,131 
Capital expenditures (6)                17,015        12,673        19,233        15,599         6,693         7,598         3,262 
Depreciation                             9,102         8,850         6,453         4,251         4,637         3,746         3,965 
Amortization of intangibles             10,922        13,140         9,097         3,923         4,328         3,141         2,827 
Total debt                             203,700       224,171       261,561        28,229        35,110        44,101        14,642 
EBITDA to total debt                      44.9%         41.1%         28.0%        153.9%        145.5%         82.5%        204.5%
Book value                             165,575       142,439       121,889       109,374        99,424        81,128        70,125 
Return on equity                          20.5%         21.3%         20.8%         19.4%         25.8%         21.4%         17.6%
Debt to total capitalization                55%           61%           68%           21%           26%           35%           17%
Number of employees                      2,291         2,116         2,140         1,148         1,182         1,176         1,072 
Sales per employee                         270           283           274           282           281           253           214 
Operating income per employee               31            33            31            30            36            26            21 
Average shares                                                                                                                     
     outstanding, diluted(7)            23,400        23,400        23,100        23,086        23,231        22,962        23,048 
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
Year Ended November 30                   1991          1990          1989          1988        
<S>                                     <C>           <C>           <C>           <C>          
Operations                                                                                     
Net sales                               $220,508      $240,146      $219,713      $203,499     
Cost of products sold                    150,669       161,626       145,592       134,114     
Gross margin percentage                     31.7%         32.7%         33.7%         34.1%    
Selling, general and                                                                           
     administrative expenses              46,921        50,404        44,113        42,516     
Research and development expenses         10,606        10,814         9,708         8,980     
Operating income                          12,312        17,302        20,300        17,889     
Operating income percentage                  5.6%          7.2%          9.2%          8.8%    
Interest expense, net                      2,254         2,573         1,111           582     
Income taxes                               4,417         6,850         8,399         7,550     
Effective income tax rate                   41.0%         40.6%         40.6%         40.9%    
Net income                                 6,357        10,022        12,574        11,284     
EBITDA(3)                                 19,994        26,117        26,670        23,316     
EBITDA interest coverage(4)                  8.9          10.2          24.0          40.1     
                                                                                               
Per Share Data(5)                                                                              
                                                                                               
Net income, diluted                          .27           .41           .51           .45     
Cash dividends                               .21           .20           .17           .15     
Book value                                  3.16          3.10          3.00          2.65     
Price range of common stock              6 1/8-4 1/8    7 5/8-4      7 1/8-5 3/8   7 1/8-4 7/8 
                                                                                               
Other Data                                                                                     
                                                                                               
Total assets                             127,342       125,371       129,025       101,357     
Working capital                           30,405        34,513        40,389        36,368     
Capital expenditures (6)                   1,928         3,968         2,486         2,930     
Depreciation                               4,038         4,021         3,387         3,133     
Amortization of intangibles                2,928         2,651         1,199           767     
Total debt                                21,501        28,345        25,560        10,007     
EBITDA to total debt                        93.0%         92.1%        104.3%        233.0%    
Book value                                74,187        73,185        74,482        65,987     
Return on equity                             8.6%         13.6%         17.9%         18.1%    
Debt to total capitalization                  22%           28%           26%           13%    
Number of employees                        1,140         1,230         1,350         1,750     
Sales per employee                           186           186           174           170     
Operating income per employee                 10            13            16            15     
Average shares                                                                                 
     outstanding, diluted(7)              23,521        24,738        25,043        24,921     
</TABLE>

(1)  This table of Selected  Financial Data should be read in  conjunction  with
     Management's Discussion and Analysis of Results of Operations and Financial
     Condition and the Company's  consolidated  financial  statements  included
     herein.

(2)  1996 includes the effect of the acquisition of Guardsman Products,  Inc. on
     April 8, 1996 and excludes the effect of a  restructuring  charge of $9,607
     which reduced net income by $5,284 or $.23 per diluted share.

(3)  EBITDA  represents  earnings  before  interest,   taxes,  depreciation  and
     amortization.

(4)  EBITDA  interest  coverage is  determined  by  dividing  EBITDA by interest
     expense.

(5)  Adjusted for all stock splits and stock dividends through November 30, 1998
     inclusive. Prices are rounded to nearest 1/8.

(6)  Excludes effect of acquisitions.

(7)  Used to calculate net income per diluted share.

<PAGE>


Management's Discussion and Analysis of
Results of Operations and Financial Condition

Operating Results 1998 vs. 1997

Consolidated net sales increased 2.9% to a record $619.0 million for fiscal year
1998,   despite  a  $10  million   unfavorable   impact  from  foreign  currency
translations.  Sales benefited from the December,  1997  acquisition of Merckens
Lackchemie GmbH & Company (See "German  Acquisition").  The  acquisition  helped
boost the Company's  international  sales,  including U.S.  exports,  to $149.3
million during 1998,  representing growth of 18.0% over 1997. During 1998, Lilly
experienced  volume  growth  in  each  of its  end  use  markets.  Sales  to the
Company's four primary end use markets (metal, wood,  composites and glass, and
specialty)  represented  39%,  38%,  12%  and 11% of  1998  consolidated  sales,
respectively. Selling prices for most of the Company's products remained stable
during the year.

     Gross profit  margin  continued to improve in 1998,  rising 0.7  percentage
points  over 1997 to  38.7%.  Raw  material  costs  continued  to  dominate  the
Company's  cost  structure.   However,   continued  emphasis  on  supply  chain
management,  as well as favorable pricing in certain commodity markets, produced
a  1.1%  reduction  in  raw  material  costs  as  a  percentage  of  net  sales.
Improvements in raw material costs were partially mitigated by a slight increase
in direct  labor  and  overhead  costs.  The  Company  will  continue  to pursue
improvement  in gross  margin by reducing  the number of raw  materials  used in
products,  process  re-engineering,  company-wide  purchasing  opportunities and
product re-formulations.

     As a percentage  of sales,  operating  expenses  increased  0.7  percentage
points to 27.0%. Selling,  general and administrative  expenses, as a percentage
of sales,  increased from 23.2% to 23.7%,  primarily due to increased  marketing
efforts.  In  addition,  the Company  made record  expenditures  on research and
development, which rose 10.1% to $20.6 million.

     Net interest  expense  declined  significantly  during  1998,  falling $2.0
million,  reflecting the benefits of the Company's 1997 debt  restructuring and
lower  average  debt  outstanding.  Continued  strong cash flow from  operations
allowed the Company to reduce average debt outstanding  during 1998, while lower
average  market  rates of  interest  reduced  the cost of  borrowing  under  the
Company's  variable rate debt  facilities.  The improvement in interest expense
was partially offset by additional  interest expense  associated with borrowings
to finance  the  Company's  German  Acquisition  (See  "Liquidity  and  Capital
Resources" and "German Acquisition").

     The Company's  effective tax rate declined  significantly  to 42.0% during
1998, due primarily to implementation of international tax planning  strategies.
The effective tax rate remained above U.S. statutory rates, primarily due to the
impact of non-deductible intangibles acquired as part of the Guardsman Products,
Inc. ("GPI") acquisition and generally higher foreign tax rates.

Operating Results 1997 vs. 1996

Consolidated  net sales  increased  18.1% to a record $601.3  million for fiscal
year 1997.  Sales  benefited  from the full-year  inclusion of GPI,  acquired in
April,  1996. During 1997, the Company  experienced volume growth in each of its
end use markets.  Sales to the Company's  four primary end use markets  (metal,
wood, composites and glass, and specialty)  represented 39%, 38%, 12% and 11% of
1997  consolidated  sales,  respectively.  International  sales,  including U.S.
exports,  grew 29.7% to a record $126.5 million during 1997. This represented an
increase of 1.8 percentage  points to 21.0% of sales.  For the first time in the
Company's history, international sales exceeded 20% of total sales, despite the
negative impact of foreign exchange rate volatility in several of the Company's
overseas  markets.  Selling prices for most of the Company's  products remained
stable during the year.

