<PAGE>
                                                                      Exhibit 13


Message from Zan Guerry
Chairman and CEO of Chattem


     Last year I reported to you that 1997 was quite simply the best year in 
Chattem's 119 year history.  Led by two large acquisitions, a 56% increase in 
diluted earnings per share before product divestitures and extraordinary 
items and strong performances from several key brands, 1998 quickly replaced 
1997 as the greatest year in our history.

     These two amazing years are the result of major accomplishments by our
managers, our strong advertising support for our brands, the continued success
of our acquisition program and no small dose of good fortune.

                                   1998 HIGHLIGHTS

     1998 could well be labeled the year of acquisitions.  During the 
calendar year we acquired BAN, DEXATRIM, ASPERCREME, SPORTSCREME, CAPZASIN-H 
and -HP, and ARTHRITIS HOT, which had combined annual sales of approximately 
$150 million, which is more than our total sales for 1997.  Included in this 
year's results are eight months of BAN sales but none for the other brands 
which we acquired just after our fiscal year end.  For 1999, we will have a 
full year of BAN and eleven months of the other brands which means total 
sales should exceed $300 million.

     Specifically, for 1998, sales rose 54% to $220 million while diluted 
earnings per share, before product divestitures and extraordinary items, 
increased 56% to $1.25. Our earnings per share for the last four years are 
$.32, $.47, $.80 and $1.25, which represent a compound annual growth rate of 
57%.  Given a forecasted increase in earnings per share of about 80% for 
1999, this is truly a remarkable period of dynamic growth for Chattem.

     For 1998, this growth was led by BAN, a full year of SUNSOURCE and strong
performances from GOLD BOND, PAMPRIN, GARLIQUE and BULLFROG.

     In addition to these accomplishments, we continue to invest in our 
brands' future by spending approximately 40% of sales behind advertising and 
promotional programs to build market share.

                            1999:  THE MOMENTUM CONTINUES

     Even more important than the strong 1998 results, I am excited to report 
to you our great enthusiasm for 1999.  We have numerous major initiatives for 
our brands which hopefully will continue our momentum.  These programs 
include the first full year of GOLD BOND Medicated Lotion; the launch of GOLD 
BOND Triple Antibiotic Ointment; dynamic new BAN packaging plus two new BAN 
products; the introduction of REPOSE, a new SUNSOURCE product; and the launch 
of FLEXALL QUIKGEL and PHISODERM 4 Way Daily Acne Cleanser.  Finally, we will 
have new advertising campaigns for our newly acquired brands, DEXATRIM, 
SPORTSCREME, ASPERCREME and CAPZASIN-P and -HP.

     Overall 1999 will be a tremendously challenging and exciting year as it 
represents an unprecedented year of new products.  The following are some 
brief highlights of these introductions:

     GOLD BOND Medicated Lotion was introduced in mid-1998 with advertising 
starting in the Fall.  From the start we have had great expectations for 
GOLD BOND Medicated Lotion.  It was the most extensively researched product 
introduction in our history and all research showed outstanding potential of 
a $25 million plus brand.  We are entering the major category of hand and 
body lotion with a unique point of difference in terms of itch relief and 
skin protection.  We have launched this product with annual advertising and 
promotion spending measuring in excess of $15 million.  So far our 
expectations for this exciting product are coming through.  Although it is 
still early, retail sales data supports a major success.

<PAGE>

     BAN will have a brand new look in 1999 with dynamic new packaging that will
significantly increase the presence of BAN at retail.  In addition, we will
launch two significantly unique new products, BAN Ultra Dry Roll-On and BAN
Ultra Dry Stick.  The Ultra Dry Roll-On will be the first roll-on to go on dry. 
Ultra Dry Stick will be the only stick deodorant that goes on dry and is clear.

     REPOSE Stress Relief Formula could be the most exciting herbal introduction
by SUNSOURCE.  With 75% of Americans suffering from stress and stress related
symptoms, the market is huge.  REPOSE brings a multidimensional formula to
stress relief.  REPOSE contains kava and magnesium for rapid relaxation and
assorted vitamins, minerals and herbs for longer term relief.  REPOSE will be
backed by a major multimillion dollar marketing campaign starting this summer.

     FLEXALL QUIKGEL represents a truly breakthrough technology in the topical
analgesic category.  The product is completely greaseless and vanishes quickly
while promoting fast pain relief, and will be supported by commercials 
featuring football star Joe Montana.

     Other new products to be launched in 1999 are PHISODERM 4 Way Daily Acne
Cleanser, an opportunity to extend the well known PHISODERM name into the acne
category; SUN-IN Super Streaks, a unique new form to deliver SUN-IN highlights
in a gel form; and MUDD Aromatherapy Deep Cleanser, a revolutionary self
heating product;  BULLFROG MAGICBLOCK, a disappearing color sun block which 
should increase BULLFROG'S share of the exciting, fast growing children's 
sunblock segment; and GOLD BOND Triple Antibiotic Ointment which affords an 
opportunity to leverage the unique itch relief heritage of GOLD BOND in the 
first aid category.


<PAGE>

                                STRATEGIC PERSPECTIVE

     The last several years have elevated Chattem to a new level.  Our goal 
is to take advantage of our increased size and financial capabilities.  We 
have proven that we can make sizable acquisitions and assimilate them with 
significant positive impact on earnings per share.

     During the early part of 1999 we will be digesting our recent acquisitions
and focusing on new product launches.  However, by mid-year we should be
aggressively looking for significant acquisition opportunities to move toward
$500 million in sales.

     The remarkable results achieved in 1998 and the exciting prospects for 1999
could not be achieved without the equally remarkable effort of our people.  We
ask much of all of our employees, particularly when we make an acquisition or
launch a new brand.  We have been able to achieve our strong growth without any
significant increase in headcount, as evidenced by selling, general and
administrative expense margin which has declined from 21% to 12% over the past
four years.  I am indebted to each of our employees for their dedication to our
business.



<PAGE>

CHATTEM CONSUMER PRODUCTS



DOMESTIC PRODUCT OVERVIEW

OTC HEALTH CARE PRODUCTS

MEDICATED SKIN PRODUCTS

GOLD BOND is America's number one medicated powder brand in the $65 million 
powder category and has successfully extended beyond its flagship Medicated 
Body Powder line into other skin care segments.  GOLD BOND Cream is one of 
the fastest growing brands in the $170 million anti-itch cream market.  
Introduced in 1997, both GOLD BOND Foot Powder and GOLD BOND Cornstarch Plus 
Medicated Baby Powder have added incremental sales to the franchise.  In 
mid-1998, GOLD BOND entered the $1 billion hand and body lotion category with 
GOLD BOND Medicated Body Lotion, a unique product that shows promise for 
significant growth.  Looking to 1999, the Company plans to further expand the 
franchise with the introduction of GOLD BOND Triple Antibiotic Ointment.  
GOLD BOND will continue to benefit from record levels of advertising and 
promotional support.

<PAGE>

TOPICAL ANALGESICS

The Company competes in the $217 million topical analgesic category with its
FLEXALL and ICY HOT brands.  On December 21, 1998, after the end of the fiscal
year, Chattem acquired the ASPERCREME, SPORTSCREME, CAPZASIN-P, CAPZASIN-HP and
ARTHRITIS HOT topical analgesics from Thompson Medical Company, Inc.  As a
result of this acquisition, Chattem will be the leader in the external analgesic
category  with approximately a 38% share, compared to an approximately 20% share
for the next closest competitor.  BENZODENT competes in the $62 million internal
irritation segment of the topical oral analgesic category.

FLEXALL  is an aloe-based topical analgesic clinically proven to provide long
lasting relief for arthritis and other muscle and joint pain.  The brand's
current product line includes Original Vitamin E Enriched and Maximum Strength
FLEXALL, which contain menthol, as well as Ultra Plus which contains three
active ingredients:  menthol, methyl salicylate and camphor.  In 1999, a new
line extension will be added with the introduction of  FLEXALL QUIKGEL.  The
product is completely greaseless and vanishes quickly while promoting fast pain
relief.  The entire FLEXALL line will be supported by a new advertising campaign
featuring Joe Montana.

ICY HOT offers the most complete product form line-up in the category with a
cream, a balm and the unique CHILL STICK.  Further, consumer research continues
to indicate that the brand's distinctive Icy and Hot Therapy for Pain
positioning enjoys high awareness and is viewed as the most compelling in the
category.

BENZODENT, a topical oral analgesic, is the only brand positioned to be 
applied directly to dentures to relieve pain.  The product contains the 
maximum amount of benzocaine allowable and is widely recommended by dentists.
Marketing efforts are focused on providing samples to consumers when they 
are initially fitted for dentures, the point of entry for the category.

INTERNAL ANALGESICS

The Company competes in the $65 million menstrual pain relief category with its
PAMPRIN and PREMSYN PMS brands.  NORWICH aspirin competes in the general
analgesics category.

PAMPRIN and PREMSYN PMS combined outsell any other OTC premenstrual internal
analgesic in the market based on units sold.  PAMPRIN, the number two brand in
the menstrual analgesics category, is a combination drug specifically designed
for relief of menstrual symptoms.  Multi-symptom PAMPRIN effectively relieves
multiple menstrual discomforts with three active ingredients.  Maximum Pain
Relief PAMPRIN is formulated to provide superior cramp relief and is the only
cramp relief product with two pain relievers.  Maximum Strength PREMSYN PMS,
the third largest brand in the category, effectively relieves the physical and
emotional symptoms of PMS.

NORWICH, a high-quality, reasonably priced aspirin, complements Chattem's
other OTC healthcare products.  This brand principally focuses its sales and
marketing support in the northeast, midwest and west coast.

<PAGE>

Chattem competes in the $32 million cold sore market with HERPECIN-L. In 1998 
three major new initiatives were undertaken:  the stick product was 
reformulated, a jar line extension was launched and a national radio 
advertising plan was begun.  The new stick and jar contain a skin protectant 
and several sun block ingredients.  Since the middle of 1998 sales of this 
brand have increased 19%.

DIETARY SUPPLEMENTS

The Company competes in the U.S. nutritional supplement category with its 
SUNSOURCE products: GARLIQUE, HARMONEX, REJUVEX, PROPALMEX, ECHINEX, 
MELATONEX and its newest product, REPOSE Stress Relief Formula. These 
products are distributed primarily through the food, drug and mass 
merchandiser trade channels.

GARLIQUE holds a 16% share of the $87 million garlic category, and is 
presently the number one selling product in the category. Clinical research 
on the benefits of garlic support the position of GARLIQUE as a dietary 
supplement for good cardiovascular health. Larry King is the spokesperson for 
radio advertising of GARLIQUE.

HARMONEX is a unique combination of two herbs: St. John's Wort for emotional 
well-being and Siberian ginseng for physical well-being. HARMONEX competes in 
the St. John's Wort category now selling at the rate of $130 million per 
year. HARMONEX is supported by strong consumer advertising and a public 
relations campaign. HARMONEX is presently the number three selling product in 
the St. John's Wort category, holding a 6.2% share.

REJUVEX is uniquely positioned to support menopausal comfort and healthy 
bones for women in the pre- and post-menopausal age group. REJUVEX is a 
unique natural formula containing a combination of magnesium, vitamins, 
anti-oxidants and other important nutrients, which help meet the changing 
nutritional needs of women.

<PAGE>

PROPALMEX, the top selling brand in the $32 million saw palmetto herbal 
category, holds a 11% share, and is positioned to support prostate health and 
free urinary flow in men over 40.  PROPALMEX is the all-natural, drug-free 
approach to maintenance of a healthy prostate.
 
ECHINEX is a standardized herbal complex of echinacea, ginger and Siberian
ginseng. This unique and effective combination is positioned to support natural
resistance against infection. ECHINEX is a seasonal product that provides added
protection during times of high risk for colds and flu.

The newest addition to the SUNSOURCE line of herbal products is REPOSE Stress
Relief Formula. REPOSE blends kava and magnesium for relaxation with
revitalizing Siberian ginseng to help the body deal with stress effectively.
Vitamins B and C complete the formula by replenishing nutrients that are lost
due to stress. REPOSE will be shipped to the trade in April 1999 and will be
supported by a powerful media and public relations campaign.

The Company competes in the $38 million melatonin category with 
MELATONEX, the third largest melatonin brand.  The brand is positioned to 
support a natural sleep cycle and holds a 10% share of the category. The 
product uses a unique time-release delivery system, releasing melatonin as 
the body does, gradually, while you sleep.  Each tablet of MELATONEX is 
scored so it can easily be divided to provide the desired dosage that 
consumers are looking for.