     Gross profit  margin  continued to improve in 1997,  rising 1.2  percentage
points over 1996 to 38.0%.  Continued  improvements in supply chain  management,
including  leveraging  larger raw  material  order  quantities  and reducing the
number of raw material items, contributed to a 1.6 percentage point reduction in
raw material costs as a percentage of sales. The Company will continue to pursue
improvement  in gross  margin by  reducing  the  number of raw  material  items,
process   engineering,   company-wide   purchasing   initiatives,   and  product
re-formulations.  Direct  labor  and  overhead  costs  increased  slightly  as a
percentage of sales during 1997.

     Operating  expenses  totaled  $158.1 million for 1997, an increase of $28.5
million, or 22.0%, over 1996 (excluding the restructuring charge reported during
1996).  Increases in 1997 operating expenses were due primarily to the full-year
inclusion  of GPI  operations.  As a  percentage  of sales,  operating  expenses
increased 0.8 percentage points to 26.3%. The increase primarily reflects higher
amortization   expense   associated  with   intangibles   acquired  in  the  GPI
transaction,  as well as higher  selling and  marketing  costs  associated  with
certain GPI product  lines,  which target retail  accounts  rather than original
equipment manufacturers.

     Net interest expense increased 36% during 1997 to $18.9 million,  primarily
due to the full-year inclusion of debt associated with the GPI acquisition.  The
increase was partially mitigated by a reduction in  interest-bearing  borrowings
during 1997.  Management  anticipates  that the  restructuring of the Company's
debt  capitalization  during the fourth  quarter of 1997 should  contribute to a
slightly  lower  average  interest  rate  on  borrowings  going  forward.   (See
"Liquidity and Capital Resources").

     The Company's  effective tax rate remained virtually unchanged for 1997 at
45.1%. The effective tax rate remained above U.S. statutory rates, primarily due
to the  impact  of  non-deductible  intangibles  acquired  as  part  of the  GPI
acquisition, and generally higher foreign taxes.

Environmental

The  Company's  operations,  like  those  of  most  companies  in the  coatings
industry,  are subject to  regulations  related to  maintaining or improving the
quality of the  environment.  Such  regulations,  along with the  Company's own
internal  compliance  efforts,  have  required,  and will  continue  to require,
ongoing expenditures.  Spending for environmental  compliance is not anticipated
to be  material  to the  Company's  financial  position.  The  Company has been
notified  that it is a  potentially  responsible  party for clean-up  costs with
respect to several  government  investigations  at independently  operated waste
disposal  sites  previously  used by the Company.  Management  has  accrued,  as
appropriate,  for  these  environmental  liabilities.  Management  believes  the
liabilities  associated with these sites will not have a material adverse effect
on its operating results or financial position.

Year 2000 Readiness

The Year 2000 issue  ("Y2K" or "Y2K  issue") is the result of computer  programs
being written using two digits rather than four to define the  applicable  year.
Any  computer  programs or any  hardware  that have date  sensitive  software or
embedded  chips may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a temporary inability to process transactions or
engage in normal manufacturing or other business activities.

     The Company is  actively  engaged in a  company-wide  effort to achieve Y2K
readiness for both information technology ("IT") and non-information  technology
("Non-IT") systems, and to determine the Y2K readiness of significant suppliers.
The Company is focusing its efforts on IT systems,  Non-IT systems and suppliers
that,  without  Y2K  readiness,  could  have a  material  adverse  effect on the
Company's operations.

     The  Company's  approach to addressing  Y2K  preparedness  consists of the
following:

     *  Inventory - identification of items to be assessed for Y2K readiness.

     * Assessment - prioritizing  the  inventoried  items,  assessing  their Y2K
readiness and defining corrective actions and developing contingency plans.

     * Deployment - implementing  corrective actions,  verifying  implementation
and finalizing contingency plans.

The  Company's  IT systems  are  comprised  of  business  computer  systems and
technical  infrastructure.  In 1996, the Company  determined that the IT systems
supporting its business units could be inadequate to meet business  requirements
after 1999 and thus  implemented  a project to replace all  critical IT systems.
All critical IT systems have been  inventoried and assessed,  and replacement of
non-conforming IT systems began during the fourth quarter of 1998. Deployment of
all critical IT systems is expected to be completed  during the third quarter of
1999.

     The  Company's   Non-IT  systems  are  comprised  of   manufacturing   and
warehousing  systems and facility support systems.  A preliminary  inventory and
assessment of these Non-IT  systems has been  completed and  deployment of these
Non-IT systems is expected to be completed during the third quarter of 1999.

     The Company is in the process of  contacting  significant  raw material and
service  suppliers  regarding  their  Y2K  readiness.  The  Company's  supplier
readiness  program  focuses  on those  suppliers  considered  essential  for the
prevention of a material disruption to the Company's  business  operation.  The
Company will make efforts to address  third-party  Y2K  compliance  issues noted
from the inquires.  However,  there is no assurance that such third-parties will
be Y2K compliant.  Non-compliance by third-parties could have a material adverse
impact on the Company's financial position and business operations.  Deployment
of the program is expected to be completed during the third quarter of 1999.

     The Company utilizes both internal and external  resources in all phases of
its Y2K readiness program. The Company estimates the total cost of resolving the
Y2K issue to be approximately $5 million.  Of this amount, the Company estimates
$2 million will be spent during fiscal year 1999. Approximately 70% of total Y2K
cost is comprised of equipment and software  replacement  costs with the balance
being  comprised of assessment and  remediation  costs.  The Company expects all
costs to be funded with  operating cash flow. Y2K costs are expensed as incurred
except for new  systems  and  equipment,  which are  capitalized  and charged to
expense over the estimated useful life of the related asset.

     While the Company  believes  that its efforts to address Y2K issues will be
successfully  completed in a timely manner,  the Company recognizes that failing
to  resolve  Y2K issues  could,  in a  reasonably  likely  worst case  scenario,
increase costs and limit the Company's ability to conduct business  operations.
The financial impact of such scenario can not be reasonably estimated.

German Acquisition

In December,  1997, the Company  acquired  Merckens  Lackchemie GmbH and Company
("Merckens"),  located in Eschweiler,  Germany. This company supplies industrial
coatings to customers  throughout  Europe.  Product lines are  complementary  to
Lilly's existing  products.  The purchase was made with cash and financed by an
unsecured  revolving line of credit denominated in Deutschemarks (See "Liquidity
and Capital Resources").

Liquidity and Capital Resources

During    fiscal    1998,    the    Company    entered    into   a    five-year,
Deutschemark-denominated   $10  million   revolving  credit  facility  (the  "DM
Facility")  to fund the  purchase of  Merckens.  The DM  facility is  unsecured.
Principal amounts available for borrowing under the DM Facility decline over the
five-year term of the agreement.  In addition, the Company continued to maintain
a $175 million revolving credit facility ("Facility") and $100 million in senior
notes  ("Notes").  Both the Facility and the Notes are  unsecured and require no
principal amortization.  The remaining terms on the Facility and Notes were four
and nine years,  respectively,  as of November 30, 1998.  Management  expects to
fund required debt service on all borrowings from operating cash flows.

     The Company  reduced  total debt by $20.5 million  during 1998.  Additional
amounts  available for borrowing under the Facility for  acquisitions or general
operating  purposes  totaled $81.3  million as of November 30, 1998.  Management
believes that funds available from internal and external  sources are sufficient
to meet the liquidity needs of the Company during the next twelve months.

     The Company manages exposure to interest rate movements  primarily  through
the issuance of  fixed-rate  debt  securities  and the use of interest rate swap
agreements.  As of November 30, 1998, the Company was party to one interest rate
swap agreement with a notional  principal  amount of $50 million.  The agreement
effectively converts a portion of the Company's debt from a floating to a fixed
interest rate, which was 6.88% as of November 30, 1998.

     Cash  provided by  operating  activities  declined by $4.1 million to $55.2
million  during  1998,  as higher net income  was  offset by the  negative  cash
effects of changes in certain  assets and  liabilities.  Cash used by  investing
activities increased by $17.9 million to $24.9 million during 1998. The increase
was driven by the purchase of Merckens, as well as greater purchases of property
and  equipment,  primarily  related to ongoing  consolidation  of corporate  and
operating  activities,   foreign  infrastructure  investment,  and  expenditures
related to achieving Y2K readiness.  Future investing activities are expected to
be financed from internal sources and existing credit  facilities.  Cash used by
financing  activities  totaled $27.1 million for 1998,  due  principally  to the
$20.5  million  reduction  in debt and cash  dividend  payments of $7.4  million
during 1998.

     The  Company  focuses  on three key  measures  of  liquidity  and access to
capital  markets:  EBITDA (earnings  before  interest,  taxes,  depreciation and
amortization);  Interest Coverage (EBITDA divided by interest expense); and Debt
Capitalization  (debt  divided by the sum of debt plus  equity).  For 1998,  the
company generated EBITDA of $91.4 million, a decrease of $0.7 million.  Interest
Coverage  improved  to 5.4 times,  due  primarily  to reduced  interest  expense
associated  with lower average  borrowings  and generally  lower market rates of
interest.  Debt  Capitalization  improved 6.8 percentage  points to 55.2% due to
higher  levels of net income  retained in the  business and lower levels of debt
outstanding at year-end 1998.

Forward-looking statements

Statements  in this  annual  report  that  are not  strictly  historical  may be
"forward-looking  statements,"  which  involve  risks  and  uncertainties.  Risk
factors include general economic and industry  conditions,  effects of leverage,
environmental matters, technological developments, product pricing, raw material
cost changes, and international operations, among others, which are set forth in
the Company's SEC filings.


<PAGE>

Consolidated Statements of Income and Retained Earnings
(In thousands, except per share data)

<TABLE>
<CAPTION>
Year ended November 30                                 1998           1997           1996
<S>                                                 <C>            <C>            <C>      
Net sales                                           $ 619,002      $ 601,296      $ 508,976
Costs and expenses:
      Cost of products sold                           379,641        373,015        321,748
      Selling, general and administrative             146,763        139,467        112,361
      Research and development                         20,567         18,680         17,294
      Restructuring charge                                 -              -           9,607
                                                    ---------------------------------------
                                                      546,971        531,162        461,010
                                                    ---------------------------------------
               Operating income                        72,031         70,134         47,966

Other income (expense):
      Sundry income (expense)                            (666)            (4)           110
      Interest expense, net                           (16,919)       (18,967)       (13,938)
                                                    ---------------------------------------
                                                      (17,585)       (18,971)       (13,828)
                                                    ---------------------------------------
               Income before income taxes              54,446         51,163         34,138

Income taxes                                           22,867         23,068         15,362
                                                    ---------------------------------------
               Net income                              31,579         28,095         18,776

Retained earnings at beginning of year                 83,745         62,990         51,446
                                                    ---------------------------------------
                                                      115,324         91,085         70,222
Deduct dividends paid ($.32 per share)                  7,410          7,340          7,232
                                                    ---------------------------------------
               Retained earnings at end of year     $ 107,914      $  83,745      $  62,990
                                                    =======================================
Net income per share:
      Basic                                         $    1.36      $    1.22      $     .83
      Diluted                                       $    1.35      $    1.20      $     .81


See accompanying notes.

</TABLE>
<PAGE>

Consolidated Balance Sheets
(In thousands)

<TABLE>
<CAPTION>

November 30                                                         1998           1997
-----------------------------------------------------------------------------------------
Assets
Current assets:
<S>                                                              <C>            <C>      
    Cash and cash equivalents                                    $  13,326      $  10,079
    Accounts receivable, less allowance
          for doubtful accounts (1998, $1,981; 1997,$2,139)         82,039         80,011
    Inventories                                                     50,796         45,704
    Deferred income taxes                                            3,251          4,300
    Other                                                            2,620          6,580
                                                                   -------        -------
            Total current assets                                   152,032        146,674
Other assets:
    Goodwill, less amortization (1998,$21,547; 1997,$15,368)       214,960        220,897
    Other intangibles, less amortization
        (1998,$22,621;1997,$17,963)                                 26,068         30,059
    Deferred income taxes                                            8,838          7,722
    Sundry                                                          12,419         13,604
                                                                   -------        -------
                                                                   262,285        272,282
Property and equipment:
    Land                                                            11,845          8,035
    Buildings                                                       62,725         50,621
    Equipment                                                       87,787         78,432
    Accumulated depreciation                                       (60,189)       (54,249)
                                                                   -------        -------
                                                                   102,168         82,839
                                                                   -------        -------
                                                                 $ 516,485      $ 501,795
                                                                   =======        =======
Liabilities and Shareholders' Equity 
Current liabilities:
    Accounts payable                                             $  66,156      $  60,510
    Salaries and payroll related items                              21,624         20,814
    Other                                                           12,453         10,936
    State and local taxes                                              855          1,212
    Federal income taxes                                               873          1,076
                                                                   -------        -------
            Total current liabilities                              101,961         94,548

Long-term debt                                                     203,700        224,171

Other liabilities                                                   45,249         40,637

Shareholders' equity:
    Capital stock, $.55 stated value per share:
            Class A (limited voting) - 27,825 shares
               issued (1997, 27,674 shares)                         15,459         15,375
            Class B (voting) - 540 shares issued                       300            300
    Additional capital                                              81,890         79,417
    Retained earnings                                              107,914         83,745
    Currency translation adjustments                                (4,096)        (2,254)
    Cost of capital stock in treasury                              (35,892)       (34,144)
                                                                   -------        -------
                                                                   165,575        142,439
                                                                   -------        -------
                                                                 $ 516,485       $501,795
                                                                   =======        =======
</TABLE>

See accompanying notes.



<PAGE>

<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
(In thousands)

Year ended November 30                                             1998           1997           1996
--------------------------------------------------------------------------------------------------------
Operating Activities
<S>                                                              <C>            <C>            <C>      
Net income                                                       $  31,579      $  28,095      $  18,776
Adjustments to reconcile net income
     to net cash provided by operating activities:
    Restructuring charge                                                -              -           9,607
    Depreciation                                                     9,102          8,850          6,453
    Amortization of intangibles                                     10,922         13,140          9,097
    Deferred income taxes                                              209          4,085          2,094
    Changes in operating  assets and  liabilities
     net of effects from  acquired business:
       Accounts receivable                                            (422)         4,581         (5,849)
       Inventories                                                  (2,574)         1,842         (7,086)
       Accounts payable and accrued expenses                         5,985          2,933          7,825
       Sundry                                                          418         (4,226)        (3,466)
                                                                 ---------      ---------      ---------
            Net cash provided by operating activities               55,219         59,300         37,451

Investing Activities
Purchases of property and equipment                                (17,015)       (12,673)       (19,233)
Payment for acquired business                                      (11,253)            --       (235,000)
Sundry                                                               3,367          5,716          4,590
                                                                 ---------      ---------      ---------
            Net cash used by investing activities                  (24,901)        (6,957)      (249,643)

Financing Activities
Dividends paid                                                      (7,410)        (7,340)        (7,232)
Proceeds from senior notes                                              --         99,200             --
Proceeds from short-term and long-term borrowings                       --             --        310,600
Principal payments on short-term and long-term borrowings          (20,470)      (136,590)      (105,817)
Sundry                                                                 809         (4,324)         1,171
                                                                 ---------      ---------      ---------
            Net cash (used) provided by financing activities       (27,071)       (49,054)       198,722
                                                                 ---------      ---------      ---------

Increase (decrease) in cash and cash equivalents                     3,247          3,289        (13,470)
Cash and cash equivalents at beginning of year                      10,079          6,790         20,260
                                                                 ---------      ---------      ---------
Cash and cash equivalents at end of year                         $  13,326      $  10,079      $   6,790
                                                                 =========      =========      =========
</TABLE>



See accompanying notes.