The Company also competes in the homeopathic category with its line of SUNSOURCE
Traditional Homeopathic Medicines. Sales of homeopathic products through mass
trade channels total $33 million, up 33% from the previous year. SUNSOURCE holds
a 7% share of the category. 

The Company plans to continue the expansion of the SUNSOURCE line of products,
and is presently evaluating new product opportunities for future introduction.


TOILETRIES AND SKIN CARE

ANTIPERSPIRANTS AND DEODORANTS

The Company competes in the $1.7 billion antiperspirant and deodorant category
with BAN.  BAN was acquired from Bristol-Myers Squibb Company in March
1998.  Originally introduced in 1955, BAN is the number one roll-on brand in the
United States.  BAN provides advanced protection from odor and wetness with five
forms - Original Roll-On, Clear Roll-On, White Solid Stick, Clear Solid Stick
and the revolutionary Clear Soft Solid.

The Company believes BAN represents a major growth opportunity and has developed
a strong 1999 marketing plan.  A comprehensive business-building consumer
promotion plan has been developed for 1999, as the antiperspirant and deodorant
category responds well to promotion.  Two major line extensions are being
introduced: 

   * Ultra Dry Roll-On, which is quick drying and non-sticky.  This product
     should help strengthen the number one share of market in the roll-on
     business that BAN currently enjoys.

   * Ultra Dry Solid Stick, which goes on clear and keeps you dry.  While the
     solid stick segment of the category represents over 60% of sales, there
     are no other ultra dry sticks that go on clear.

BAN is being repackaged in the spring of 1999 to provide a more  consistent and
contemporary image and an improved shelf presence.  As a complement to its
strong 1999 marketing plan,  BAN will be supported with a record breaking level
of national television and radio advertising that is comparable with the levels
of the market leaders.

FACIAL CLEANSERS AND MASQUES

Within the skin care category, the Company competes in the $480 million facial
cleanser category with its PHISODERM brand and in the $30 million facial masque
sub-segment with MUDD Spa Treatment Masque products.

PHISODERM is a specialty facial cleanser positioned as the daily prescription 
for healthy skin.  The dermatologist developed, pH balanced formulas are 
available in four different varieties of liquid, a bar product and a 
cleansing puff product.  The liquids are available in Normal to Dry, Normal 
to Oily, Sensitive Skin and for Baby.  In 1998 PHISODERM facial cleansers 
drove consumer awareness as well as solid sales growth through a year round 
testimonial radio campaign.  The effort allowed PHISODERM to claim the 
dominant share of voice for facial cleansers on radio and laid the groundwork 
for expansion in 1999.  In 1999 PHISODERM will introduce contemporary 
packaging and two line extensions:  PHISODERM 4 Way Daily Acne Cleanser, 
which will compete in the $80 million acne cleanser category, and the new 
PHISODERM Kids Bar which targets toddlers with a PHISODERM quality bar in a 
playful, floatable animal soap dish.

In 1998 MUDD focused advertising on promoting its revolutionary 5 Minute 
Masque in print ads in women's magazines. In 1999 MUDD plans two key 
initiatives:  a permanent bonus size in bold new packaging and the new MUDD 
Aromatherapy Self-Heating Deep Cleanser.

SEASONALS

The Company competes in three seasonal product categories:  suncare, spray-on
hair lighteners and chlorine removal haircare.  The Company competes in the $285
million suncare category among products with a sun protection factor (SPF) of
greater than 15 with the BULLFROG Sunblock line.  SUN-IN competes in the $12
million spray-on hair lightener category, while ULTRASWIM Shampoo, Conditioner,
Soap and Shower Gel dominate the small chlorine removal category.

BULLFROG Sunblock is positioned as the ultimate waterproof sunblock and is an 
essential sun protection product for an outdoor active lifestyle. BULLFROG 
Sunblock products are available in ten unique gels and lotions and provide 
all-day protection in or out of the water.  In 1998 BULLFROG enjoyed its 
strongest year ever as a result of strong support by several accounts.  

Across all classes of trade, BULLFROG was the fastest growing high protection 
sunblock, charting retail sales growth in excess of 19%.   In 1998, growth 
was also fueled by the introduction of BULLFROG for Babies SPF 45 and 
BULLFROG SUPERBLOCK SPF 45.  In 1999 BULLFROG will continue the momentum with 
the introduction of BULLFROG MAGICBLOCK SPF 30, a disappearing green lotion 
product, and BULLFROG QUIK STICK SPF 36, which is the highest protection 
product in the lipcare sub-segment of the sun protection category.  BULLFROG 
drives consumer awareness with national radio advertising during an expanded 
summer schedule.

<PAGE>

SUN-IN, which is available in three formulas (Super, Super With Lemon, and for
Men), enjoyed renewed interest by consumers in the spray-on category and strong
brand growth.  In 1998, SUN-IN introduced dramatic new packaging that accented
its leading position in the category and a promotional buy-one-get-one-free
pack.  Both efforts were successful in growing sales by almost 20% at retail. 
In 1999, SUN-IN will capitalize on new levels of consumer interest with an
innovative line extension:  SUN-IN Super Streaks, a hair highlighter in a clear
gel base.  SUN-IN Super Streaks will be advertised through seasonal teen radio
advertising.

ULTRASWIM has been the gold standard for chlorine removal from hair and skin
since its introduction in the early 1980's.  The ULTRASWIM product line includes
shampoo, conditioner, soap and shower gel.  In 1998, ULTRASWIM retained its
leadership position and achieved solid retail sales growth despite a major
competitive product launch.  The key elements of the 1998 program were the
introduction of a sporty new bottle and package graphics, reformulation of the
shampoo and conditioner as ULTRASWIM Shampoo Plus and ULTRASWIM Ultra Repair
Conditioner.  A targeted print advertising campaign to competitive, fitness and
recreational swimmers was also continued in 1998.  Sampling and event marketing
are additional ongoing efforts driving awareness of the ULTRASWIM brand.