<PAGE>

Notes to Consolidated Financial Statements
November 30, 1998


1. Summary of Significant Accounting Policies

Business:  Lilly  Industries,  Inc. and its  subsidiaries  (the  "Company")  are
principally  in  the  business  of  formulating,   manufacturing  and  marketing
industrial  coatings and specialty  chemicals to  manufacturing  companies.  The
Company's  products include wood coatings for furniture,  building products and
cabinets;  coil coatings for building  products,  appliances and  transportation
equipment;  specialty  coatings for a variety of metal  products and  fiberglass
reinforced products;  powder coatings for a variety of metal products; and glass
coatings  for  mirrors.  The  Company  also sells  various  household  products,
including fabric protectors, furniture care products and cleaning aids.

Consolidation  and  Use of  Estimates:  The  consolidated  financial  statements
include the  accounts of all  subsidiaries  after  elimination  of  intercompany
accounts and  transactions.  Preparation of these  statements in conformity with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Cash  Equivalents:  Cash  equivalents  include time deposits and certificates of
deposit with original maturities of three months or less.

Inventories:  Coatings  inventories in the United States are stated at the lower
of cost,  determined by the last-in,  first-out  (LIFO) method,  or market.  All
other  inventories are stated at the lower of cost,  determined by the first-in,
first-out (FIFO) method, or market.

Intangible Assets: Goodwill, which represents the excess of cost over fair value
of net assets of purchased businesses,  is amortized by the straight-line method
over periods  ranging from 20 to 40 years.  Other  intangible  assets consist of
noncompete  agreements,  customer  lists and technology and are amortized by the
straight-line method over periods ranging from 5 to 20 years.

     The  Company  periodically  evaluates  the  value of  intangible  assets to
determine if an  impairment  has occurred.  This  evaluation is based on various
analyses including reviewing anticipated cash flows.

Property and Equipment:  Property and equipment is recorded on the basis of cost
and  includes  expenditures  for new  facilities  and items which  substantially
increase the useful life of existing  buildings and equipment.  Depreciation  is
based on  estimated  useful  lives  (ranging  from 3 to 40 years)  and  computed
primarily by the straight-line method.

Interest-Rate   Swap   Agreements:   The   Company   periodically   enters  into
interest-rate  swap  agreements  to modify the interest  characteristics  of its
outstanding  debt.  Swap  agreements  involve the exchange of interest  payments
based  on a  variable  interest  rate  for  interest  payments  based on a fixed
interest rate  calculated by reference to a notional amount over the life of the
agreement.  The  notional  amount of each  swap  agreement  represents  all or a
portion of the principal balance of a specific debt obligation. The differential
to be paid or received is accrued and  recognized  as an  adjustment of interest
expense.

Reclassifications:  Certain prior year amounts have been reclassified to conform
with the current year presentation.

Net Income Per Share:  The Company  adopted  Statement of  Financial  Accounting
Standards No. 128, "Earnings Per Share",  (SFAS 128) during the first quarter of
1998. SFAS 128 requires the  calculation of both basic and diluted  earnings per
share.  Per share amounts shown for periods prior to adoption have been restated
to conform to the requirements of SFAS 128.


<PAGE>

     Basic and diluted net income per share are  computed by dividing net income
as  reported  by the  average  number  of  shares  outstanding  as  follows  (in
thousands):

                                                       1998      1997     1996

--------------------------------------------------------------------------------
Basic
   Weighted-average common shares outstanding        23,160    22,940    22,600
Diluted
   Weighted-average common shares outstanding         23,160    22,940    22,600
   Dilutive effect of stock options                      240       460       500
                                                      ------    ------    ------
Average common shares outstanding assuming dilution   23,400    23,400    23,100
                                                      ======    ======    ======


2. Acquisition

On  April  8,  1996  the  Company  acquired  for  $235,000,000  in cash  all the
outstanding shares of Guardsman  Products,  Inc.  ("Guardsman").  To finance the
acquisition,  the Company used credit facilities to fund the initial purchase of
shares,  pay-off  existing debt and pay related  expenses.  The  acquisition was
recorded using the purchase  method and the  consolidated  financial  statements
include the results of  operations of Guardsman  since the date of  acquisition.
The fair value of net assets acquired included  $40,031,000 net working capital,
$50,246,000  noncurrent  assets,  $213,642,000  intangible  assets,  $28,549,000
long-term  debt,  and  $40,370,000  noncurrent  liabilities.  Goodwill  is being
amortized by the straight-line method over 40 years.

     If the  acquisition  had occurred on December 1, 1995,  pro forma net sales
and net income for the year ended  November 30, 1996 would be  $598,722,000  and
$20,767,000,  respectively,  and basic and diluted net income per share would be
$.92 and $.90,  respectively.  The pro  forma  results  include a  restructuring
charge of  $9,607,000  which reduced net income by $5,284,000 or $.23 per share,
both  basic and  diluted  (see Note 3).  The pro forma  consolidated  results of
operations  are not  necessarily  indicative of future  results of operations or
actual results of operations that would have occurred had the purchase been made
at December 1, 1995.


3. Restructuring

In 1996,  the Company  adopted  and  commenced  implementation  of plans for the
consolidation  of  manufacturing   facilities  related  to  the  acquisition  of
Guardsman.  These  plans  included  the  closure  of both  Lilly  and  Guardsman
facilities  and  workforce  reductions  totaling  approximately  250  employees.
Closure costs included facility and equipment valuation  adjustments,  inventory
disposal costs, dismantling and maintenance costs, and termination benefits. The
primary employee groups affected included manufacturing, selling, administrative
and research and development  personnel.  As of November 30, 1997 the plans were
complete.

     Costs  associated  with the planned  closure of former Lilly  facilities of
$7,827,000  and workforce  reductions  of $1,780,000  were recorded in 1996 as a
restructuring  charge of  $9,607,000,  which reduced net income by $5,284,000 or
$.23 per share, both basic and diluted. Amounts paid or charged related to Lilly
facilities  were  $365,000 and  $7,462,000  during 1996 and 1997,  respectively.
Amounts paid or charged related to Lilly workforce  reductions were $447,000 and
$1,333,000 during 1996 and 1997, respectively.

     Costs associated with the planned closure of former Guardsman facilities of
$6,532,000 and workforce  reductions of $2,476,000  were recorded in the opening
balance sheet of the combined  entity at the  acquisition  date,  April 8, 1996.
Amounts paid or charged  related to Guardsman  facilities  were  $1,642,000  and
$3,590,000  during  1996 and 1997,  respectively.  During  1997,  the  remaining
$1,300,000  liability  related  to the  Guardsman  facilities  was  credited  to
goodwill. Amounts paid or charged related to Guardsman workforce reductions were
$469,000  and $589,000  during 1996 and 1997,  respectively.  During  1997,  the
remaining  $1,418,000  liability related to the Guardsman workforce was credited
to goodwill.


4. Inventories

The principal inventory classifications at November 30 are summarized as follows
(in thousands):

                                                  1998        1997
                                                 -------     -------
Finished products                                $29,761     $26,361
Raw materials                                     27,411      27,019
                                                 -------     -------
                                                  57,172      53,380
Less adjustment of certain inventories
   to last-in, first-out (LIFO) basis              6,376       7,676
                                                 -------     -------
                                                 $50,796     $45,704
                                                 =======     =======

     Inventory cost is determined by the LIFO method of inventory  valuation for
approximately  64% and  68% of  inventories  at  November  30,  1998  and  1997,
respectively.


5. Benefit Plans

The Company maintains defined benefit and defined  contribution plans that cover
substantially all employees. Retirement benefits under the defined benefit plans
are  based on final  monthly  compensation  and  years  of  service.  Retirement
benefits under the defined contribution plans are based on employer and employee
contributions plus earnings to retirement.  The plans' assets consist primarily
of common stock, fixed income securities and guaranteed insurance contracts.  In
addition,   unfunded  supplemental  executive  retirement  plans  cover  certain
employees in which benefits,  determined by the Board of Directors,  are payable
after retirement over periods ranging from 15 years to life of the participant.

     The provision  for defined  benefit  pension cost is  determined  using the
projected unit credit actuarial method. The Company's policy is to fund amounts
as are necessary on an actuarial basis to provide assets  sufficient to meet the
benefits to be paid to plan members in accordance  with the Employee  Retirement
Income  Security Act of 1974.  Amounts  contributed to  union-sponsored  pension
plans are based upon requirements of collective bargaining  agreements.  Company
contributions  to the defined  contribution  plans are based on a percentage  of
employee contributions.

     The Guardsman defined benefit pension plans covering substantially all U.S.
employees  were  amended to freeze  years of service at  December  31,  1996 and
merged into the defined  benefit plan  maintained  by the Company.  Concurrently
with this  amendment,  these  employees  became  participants  in the Company's
defined  contribution  plans.  The  impact of the plan  merger was  recorded  in
connection  with the Guardsman  acquisition.  All 1996 amounts  disclosed  below
reflect the effect of  freezing  years of service  for the  Guardsman  plans and
their merger into the Lilly plan.

     The  components  of net  pension  cost for the  defined  benefit  plans and
amounts  charged to expense  for the  defined  contribution  plans for the years
ended November 30 are as follows (in thousands):

<TABLE>
<CAPTION>

                                                          1998         1997     1996
                                                        --------      --------     --------
<S>                                                     <C>           <C>          <C>     
Defined benefit plans
   Service cost - benefits earned during the period     $  2,034      $  2,099     $  1,733
   Interest cost on projected benefit obligation           5,653         5,484        4,594
   Actual net gain on plan assets                        (11,830)       (8,482)      (9,056)
   Net amortization and deferral                           3,236         1,012        3,104
                                                        --------      --------     --------
   Net pension cost (benefit)                               (907)          113          375
Defined contribution plans                                 4,113         3,740        2,219
                                                        --------      --------     --------
Pension expense                                         $  3,206      $  3,853     $  2,594
                                                        ========      ========     ========
</TABLE>

     The  expected  long-term  rates of  return on assets  used to  compute  the
defined  benefit  plans'pension  expense were 10.25% for 1998 and 9.25% for 1997
and 1996.

     The following table sets forth the funded status and amounts  recognized in
the consolidated balance sheets at November 30 for the Company's defined benefit
pension plans (in thousands):

                                                      1998          1997
                                                    --------      --------
Actuarial present value of benefit obligations:
   Vested                                           $ 65,051      $ 60,141
   Nonvested                                           4,216         4,767
                                                    --------      --------
Total accumulated benefit obligations               $ 69,267      $ 64,908
                                                    ========      ========
Actuarial present value of projected benefit
 obligations for services rendered to date          $(76,458)     $(82,542)
Plan assets at fair value                             96,571        88,594
                                                    --------      --------
Excess of plan assets over projected
 benefit obligations                                  20,113         6,052
Unrecognized net gains                               (15,317)       (4,277)
Unrecognized prior service cost                        4,813         5,274
Unrecognized transition obligation at
 December 1, 1985, net of amortization                  (933)       (1,135)
                                                    --------      --------
Net pension asset                                   $  8,676      $  5,914
                                                    ========      ========

     The discount rates used to measure benefit  obligations were 6.75% and 7.0%
in 1998 and 1997,  respectively.  The rates of increase in  compensation  levels
used to  measure  benefit  obligations  were 4% and 5%  during  1998  and  1997,
respectively.

     Certain   employees  from  one  of  the  Company's   German   subsidiaries
participate in a frozen defined benefit  retirement plan. The liability  related
to such plan totaled $4,400,000 at November 30, 1998.

     Accumulated  benefits for supplemental  executive  retirement plans totaled
approximately   $8,465,000  and  $7,953,000  at  November  30,  1998  and  1997,
respectively.



<PAGE>

6. Long-Term Debt
Long-term debt consists of the following as of November 30 (in thousands):

                                            1998         1997
         ------------------------------------------------------
         7.75% Senior Unsecured Notes     $100,000     $100,000
         Revolving Credit Facility          93,700      124,000
         
         German Credit Facility             10,000           - 
         Other                                  -           171
                                          --------     --------
                                          $203,700     $224,171
                                          ========     ========

          In    February    1998,    the   Company    obtained   an    unsecured
          Deutschemark-denominated   revolving   credit  facility  (the  "German
          Facility") with a bank. Borrowings available under the German Facility
          are  $10,000,000  until  November 29, 1999,  gradually  decreasing  to
          $2,350,000 on December 1, 2001.  German  Facility  advances of greater
          than $60,000 bear interest,  at the Company's  option,  at either (i)
          the money  market rate of the bank's  German  affiliate,  or (ii) the
          Frankfurt,  Germany  Interbank  Offered  Rate for DM deposits  plus an
          interest  rate  margin  ranging  from .40% to .80%,  depending  on the
          Company's leverage. Other advances bear interest at the prime rate of
          the bank's  German  affiliate.  The  principal of the facility is due
          upon termination, February 2003.

                  In November 1997, the Company  restructured its long-term debt
          into a $175,000,000  revolving  credit  facility  ("Facility")  with a
          group of  financial  institutions  and  $100,000,000  of senior  notes
          ("Notes").  The Notes were issued as a 144A private placement offering
          with registration  rights.  The Facility is unsecured and provides for
          borrowings under a revolving note.

                  Interest is payable upon maturity of each  revolving  advance,
          but in no case less frequently  than  quarterly.  The principal of the
          Facility is due October,  2002. The Notes are  unsecured.  Interest is
          payable  on  June  1  and  December  1 of  each  year  the  Notes  are
          outstanding.  The  principal of the Notes is due December,  2007.  The
          Facility bears interest,  at the Company's  option, at (i) the higher
          of the agent  bank's  prime rate (7.75% at November  30, 1998) or the
          Federal Funds rate plus 0.50%,  or (ii) the London  Interbank  Offered
          Rate  for  U.S.  Dollars  plus  0.40%  to  1.00%,  depending  upon the
          Company's  credit  rating.  A  commitment  fee ranging  from 0.15% to
          0.25%,  depending upon the Company's credit rating, is payable on the
          unused portion of the Facility.

                  In April 1996,  the Company  entered into a  forty-four  month
          amortizing  interest  rate swap  agreement  ("Swap")  with a  notional
          amount of $175,000,000.  This agreement effectively converts a portion
          of the revolving  note from variable rate debt to fixed rate debt with
          a rate of 6.88% at November 30, 1998. The notional  amount of the Swap
          was $50,000,000 at November 30, 1998.

                  Interest of $12,369,000,  $20,628,000 and $12,746,000 was paid
         in fiscal 1998, 1997 and 1996, respectively.

                  The  Company is subject to various  debt  covenants  under the
         Facility,  Notes and German Facility including affirmative and negative
         covenants  which require the  maintenance of certain ratios for maximum
         leverage,  fixed charge coverage and interest  coverage.  Additionally,
         such covenants place certain  restrictions on the Company's  ability to
         engage in mergers and acquisitions and incur additional indebtedness.



<PAGE>

7. Income Taxes

Income tax expense for the years ended November 30 is comprised of the following
components (in thousands):

                                          1998           1997          1996
         --------------------------------------------------------------------
         Current expense:
            Federal                     $12,757        $10,612        $ 7,204
            Foreign                       7,290          7,674          4,736
            State                         2,358            697          1,328
                                        -------        -------        -------
                                         22,405         18,983         13,268
         Deferred expense (credit):
            Federal                         593          2,818          1,829
            Foreign                        (139)           210           (119)
            State                             8          1,057            384
                                        -------        -------        -------
                                            462          4,085          2,094
                                        -------        -------        -------
                                        $22,867        $23,068        $15,362
                                        =======        =======        =======

         A  reconciliation  of the statutory U.S.  federal rate to the effective
income tax rate for the years ended November 30 is as follows:
<TABLE>
<CAPTION>

                                                        1998            1997           1996
         -----------------------------------------------------------------------------------
<S>                                                     <C>             <C>             <C>  
         Statutory U.S. federal income tax rate         35.0%           35.0%           35.0%
         Increase resulting from:
            Goodwill                                     3.6             3.9             4.1
            State income taxes, net of 
               federal income tax benefit                2.8             2.3             3.3
            Foreign                                      1.8             2.2             1.3
            Other items                                 (1.2)            1.7             1.3
                                                        ----            ----            ---- 
         Effective income tax rate                      42.0%           45.1%           45.0%
                                                        ====            ====            ==== 
</TABLE>

         Deferred income taxes are recorded based upon  differences  between the
financial statement and tax basis of assets and liabilities.