INTERNATIONAL MARKET OVERVIEW


EUROPE

Chattem's European business is conducted through Chattem (U.K.) Limited, a 
wholly-owned subsidiary located in Basingstoke, Hampshire, England.  This 
unit also services distributors in Australia and the Middle East.  
Manufacturing and packaging of the products is performed principally in the 
U.K. with a limited number of ingredients purchased from Chattem.  Chattem 
(U.K.) employs its own sales force  in the United Kingdom while exclusive 
distributors are used to market and sell its products on the Western European 
Continent.  Due to the difficulty and expense involved in the registration of 
OTC pharmaceuticals in Europe, the unit markets exclusively the Company's 
toiletry and skin care products.  Chattem's products in Europe include 
SUN-IN, a range of MUDD face and body products, and ULTRASWIM.  CORNSILK is 
sold under a licensing arrangement with another company. SPRAY BLOND Spray-In 
Hair Lightener is only marketed on the continent.

<PAGE>

CANADA

Chattem (Canada) Inc. is a wholly-owned subsidiary based in Mississauga, Ontario
which markets and distributes Chattem's consumer products throughout Canada. 
The manufacturing of the brands is principally done in the Company's facilities
in Chattanooga while some packaging takes place in Mississauga.  The division
utilizes a national broker for its sales efforts.  Brands marketed and sold in
Canada include BAN, GOLD BOND, PAMPRIN, FLEXALL, MUDD, SUN-IN, ULTRASWIM and
PHISODERM.

U.S. EXPORT

The U.S. Export division services various distributors primarily located in the
Caribbean and Central and South America.  The Company sells BAN, ICY HOT, GOLD
BOND, PAMPRIN, MUDD, and PHISODERM into these markets with the primary focus
being the development of its OTC healthcare products.




<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The following analysis of the financial condition and results of operations
should be read in conjunction with the audited consolidated financial statements
and related notes thereto included elsewhere in this Annual Report.

GENERAL
Fiscal 1998 was highlighted by the purchase of BAN, the issuance of $200,000,000
of senior subordinated notes, the sale of CORNSILK and the acquisition of
certain products from Thompson Medical Company, Inc. and related refinancing of
senior debt that occurred shortly after the end of Company's 1998 fiscal year.

On March 24, 1998, the Company acquired the BAN line of antiperspirant and
deodorant products from Bristol-Myers Squibb Company for a purchase price of
approximately $165,000,000, plus assumed liabilities.  The Company acquired the
BAN trademarks, formulae, certain patents pertaining to antiperspirant/deodorant
technology, technical information, inventory, manufacturing equipment and
packaging related assets used in the manufacture of BAN, but not the right to
sell BAN in Japan.


                                           
<PAGE>

Also on March 24, 1998, the Company issued at par value $200,000,000 of  8.875%
Senior Subordinated Notes due 2008 (the "Notes") and entered into an amended and
restated senior secured bank credit agreement.  The proceeds of the Notes
offering were used to fund the BAN purchase and related fees and expenses, repay
revolving bank indebtedness and provide additional working capital.

On May 12, 1998, the Company sold the CORNSILK oil control makeup brand to Del
Laboratories, Inc. for $10,750,000 plus inventories and the assumption of
certain liabilities.  The Company sold, at a gain of $9,548,000, CORNSILK
trademarks, formulae, technical information, inventory and other related assets,
but will continue to operate the CORNSILK business in the United Kingdom
pursuant to a license agreement.  The Company used the net proceeds from the
sale to reduce bank indebtedness.

<PAGE>


During the year ended November 30, 1998, the Company prepaid previously
outstanding long-term bank debt and a portion of its 12.75% Senior Subordinated
Notes.  In connection with the prepayment of those borrowings, the Company
recorded an extraordinary loss of $2,859,000 (net of income taxes), or $.29 per
share.  The loss primarily related to the write-off of debt issuance costs.

The Company experienced an increase in net sales, operating income and income
before  extraordinary loss for the year ended November 30, 1998.  Net sales
increased $76,829,000, or 53.6%, to  $220,064,000 from $143,235,000 in 1997. 
Operating income increased $19,716,000, or 77.3%, to $45,219,000 from
$25,503,000 in 1997.  Income before extraordinary loss increased $10,873,000, or
149.9%, to $18,128,000 from $7,255,000 in 1997.  Net income, which includes
extraordinary charges of $2,859,000 and $1,370,000 in 1998 and 1997,
respectively, relating to the early extinguishment of debt in those respective
years, increased $9,384,000, or 159.5%, to $15,269,000  from $5,885,000 in
fiscal year 1997. 

In fiscal year 1998, earnings per share before extraordinary loss increased
$1.06, or 132.5%, to $1.86 while earnings per share after the extraordinary loss
increased $.92, or 141.5%, to $1.57 when compared to the 1997 fiscal year.


<PAGE>

The results of operations for fiscal year 1998 reflect a full year of operations
of the SUNSOURCE product line, which was acquired in mid-1997, approximately
eight months' operations of the BAN brand, which was purchased in March 1998 and
approximately five and one half months of the CORNSILK brand, which was sold in
May, 1998.

The Company will continue to seek sales increases through a combination of 
acquisitions and internal growth while maintaining high operating income 
levels. As previously high growth brands mature, sales increases will become 
more dependent on acquisitions and the development of successful line 
extensions. During the year ended November 30, 1998, new additions to the 
GOLD BOND (Medicated Lotion), BULLFROG (for Babies and SUPERBLOCK SPF45), 
HERPECIN-L (jar lip balm) and SUNSOURCE (HARMONEX) product lines were 
introduced.