         The deferred tax assets and  liabilities  recorded on the balance sheet
at November 30 are as follows (in thousands):

                                                             1998        1997
         -----------------------------------------------------------------------
         Deferred tax assets:
            Goodwill and intangibles                       $ 1,279      $ 1,426
            Employee benefits                                5,565        6,467
            Accounts receivable, inventory and other        13,839       13,937
                                                           -------      -------
                                                            20,683       21,830
         Deferred tax liabilities:
            Property and equipment                           5,526        7,709
            Pension                                          3,068        2,099
                                                           -------      -------
                                                             8,594        9,808
                                                           -------      -------
         Net deferred tax assets                           $12,089      $12,022
                                                           =======      =======

     No  provision  has been  made  for U.S.  federal  income  taxes on  certain
undistributed  earnings  of foreign  subsidiaries  that the  Company  intends to
permanently invest or that may be remitted tax-free.  The total of undistributed
earnings that would be subject to federal  income tax if remitted under existing
law is  approximately  $16,000,000  at November 30, 1998.  Determination  of the
unrecognized deferred tax liability related to these earnings is not practicable
because of the complexities with its hypothetical calculation. Upon distribution
of these  earnings,  the Company will be subject to U.S.  taxes and  withholding
taxes payable to various foreign governments. A credit for foreign taxes already
paid would be available to reduce the U.S. tax liability.

     Income taxes of $21,800,000, $20,500,000 and $20,177,000 were paid in 1998,
1997 and 1996, respectively.
<PAGE>

8. Capital Stock

The Company has two  classes of common  stock,  Class A stock and Class B stock.
Authorized  shares of Class A and Class B stock are  97,000,000  and  3,000,000,
respectively.  The limited  voting rights of Class A  shareholders  are equal to
voting  rights of Class B  shareholders  only with  regard to voting for merger,
consolidation  or  dissolution  of the  Company  and  voting and  electing  four
directors of the Company if there are ten or more directors and two directors if
there are nine or fewer directors. With respect to all rights other than voting,
Class A shareholders are the same as Class B shareholders.

     The terms of the Class B stock,  which is held only by  employees,  provide
that these shares be exchanged for Class A stock on a share-for-share basis when
the  shareholder  ceases to be an  employee or decides to dispose of the shares.
Accordingly,  3,000,000 shares of authorized Class A stock are reserved for this
purpose.

     On January 12, 1996, the Company's board of directors ("Board") declared a
dividend of one purchase right for each outstanding share of Class A and Class B
stock. In addition, one right is distributed for each share issued after January
26,  1996.  Upon  exercise,  each right  entitles  holders to purchase  from the
Company one share of stock at $55 per share, subject to certain adjustments. The
rights become exercisable when a person or group acquires  beneficial  ownership
of 15  percent or more of Class A stock or becomes  the  beneficial  owner of an
amount  of  Class A stock  (but  not  less  than 10  percent)  which  the  Board
determines to be substantial and not in the Company's best long-term  interests
or following the  announcement  of a tender or exchange offer for 30% or more of
the Class A stock.

     In the event a person  acquires 15 percent or more of Class A stock,  or is
determined by the Board to be a substantial  owner whose ownership is not in the
Company's  best long-term  interests or an acquiring  person engages in certain
self-dealing  transactions,  each  holder  will have the right to  receive  that
number of common shares having a market value of two times the exercise price of
the right.  At any time after a person becomes an acquiring  person,  but before
such person acquires 50 percent or more of outstanding  Class A stock, the Board
may exchange each right for one common share (subject to adjustment).

     In the event the  Company  is  involved  in  certain  business  combination
transactions,  or 50 percent or more of the  Company's  consolidated  assets or
earning  power are sold,  each  holder  will  have the  right to  receive,  upon
exercise at the then-current  exercise price of the right, that number of shares
of common stock of the acquiring  company having a market value of two times the
exercise price of the right.

     The  Company may redeem the rights at a price of $.01 per right at any time
prior to the time a person or group  becomes an  acquiring  person as defined by
the rights agreement. The rights expire in January, 2006.

     A summary of shares issued and held in treasury follows (in thousands):
<TABLE>
<CAPTION>


                                                                    Capital Stock                  Capital Stock
                                                                       Issued                    Held in Treasury
                                                              Class A          Class B        Class A         Class B
         -----------------------------------------------------------------------------------------------------------
<S>                                                           <C>               <C>           <C>               <C>
         Balance at December 1, 1995                          26,903            540           4,754             187
              Class A exchanged for Class B                       -              -               78             (78)
              Class B exchanged for Class A                       -              -              (54)             54
              Stock options exercised                            281             -               32              28
                                                              ------            ---           -----             ---
         Balance at November 30, 1996                         27,184            540           4,810             191
              Class A exchanged for Class B                       -              -              106            (106)
              Class B exchanged for Class A                       -              -              (22)             22
              Stock options exercised                            490             -               29              75
                                                              ------            ---           -----             ---
         Balance at November 30, 1997                         27,674            540           4,923             182
              Class A exchanged for Class B                       -              -               92             (92)
              Class B exchanged for Class A                       -              -               (9)              9
              Acquisition for treasury                            -              -               39              - 
              Stock options exercised                            151             -               37              12
                                                              ------            ---           -----             ---
         Balance at November 30, 1998                         27,825            540           5,082             111
                                                              ======            ===           =====             ===
</TABLE>

         Changes in the capital  stock  components of  shareholders'  equity are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
                                                                                                            Cost of
                                                                  Capital Stock                             Capital
                                                                 (Stated Amount)           Additional      Stock in
                                                             Class A          Class B        Capital       Treasury
         -----------------------------------------------------------------------------------------------------------
<S>                                                          <C>              <C>           <C>             <C>    
         Balance at December 1, 1995                         $14,947          $ 300         $73,450         $31,057
              Stock options exercised                            156             -            1,828             968
              Disqualifying disposition
              of stock options                                    -              -              155              - 
                                                              ------            ---           -----             ---
         Balance at November 30, 1996                         15,103            300          75,433          32,025
              Stock options exercised                            272             -            3,834           2,119
              Disqualifying disposition
              of stock options                                    -              -              150              - 
                                                              ------            ---           -----             ---
         Balance at November 30, 1997                         15,375            300          79,417          34,144
              Stock options exercised                             84             -            1,820           1,018
              Disqualifying disposition
              of stock options                                    -              -              653              - 
              Acquisition for treasury                            -              -               -              730
                                                             -------          -----         -------         -------
         Balance at November 30, 1998                        $15,459          $ 300         $81,890         $35,892
                                                             =======          =====         =======         =======
</TABLE>


     Incentive stock option plans entitle certain directors,  officers and other
key employees to buy shares of Class A stock at prices not less than fair market
value on the date of grant. The options vest and become exercisable ratably over
a three-year period commencing two years after the date of grant and expire five
or ten years after the date of grant.  Certain  options  are granted  with stock
appreciation  rights (SAR) and reload options. An SAR entitles the option holder
to receive a cash payment equal to the  difference  between the option price and
the current value of Class A stock. The reload option entitles the option holder
to the same number of options  exercised  with an option price equal to the fair
market value at the date of  exercise.  Shares  reserved  under these plans were
1,931,420 and 2,109,310 at November 30, 1998 and 1997, respectively.

     A summary of stock option activity for the years ended November 30 follows:

                                                                Weighted
                                                                 Average
                                                 Number of      Exercise
                                                  Shares          Price
--------------------------------------------------------------------------------
         Balance at December 1, 1995           1,198,880         $  9.64
              Grants                             311,304           12.88
              Exercised                         (280,962)           7.06
              Terminated                         (16,932)          10.84
                                               ---------         -------
         Balance at November 30, 1996          1,212,290           11.05
              Grants                              77,072           18.43
              Exercised                         (489,610)           8.39
              Terminated                         (10,250)          13.39
                                               ---------         -------
         Balance at November 30, 1997            789,502           13.39
              Grants                             460,022           18.84
              Exercised                         (151,233)          12.60
              Terminated                         (37,975)          17.41
                                               ---------         -------
         Balance at November 30, 1998          1,060,316         $ 15.72
                                               =========         =======


<PAGE>

8. Capital Stock, continued

At November 30, 1998 the range of exercise prices and weighted-average remaining
contractual  life of  outstanding  options  were  $12.25 - $21.63 and 5.4 years,
respectively.  At November 30, 1998 and 1997, the number of options  exercisable
was 340,000 and 279,000 respectively, and the weighted-average exercise price of
those options was $13.49 and $12.93, respectively.

     Statement  of  Financial  Accounting  Standards  No. 123,  "Accounting  for
Stock-Based Compensation",  (SFAS 123) became effective for the Company in 1997.
SFAS 123 permits companies to continue to apply APB Opinion 25,  "Accounting for
Stock Issued to Employees"  (APB 25) and related  Interpretations  in accounting
for  its  plans.   The  Company  has  elected  to  follow  APB  25  and  related
Interpretations.  Under APB 25,  because the  exercise  price of the  Company's
employee  stock  options is not less than fair market  price of the share at the
date  of  grant,  no  compensation   expense  is  recognized  in  the  financial
statements.

     Pro forma  information  regarding  net  income  and net income per share is
required by SFAS 123 and has been determined as if the Company accounted for its
employee stock options using the fair value method of that Statement.

     The fair  value  of  options  was  estimated  at the date of grant  using a
Black-Scholes   option   pricing  model  with  the  following   weighted-average
assumptions for 1998, 1997 and 1996,  respectively:  risk-free  interest rate of
4.7%, 5.8%, and 6.0%; dividend yields of 1.9% for all years;  volatility factors
of the  expected  market price of the  Company's  Class A stock of .27, .30 and
 .32; and a weighted average expected life of options of 5.2 years, 4 years and 4
years.

     For  purposes  of pro forma  disclosure,  the  estimated  fair value of the
options  is  amortized  to  expense  over  the  option's  vesting  period.  The
Company's  pro forma  information  follows (in  thousands  except for per share
amounts):

<TABLE>
<CAPTION>
                                                    1998             1997            1996
-----------------------------------------------------------------------------------------
<S>                                               <C>             <C>             <C>    
         Pro forma net income                     $30,924         $27,608         $18,439
         Pro forma net income per share:
            Basic                                 $  1.34         $  1.20         $   .81
            Diluted                                  1.32            1.18             .79
         Weighted-average fair value
         of options granted during the year       $  5.76         $  4.93         $  3.71
</TABLE>

     Due to the required phase-in  provisions,  the effects of applying SFAS 123
to  arrive  at the above pro  forma  amounts  may not be  representative  of the
expected  effects  on pro forma net  income  or net  income  per share in future
years.


9. Geographic Information
The Company  maintains  operations in the United  States as well as Canada,  the
United Kingdom,  Germany,  Taiwan,  Malaysia,  China,  Ireland and Australia.  A
summary of  geographic  data for the years  ended  November 30 is as follows (in
thousands):

<TABLE>
<CAPTION>
                                                            1998             1997            1996
----------------------------------------------------------------------------------------------------
         Net sales to unaffiliated customers:
<S>                                                       <C>              <C>              <C>     
             United States                                $488,703         $491,973         $423,753
             Outside U.S., excluding U.S. exports          130,299          109,323           85,223
                                                          --------         --------         --------
             Consolidated                                 $619,002         $601,296         $508,976
                                                          ========         ========         ========

         Operating income:
             United States                                $ 50,942         $ 51,150         $ 42,463
             Outside U.S.                                   21,089           18,984           15,110
             Restructuring charge                               -                -            (9,607)
                                                          --------         --------         --------
             Consolidated                                 $ 72,031         $ 70,134         $ 47,966
                                                          ========         ========         ========

         Total assets:
             United States                                $430,081         $453,456         $473,957
             Outside U.S.                                   87,165           49,007           48,325
             Eliminations (deductions)                        (761)            (668)            (422)
                                                          --------         --------         --------
             Consolidated                                 $516,485         $501,795         $521,860
                                                          ========         ========         ========

</TABLE>

10. Quarterly Results of Operations (Unaudited)

Quarterly results of operations are summarized as follows (in thousands,  except
per share data):

<TABLE>
<CAPTION>

                                                           Quarter Ended
         1998                       Feb. 28          May 31           Aug. 31         Nov. 30
         -------------------------------------------------------------------------------------
<S>                                <C>              <C>              <C>              <C>     
         Net sales                 $143,334         $159,198         $159,345         $157,125
         Gross profit                53,431           61,794           61,752           62,384
         Net income                   5,140            8,715            8,674            9,050
         Net income per share
            Basic                       .22              .38              .37              .39
            Diluted                     .22              .37              .37              .39


                                                           Quarter Ended
         1997                       Feb. 28          May 31           Aug. 31         Nov. 30
         -------------------------------------------------------------------------------------
         Net sales                 $142,160         $154,238         $150,904         $153,994
         Gross profit                52,048           59,193           57,072           59,968
         Net income                   4,710            7,401            7,679            8,305
         Net income per share
            Basic                       .21              .32              .33              .36
            Diluted                     .20              .32              .33              .35

</TABLE>

Report of Independent Auditors


Shareholders and Board of Directors
Lilly Industries, Inc.

We  have  audited  the  accompanying   consolidated   balance  sheets  of  Lilly
Industries,  Inc. and  subsidiaries  as of November  30, 1998 and 1997,  and the
related  consolidated  statements of income and retained earnings and cash flows
for each of the  three  years in the  period  ended  November  30,  1998.  These
financial  statements are the responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits  provide a reasonable  basis for our opinion.  

     In our opinion,  the financial statements referred to above present fairly,
in  all  material  respects,   the  consolidated  financial  position  of  Lilly
Industries,  Inc.  and  subsidiaries  at  November  30,  1998 and 1997,  and the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended November 30, 1998, in conformity  with generally
accepted accounting principles.




/s/ Ernst & Young LLP
Indianapolis, Indiana
January 15, 1999




Responsibility for Financial Statements
--------------------------------------------------------------------------------
The management of Lilly  Industries,  Inc. is responsible for the preparation of
the  financial  statements  in the  Annual  Report  and  for the  integrity  and
objectivity of the  information  presented.  The financial  statements have been
prepared  in  conformity  with  generally  accepted  accounting  principles  and
necessarily  include amounts which are estimates and judgments.  The fairness of
the  presentation  in these  statements  of the  Company's  financial  position,
results of operations and cash flows is reported on by the independent auditors.

     To assist  in  carrying  out the  above  responsibility,  the  Company  has
internal systems which provide for selection of personnel, segregation of duties
and the  maintenance  of accounting  policies,  systems,  procedures and related
controls.

     Although no cost-effective system can insure the elimination of errors, the
Company's  systems  have been  designed to provide  reasonable  but not absolute
assurances  that  assets are  safeguarded,  that  policies  and  procedures  are
followed,  and that the financial  records are adequate to permit the production
of reliable financial statements. The Audit Committee of the Board of Directors,
which is  composed  of  directors  who are not  employees  of the Company or its
subsidiaries,  meets regularly with Company officers and independent auditors in
connection with the adequacy and integrity of the Company's  financial reporting
and internal controls.



/s/ John C. Elbin                                    /s/ Kenneth L. Mills
John C. Elbin                                        Kenneth L. Mills
Vice President, Chief Financial Officer              Corporate Controller and
and Secretary                                        Assistant Secretary


<PAGE>

Investor Information

Form 10-K
--------------------------------------------------------------------------------
A copy of the Form  10-K,  which  is filed  with  the  Securities  and  Exchange
Commission,  will be sent free to any shareholder upon written request.  Contact
Kenneth  L.  Mills,  Corporate  Controller  and  Assistant  Secretary,  at Lilly
Industries,  Inc.  733  S.  West  Street  Indianapolis,  IN  46225;  or  E-mail:
millsk@lillyindustries.com.