RESULTS OF OPERATIONS

The following table sets forth, for income before extraordinary loss and for the
periods indicated, certain items from the Company's Consolidated Statements of
Income expressed as a percentage of net sales:


<PAGE>



                                              YEAR ENDED NOVEMBER 30,
                                            --------------------------
                                             1998      1997      1996
                                            ------    ------    ------
NET SALES                                   100.0%    100.0%    100.0%
                                            ------    ------    ------
COST AND EXPENSES:
   Cost of sales                              27.7      27.4      29.5
   Advertising and promotion                  39.3      39.2      38.3
   Selling, general and administrative        12.4      15.6      18.2
                                            ------    ------    ------
     Total costs and expenses                 79.4      82.2      86.0
                                            ------    ------    ------

INCOME FROM OPERATIONS                        20.6      17.8      14.0
                                            ------    ------    ------

OTHER INCOME (EXPENSE):
   Interest expense                          (12.1)    (11.1)    (11.3)
   Investment and other income                  .4       1.2       1.2
   Gain on product divestitures                4.3        --        .8
                                            ------    ------    ------
     Total other income (expense)             (7.4)     (9.9)     (9.3)
                                            ------    ------    ------

INCOME BEFORE INCOME TAXES                    13.2       7.9       4.7

PROVISION FOR INCOME TAXES                     4.9       2.8       1.5
                                            ------    ------    ------

INCOME BEFORE EXTRAORDINARY LOSS               8.3%      5.1%      3.2%
                                            ======    ======    ======



FISCAL 1998 COMPARED TO FISCAL 1997

Net sales for the year ended November 30, 1998 increased $76,829,000, or 53.6%,
to $220,064,000 from $143,235,000 for the previous fiscal year.  The increase
consisted of a $71,787,000, or 56.1%, increase in domestic consumer products 
sales from $128,024,000 in 1997 to $199,811,000 in 1998 and an increase of 
$5,042,000, or 33.1%, in international sales to $20,253,000 from $15,211,000.

<PAGE>


For domestic consumer products, sales of the BAN, SUNSOURCE and GOLD BOND
products accounted for the majority of the sales increase in 1998.  Sales
increases were also realized for the PAMPRIN, SUN-IN and BULLFROG brands.  Sales
declines were recognized for FLEXALL, ICY HOT, NORWICH Aspirin, MUDD and
PHISODERM.  The remaining domestic brands were basically flat or had modest
declines over the prior fiscal year.  All sales variances were largely the
result of changes in the volume of unit sales of the particular brands.

The increase in sales of the GOLD BOND brand was due primarily to the 
introduction of the lotion line extension in 1998 and also to growth of the 
existing business.  The sales increases for the PAMPRIN and BULLFROG product 
lines were principally the result of increased marketing expenditures.  Also 
for the BULLFROG brand, the introduction of two new products and a new major 
customer had a favorable impact on that product line's 1998 sales.  The BAN 
brand was acquired in March 1998 and the SUNSOURCE product line was purchased 
in June 1997.

The sales declines for the FLEXALL, ICY HOT, MUDD and PHISODERM brands were
principally the result of decreased advertising and promotional support. 
CORNSILK was sold in May 1998.  The modest sales declines experienced by certain
of the other domestic products were essentially due to increased competition 
in their respective categories, the maturation of these brands and, in 
certain cases, reduced marketing expenditures.

<PAGE>

In fiscal 1998, sales for the international consumer products segment increased
$447,000, or 9.2%, for the Canadian operation and $1,808,000, or 19.5%, for the
United Kingdom business.  The BAN product line accounted for the majority of the
net sales increase in Canada, while increases were also realized for the
PAMPRIN, SUN-IN and GOLD BOND brands.  Sales increases were realized for all of
the product lines marketed by the United Kingdom operation.  U.S. export sales
increased $2,787,000, or 264.8%, to $3,839,000 in 1998 to $1,052,000 in 1997,
with essentially all of the increase being associated with the BAN brand.  All
sales variances were largely the result of changes in the volume of unit sales
of the particular brands.

Cost of goods sold as a percentage of net sales in 1998 was essentially
unchanged at 27.7% versus 27.4% for 1997.  Cost of sales was affected by the
full year favorable impact of the SUNSOURCE line which was slightly more than
offset by the unfavorable impact of the BAN acquisition.

Advertising and promotion expenses increased $30,416,000, or 54.1%, to 
$86,592,000 in 1998 from $56,176,000 in 1997 and were 39.3% of net sales 
compared to 39.2% in 1997.  This increase was principally associated with 
advertising and promotional expenses incurred in connection with the BAN 
product line, acquired in March 1998,  a full year of the SUNSOURCE brands 
and the introduction of GOLD BOND Lotion.  Increases in advertising and 
promotion in 1998 were also recorded for the PAMPRIN and BULLFROG brands.

<PAGE>

Selling, general and administrative expenses increased $5,061,000, or 22.7%, to
$27,364,000 in 1998 from $22,303,000 in 1997, but decreased as a percentage of
net sales to 12.4% in 1998 as compared to 15.6% in 1997.  This dollar increase
was largely associated with increases in direct selling costs, freight, bad
debts and field sales expenses as a result of increased sales from acquired
brands and associated increases in administrative, financial and legal services.

Interest expense increased $10,742,000, or 67.4%, to $26,676,000 in 1998 from
$15,934,000 in 1997 primarily as a result of increased indebtedness associated
with the BAN product acquisition in March 1998 and the SUNSOURCE brand purchase
in mid-1997.  Interest expense is expected to increase in 1999 due to the full
year impact of the higher debt levels associated with product acquisitions. 
Until the Company's indebtedness is reduced substantially, interest expense will
continue to represent a significant percentage of the Company's net sales.

Investment and other income decreased $798,000, or 47.5%, to $881,000 in 1998
from $1,679,000 in 1997.  The decrease was due primarily to the Company's sale
of a portion of its investment in Elcat, Inc.

A gain of $9,548,000 on the sale of the CORNSILK brand was recognized in 1998.

The provision for income taxes was 37.4% of income before income taxes in 1998
as compared to 35.5% in 1997.  See Note 8 of Notes to Consolidated Financial
Statements.

Income before extraordinary loss increased $10,873,000, or 149.9%, to
$18,128,000 in 1998 from $7,255,000 in 1997.  This increase resulted primarily
from increased sales and the gain on the sale of the CORNSILK brand.


<PAGE>

FISCAL 1997 COMPARED TO FISCAL 1996

For the year ended November 30, 1997, net sales increased $24,332,000, or 20.5%,
to $143,235,000 from $118,903,000 for the previous fiscal year.  This increase
consisted of a $23,580,000, or 22.6%, increase in domestic consumer products
sales from $104,444,000 in 1996 to $128,024,000 in 1997 and an increase of
$752,000, or 5.2%, in international sales to $15,211,000 from $14,459,000.

For domestic consumer products, sales of the GOLD BOND, HERPECIN-L, ICY HOT and
the SUNSOURCE products accounted for the majority of the sales increase in 1997.
Sales increases were also realized for the SUN-IN and MUDD brands.  Sales
declines were recognized for FLEXALL, NORWICH Aspirin, CORNSILK, BULLFROG and
PHISODERM.  The remaining domestic brands were basically flat or had modest
declines over the prior fiscal year.  All sales variances were largely the
result of changes in volume of unit sales of the particular brands.

The increase in sales of the SUN-IN brand was largely the result of increased
marketing support, while the MUDD sales increase was primarily due to the
addition of the 5 Minute Mask to the line in 1997 and the continuing effect of
new packaging in late 1995.  The sales increase of the ICY HOT brand reflected
the line extension launched in early 1997 and a 68.0% increase in advertising
and promotion expenditures in 1997 over 1996.

Sales declines for the remainder of the domestic products were primarily due to
increased competition in their respective product categories, the maturation of
these brands and in most cases reduced marketing support.  The decline in sales
of the BULLFROG brand reflected the loss of a major customer and the cool, wet
spring experienced in 1997.


<PAGE>

In fiscal 1997, sales for the international consumer products' segment increased
$847,000, or 21.0%, for the Canadian operation but declined $252,000, or 2.6%,
for the United Kingdom business.  The GOLD BOND product line accounted for
practically all of the net sales increase in Canada, although increases were
also realized for the remainder of the product lines marketed in that country,
except for ULTRASWIM and CORNSILK. Sales declines were recognized for all of the
product lines marketed by the United Kingdom operation, except for MUDD.  These
sales decreases were largely due to a change in the United Kingdom from a dealer
distribution system to one operated by the Company's U.K. subsidiary in that
country.  U.S. export sales increased $157,000, or 17.5%, in 1997 over 1996,
with essentially all of the increase being associated with the ICY HOT brand. 
All sales variances were largely the result of changes in volume of unit sales
of the particular brands.  

Cost of goods sold as a percentage of net sales in 1997 decreased to 27.4% from
29.5% in 1996.  The decrease was largely the result of a shift in product mix of
sales of domestic consumer products to higher margin products and the addition
of GOLD BOND and SUNSOURCE.

Advertising and promotion expenses increased $10,664,000, or 23.4%, to
$56,176,000 in 1997 from $45,512,000 in 1996 and were 39.2% of net sales
compared to 38.3% in 1996.  This increase was principally associated with the
GOLD BOND and HERPECIN-L brands, which were acquired in 1996; the SUNSOURCE
product line, acquired in mid-1997; and ICY HOT.  Increases in 1997 were also
recorded for the PAMPRIN, PREMSYN PMS, ULTRASWIM and SUN-IN brands.



<PAGE>

Selling, general and administrative expenses increased $721,000, or 3.3%, to
$22,303,000 in 1997 from $21,582,000 in 1996, but decreased as a percentage of
net sales to 15.6% in 1997 as compared to 18.2% in 1996.  This increase was
largely associated with increases in direct selling costs, freight and field
sales expenses, resulting from increased sales, offset in part by reductions in
financial and legal services expenses.

Interest expense increased $2,540,000, or 19.0%, to $15,934,000 in 1997 from
$13,394,000 in 1996 primarily as a result of increased indebtedness associated
with the GOLD BOND and HERPECIN-L product acquisitions in 1996 and the SUNSOURCE
brands' purchase in mid-1997.

Investment and other income increased $229,000, or 15.8%, to $1,679,000  in 1997
from $1,450,000 in 1996.

The provision for income taxes was 35.5% of income before income taxes in 1997
as compared to 32.3% in 1996.  See Note 8 of Notes to Consolidated Financial
Statements.

Income before extraordinary loss increased $3,451,000, or 90.7%, to $7,255,000
in 1997 from $3,804,000 in 1996.  This increase resulted primarily from
increased sales and a more favorable product sales mix with regard to gross
margins in 1997.


<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically financed its operations and acquisitions with a
combination of internally generated funds and borrowings.  The Company's
principal uses of cash are operating expenses, working capital, capital
expenditures, acquisitions and servicing long-term debt.

Cash provided by operating activities was $20,790,000 and $10,116,000 for 1998
and 1997, respectively.  The increase in cash flows from operations from 1997 to
1998 was primarily the result of increases in net income, depreciation and
amortization, accounts receivable, accounts payable and accrued liabilities. 
The operating activities were favorably impacted by the acquisition of the
SUNSOURCE product line in 1997 and the BAN brand in 1998.

Investing activities used cash of  $161,595,000 and $32,722,000 in 1998 and 
1997, respectively.  The use of cash in 1998 reflected the expenditures 
required for the purchase of BAN, while the 1997 amount represented the 
purchase of the SUNSOURCE product line.  In 1998, capital expenditures 
totaled $9,050,000 compared to $2,758,000 in 1997.  The increase was due 
primarily to the machinery and equipment purchased as a part of the BAN 
acquisition and the purchase of the 68,000 square foot manufacturing and 
warehouse facility in Chattanooga, Tennessee.  Capital expenditures are 
expected to be approximately $7,000,000 in fiscal 1999.

<PAGE>

Financing activities provided cash of $138,090,000 in 1998 and $11,434,000 in
1997.  In 1998, the Company financed the acquisition of BAN and repaid all
revolving bank indebtedness with the proceeds from its issuance of $200,000,000
of 8.875% Senior Subordinated Notes due 2008.   In the 1997 period, the Company
financed the SUNSOURCE acquisition with the proceeds of a $95,000,000 credit
agreement and with the issuance of 300,000 shares of the Company's common stock
at a value of $13.50 per share to the sellers of SUNSOURCE.  In December 1998
the Company financed the acquisition of the Thompson Products with the 
proceeds of a $165,000,000 bank credit agreement and 125,500 shares of common 
stock valued at approximately $39.85 per share.

In connection with certain of its acquisitions, the Company has agreed to make
certain deferred payments.  The Company is obligated to make additional
payments, not to exceed $7.9 million in the aggregate, over a six year period
from the June 1997 closing if sales of the SUNSOURCE business exceed certain
levels as defined in the purchase agreement.  In addition, for two new dietary
supplement products introduced in the first three years following the
acquisition of the SUNSOURCE business, the Company is obligated to pay a 3.5%
royalty on net sales of such new products for a period of seven years.  The
Company is obligated to pay a royalty on HERPECIN-L equal to the greater of
$214,000, or 5% of net sales, for each twelve month period ending June 30, 2003.