Registrar and Transfer Agent
--------------------------------------------------------------------------------
Communications concerning shareholder records,  including address changes, stock
transfers,  cash  dividends or other  service needs should be directed to Harris
Trust and Savings Bank, Attn:  Shareholder Services,  311 W. Monroe Street, 11th
Floor, P. O. Box A3504 Chicago, Illinois 60690 (800) 942-5909 or (312) 461-6001.

Dividend Reinvestment Plan
--------------------------------------------------------------------------------
A dividend  reinvestment and voluntary stock purchase plan for Lilly Industries,
Inc.  shareholders  permits  purchase  of the  Company's  Class A stock  without
payment of brokerage commission or service charge. Participants in this plan may
have cash  dividends  on their  shares  automatically  reinvested  and,  if they
choose, invest by making optional cash payments.  Additional  information on the
plan is available by writing or calling:  Harris Trust and Savings  Bank,  Attn:
Dividend  Reinvestment 311 W. Monroe Street,  2nd Floor P. O. Box A3309 Chicago,
Illinois 60690 (800) 942-5909.

Analyst Contacts
--------------------------------------------------------------------------------
Security  analyst  inquiries  are  welcomed.  Please call:  John C. Elbin,  Vice
President, Chief Financial Officer, and Secretary (317) 687-6703.

Annual Meeting
--------------------------------------------------------------------------------
The meeting notice and proxy  materials were mailed to  shareholders  with their
copies of this annual report. Lilly urges all shareholders to vote their proxies
and thus  participate in the decisions that will be made at the annual  meeting.
The meeting  will be held on  Thursday,  April 22,  1999 at 10:00 A.M.,  EST, in
rooms 101 and 102 at the Indiana Convention Center and RCA Dome in Indianapolis,
Indiana.

Stock Trading and Dividend Information
--------------------------------------------------------------------------------
The Company's  Class A stock is traded on the New York Stock  Exchange under the
symbol LI. Dividends are traditionally  paid on the 1st business day of January,
April,  July and October to  shareholders  of record  approximately  three weeks
prior.  The following table sets forth the dividends paid per share of stock and
the high and low  prices in each of the  quarters  in the past two  years  ended
November 30.

                                        Dividends           Price Range
         Fiscal 1998                    Per Share       High          Low
         --------------------------------------------------------------------
         1st quarter ended Feb. 28       $  .08         $ 20 5/8      $ 17 7/8
         2nd quarter ended May 31           .08           22 3/4        17 3/4
         3rd quarter ended Aug. 31          .08           24 5/8        18 1/2
         4th quarter ended Nov. 30          .08           19 7/8        14 3/8
                                         ------
                                         $  .32
                                         ======

                                        Dividends           Price Range
         Fiscal 1997                    Per Share       High          Low
         --------------------------------------------------------------------
         1st quarter ended Feb. 28       $  .08         $ 20         $ 17
         2nd quarter ended May 31           .08           21           16 3/4
         3rd quarter ended Aug. 31          .08           24 1/8       19 3/4
         4th quarter ended Nov. 30          .08           22 1/2       17 7/8
                                         ------
                                         $  .32
                                         ======
<PAGE>


   At November 30, 1998 there were approximately  2,400 registered  shareholders
of Class A stock  and 63  registered  shareholders  of  Class B stock,  which is
reserved for employees of the Company.


Locations

International
-------------------------------------------
Australia
283 Alfred Street
North Sydney, NSW 2060
Australia

Canada
1915 Second Street West
Cornwall, Ontario K6H 5T1
Canada

65 Duke Street
London, Ontario N6J 2X3
Canada

China
Lot 3 Xintang 
District Administration
Dalinshan, Dongguan
Guangdon, China 511774

England
152 Milton Park
Abingdon
Oxfordshire OX14 4SD
England

Germany
D-8649 Wallenfels
Postfach 1126
Germany

Friedensstrasse 40
D-52249 Eschweiler
Germany

Ireland
Willowfield Road
Ballinamore
Co. Leitrim
Ireland

Malaysia
Lot No. 4963, Jalan Teratai
51/2 Miles Meru Industrial Zone
41050 Klang 
Selangor Darul Ehsan
Malaysia

Mexico
Ave. Central No. 223
Los Lermas, Guadalupe
N.L. Mexico 67190


<PAGE>

Singapore
09-09 International Building
360 Orchard Road
Singapore

Taiwan, R.O.C.
No. 1 Kung Yeh First Road
Zenwu Village
Kaohsiung Hsien
Taiwan, R.O.C.

United States
-------------------------------------------
Alabama
1771 Industrial Road Dothan, AL 36303

Arkansas
1900 E. 145th Street Little Rock, AR 72206

California
210 East Alondra Blvd. Gardena, CA 90248

901 West Union Street Montebello, CA 90640

Connecticut
145 Dividend Road Rocky Hill, CT 06067

15 Lunar Drive Woodbridge, CT 06525

Florida
2355 S.W. 66th Terrace Davie, FL 33317

Illinois
5400 23rd Avenue Moline, IL 61265

Indiana
28335 Clay Street Elkhart, IN 46517

546 W. Abbott Street Indianapolis, IN 46225

Kentucky
347 Central Avenue Bowling Green, KY 42101

Michigan
411 Darling Street, N. Fremont, MI 49412

4999 36th Street, SE Grand Rapids, MI 49512

Missouri
1136 Fayette N. Kansas City, MO 64116

New Jersey
1991 Nolte Drive Paulsboro, NJ 08066

North Carolina
10300 Claude Freeman Drive Charlotte, NC 28262

2147 Brevard Road High Point, NC 27263

1717 English Road High Point, NC 27262

Texas
2518 Chalk Hill Road Dallas, TX 75212

Washington
13535 Monster Road Seattle, WA 98178

Corporate Offices
-------------------------------------------
733 S. West Street
Indianapolis, Indiana 46225

Corporate Technology Center
521 W. McCarty Street
Indianapolis, Indiana 46225
<PAGE>

Officers and Directors


Officers
-------------------------------------------
Douglas W. Huemme, 57
Chairman, President and
Chief Executive Officer

Robert A. Taylor, 44
Executive Vice President and
Chief Operating Officer

Hugh M. Cates, 55
Vice President and General Manager,
Wood Coatings

Larry H. Dalton, 51
Vice President,
Manufacturing and Engineering

Alain DeBlandre, 42
Vice President and Managing Director - Europe

William C. Dorris, 55
Vice President, Corporate Development

John C. Elbin, 45
Vice President, Chief Financial Officer and Secretary

Ned L. Fox, 57
Vice President, Supply Chain Management

A. Barry Melnkovic, 41
Vice President, Human Resources

John D. Million, 56
Vice President and Managing Director- Asia Pacific

Kenneth L. Mills, 50
Corporate Controller and
Assistant Secretary

Gary D. Missildine, 57
Vice President and General Manager,
Industrial Coatings

Virgil E. Underwood, 47
Vice President and General Manager,
Coil Coatings

Keith C. Vander Hyde, Jr., 40
Vice President and General Manager,
Specialty

Jay M. Wiegner, 55
Vice President and General Manager,
Composites and Glass Coatings

<PAGE>

Directors
-------------------------------------------
James M. Cornelius,
Chairman, Guidant Corporation

William C. Dorris,
Vice President, Corporate Development

Paul K. Gaston,
Former Chairman, Guardsman Products, Inc.

Douglas W. Huemme,
Chairman, President and
Chief Executive Officer

Harry Morrison, Ph.D.,
Dean, School of Science
Purdue University

Norma J. Oman,
President and
Chief Executive Officer
Meridian Insurance Group, Inc.

John D. Peterson,
Chairman, City Securities Corporation

Thomas E. Reilly, Jr.,
Chairman and Chief Executive Officer
Reilly Industries, Inc.

Van P. Smith,
Chairman, Ontario Corporation

Robert A. Taylor,
Executive Vice President and
Chief Operating Officer

[photo of Directors]