<PAGE>

The following table presents certain working capital data at November 30, 1998
and 1997 or for the respective years then ended:


                     ITEM                           1998           1997
-----------------------------------------------  -----------    -----------

Working capital (current assets less
   current liabilities)                          $   684,000    $15,520,000
Current ratio (current assets divided
   by current liabilities)                              1.01           1.45
Quick ratio (cash and cash equivalents
   and receivables divided by current 
   liabilities)                                          .63            .96
Average accounts receivable turnover                    6.81           5.92
Average inventory turnover                              3.57           3.17
Working capital as a percentage of total assets        0.19%          8.68%


The decrease in the current and quick ratios at November 30, 1998 as compared to
November 30, 1997 was primarily due to a decrease in cash and cash equivalents
and  increases in current maturities of long-term debt, accounts payable and
accrued liabilities.



<PAGE>

Total debt outstanding at November 30, 1998 was $291,357,000 compared to 
$142,394,000 at November 30, 1997.  The net 1998 increase of $148,963,000 
reflects the financing of the acquisition of the BAN product line in March, 
1998, offset by debt repayments from cash generated from operations, net 
proceeds of brand and investment sales and scheduled principal amortization. 
The availability of credit under the working capital line of credit is 
determined based on the Company's accounts receivable and inventories.  The 
Company had $2,000,000 of outstanding borrowings on its $30,000,000 working 
capital line of credit as of November 30, 1998.  The Company had $1,528,000 
invested in highly liquid short-term investments as of November 30, 1998.  

Management of the Company believes that cash generated by operations, along with
funds available from its short-term, highly liquid investments and available
funds under its credit facility, will be sufficient to fund the Company's
current commitments and proposed operations.  Also on December 21, 1998, the
Company filed with the Securities and Exchange Commission a shelf registration
for $250,000,000 of debt and equity securities.



<PAGE>

YEAR 2000

The Company recognizes the need to ensure its operations will not be adversely
impacted by year 2000 software failures.  Software failures due to processing
errors potentially arising from calculations using the year 2000 date are a
known risk.  The Company has developed a plan to ensure its systems are
compliant with the requirements to process transactions in the year 2000.  The
following is a status report of the Company's efforts to date for fulfilling
those compliance requirements:

THE COMPANY'S STATE OF READINESS

The Company is in the process of replacing its current information technology
(IT) systems with a new fully integrated computer system to replace all hardware
and software that the Company uses in its financial, manufacturing and customer
services functions. The new IT system will be year 2000 compliant.  Accordingly,
the year 2000 compliance requirements are considered only a portion of the
Company's systems replacement effort.  This replacement is expected to be
completed on or before December 1, 1999, the beginning of the Company's 2000
fiscal year.  Although the Company believes that the new IT system will be year
2000 compliant, the Company uses third party equipment and software that may not
be year 2000 compliant.  If any of this software or equipment does not operate
properly in the year 2000 and thereafter, the Company could be forced to make
unanticipated expenditures to cure these problems, which could adversely affect
the Company's business.


<PAGE>

COST TO ADDRESS YEAR 2000 ISSUES

The total cost of the new software and implementation necessary to replace the
Company's current IT system plus address the year 2000 issues is estimated to be
from $1,500,000 to $2,000,000.  Plan costs have been budgeted in the Company's
capital expenditures budget.  The projected costs are based on management's best
estimates and actual results could differ as the new system is implemented. 
Approximately $957,000 had been expended and capitalized on this system at
November 30, 1998.

RISKS OF YEAR 2000 ISSUES

The Company is in the process of execution of its formal year 2000 compliance
plan and expects to achieve implementation on or before December 1, 1999.

The Company is requesting from certain of its principal customers and suppliers
written statements regarding their knowledge of and plans for meeting the year
2000 compliance requirements.  All respondents indicate that they have knowledge
of and are in the process of fulfilling these requirements.  These companies
have stated that they are at various stages of completion of their compliance
plans, but all have indicated that they expect to be in full year 2000
compliance by or before the end of their 1999 fiscal year.

In the event that the Company or any of its significant customers or suppliers
does not successfully and timely achieve year 2000 compliance, the Company's
business or operations could be adversely affected.



<PAGE>

CONTINGENCY PLANS

The Company is currently developing a "Worst Case Contingency Plan", which will
include generally an environment of utilizing "Work Force", "Spreadsheet" and
"Work Around" programming and procedural efforts.  This contingency system will
be activated by December 1, 1999.  The cost of these temporary measures is
estimated between $500,000 and $1,000,000.

The Company's current existing systems are fully capable (except for year 2000
date handling) of processing all present and future transactions of the
business.  Accordingly, no major efforts have been delayed or avoided which
affect normal business operations as a result of the incomplete implementation
of the year 2000 IT systems.  These current systems will become the foundation
of the Company's contingency system.


FOREIGN OPERATIONS

The Company's primary foreign operations are conducted through its Canadian 
and U.K. subsidiaries.  The functional currencies of these subsidiaries are 
Canadian dollars and British pounds, respectively. Fluctuations in exchange 
rates can impact operating results, including total revenues and expenses, 
when translations of the subsidiary financial statements are made in 
accordance with SFAS No. 52, "Foreign Currency Translation."  For the years 
ended November 30, 1998 and 1997, these subsidiaries accounted for 7.5% and 
9.9% of total revenues, respectively, and 2.4% and 4.5% of total assets, 
respectively.  It has not been the Company's practice to hedge its assets and 
liabilities in  Canada and the U.K. or its intercompany transactions due to 
the inherent risks associated with foreign currency hedging transactions and 
the timing of payment between the Company and its two foreign subsidiaries.  
Historically, gains or losses from foreign currency transactions have not had 
a material impact on the Company's operating results.  Losses of $74,000 and 
$68,000 for the years ended November 30, 1998 and 1997, respectively, 
resulted from foreign currency transactions.  See "Foreign Currency 
Translation" in Note 2 of Notes to Consolidated Financial Statements.

<PAGE>

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income."  The statement must be adopted by the Company
on December 1, 1998.  Under provisions of this statement, the Company will be
required to include a financial statement presentation of comprehensive income
and its components to conform to these new requirements.  As a consequence of
this change, certain reclassifications will be necessary for previously reported
amounts to achieve the required presentation of comprehensive income. 
Implementation of this disclosure standard will not affect the Company's
financial position or results of operations.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information."  The
statement must be adopted by the Company for fiscal 1999.  Under provisions of
this statement, the Company will be required to modify or expand the financial
statement disclosures for operating segments, products and services, and
geographic areas.  Implementation of this disclosure standard will not affect
the Company's financial position or results of operations.



<PAGE>

In February 1998, the Financial Accounting Standards Board issued SFAS No. 132,
"Employers' Disclosures about Pensions and Other Post Retirement Benefits."  The
statement amends SFAS Nos. 87, 88 and 106.  SFAS No. 132 revises employers'
disclosures about pension and other post retirement benefit plans.  The Company
is required to adopt SFAS No. 132 for fiscal 1999.

In June 1998, the Financial Accounting Standards Board issued SFAS No.133, 
"Accounting for Derivative Instruments and Hedging Activities."   SFAS No.133
established accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No.133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met.  Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting.

SFAS No.133 is effective for fiscal years beginning after June 15, 1999.  A
company may also implement SFAS No.133 as of the beginning of any fiscal quarter
after issuance (that is, fiscal quarters beginning June 16, 1998 and 
thereafter). SFAS No.133 cannot be applied retroactively. SFAS No.133 must be 
applied to (a) derivative instruments and (b) certain derivative instruments 
embedded in hybrid contracts that were issued, acquired or substantively 
modified after December 31, 1997 (and, at the Company's election, before 
January 1, 1998).

<PAGE>


The Company has not yet quantified the impacts of adopting SFAS No.133 on its
financial statements and has not determined the timing of or method of its
adoption of SFAS No.133.  However, SFAS No.133 could increase volatility in
earnings and other comprehensive income.

SEASONALITY

During recent fiscal years, the Company's first quarter's net sales and gross
profit have trailed the other fiscal quarters on average from 25% to 35% because
of slower sales of domestic seasonal and international consumer products and the
relative absence of promotional campaigns during this quarter.  As a result of
the Company's acquisitions of BAN and the Thompson Products, seasonality should
not be as pronounced as in years past; however, because of seasonal products,
net sales and gross profit during the first fiscal quarter will continue to
trail the other fiscal quarters.


<PAGE>

FORWARD LOOKING STATEMENTS

The Company may from time to time make written and oral forward looking 
statements. Written forward looking statements may appear in documents filed 
with the Securities and Exchange Commission, in press releases and in reports 
to shareholders. The Private Securities Litigation Reform Act of 1995 contains 
a safe harbor for forward looking statements. The Company relies on this safe 
harbor in making such disclosures. The forward looking statements are based on 
management's current beliefs and assumptions about expectations, estimates, 
strategies and projections for the Company.  These statements are not 
guarantees of future performance and involve risks, uncertainties and 
assumptions that are difficult to predict.  Therefore, actual outcomes and 
results may differ materially from what is expressed or forecasted in such 
forward looking statements.  The Company undertakes no obligation to update 
publicly any forward looking statements whether as a result of new 
information, future events or otherwise.  The risks, uncertainties and 
assumptions regarding forward looking statements include, but are not limited 
to, risks related to acquisitions; product demand and market acceptance risks; 
product development risks, such as delays or difficulties in developing, 
producing and marketing new products or line extensions; the impact of 
competitive products, pricing and advertising; constraints resulting from 
financial condition of the Company, including the degree to which the Company 
is leveraged, debt service requirements and restrictions under bank loan 
agreements and indentures; government regulation; risks of loss of material 
customers; public perception regarding our products; dependence on third party 
manufacturers; reliance on brands and intellectual property concerns; 
availability of raw materials; environmental matters; product liability and 
insurance; year 2000; and other risks described in the Company's Securities 
and Exchange Commission filings.

<PAGE>

                             SELECTED FINANCIAL DATA
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                YEAR ENDED NOVEMBER 30,   
                              --------------------------------------------------------
                                 1998        1997        1996        1995       1994
                              ---------   ---------   ---------   ---------   --------
<S>                           <C>         <C>         <C>         <C>         <C>     
INCOME STATEMENT DATA

 NET SALES .................  $ 220,064   $ 143,235   $ 118,903   $ 100,598   $ 94,370

 OPERATING COSTS AND
     EXPENSES ..............    174,845     117,732     102,214      86,130     81,830
                              ---------   ---------   ---------   ---------   --------

 INCOME FROM OPERATIONS ....     45,219      25,503      16,689      14,468     12,540

 OTHER EXPENSE, NET ........    (16,247)    (14,255)    (11,069)    (10,858)    (9,248)
                              ---------   ---------   ---------   ---------   --------

 INCOME FROM CONTINUING
     OPERATIONS BEFORE
     INCOME TAXES AND
     EXTRAORDINARY LOSS ....     28,972      11,248       5,620       3,610      3,292

 PROVISION FOR INCOME
     TAXES .................     10,844       3,993       1,816       1,285      1,182
                              ---------   ---------   ---------   ---------   --------

 INCOME FROM CONTINUING
     OPERATIONS BEFORE
     EXTRAORDINARY LOSS ....  $  18,128   $   7,255   $   3,804   $   2,325   $  2,110
                              =========   =========   =========   =========   ========

PER SHARE DATA

 INCOME PER DILUTED SHARE
     FROM CONTINUING
     OPERATIONS BEFORE
     EXTRAORDINARY LOSS ....  $    1.86   $     .80   $     .47   $     .32   $    .29

BALANCE SHEET DATA
  (At End of Period)

  TOTAL ASSETS .............  $ 369,012   $ 178,744   $ 152,183   $  83,410   $ 85,442

  LONG-TERM DEBT, less
     current maturities ....  $ 273,913   $ 133,475   $ 127,438   $  78,089   $ 94,486
</TABLE>

<PAGE>

MARKET PRICES

The Company's common shares trade over-the-counter on the National Market 
System under the NASDAQ symbol CHTT. A quarterly summary of the high and low 
market prices per common share as reported by NASDAQ is shown below:

                                 1998                             1997      
                           -----------------                ----------------
QUARTER ENDED:             HIGH        LOW                  HIGH       LOW 
                           -----------------                ----------------
February ...............   23 5/8     12 7/8                10         8 1/8
May ....................   30 1/2     19 3/8                10 7/8     8
August .................   33 7/8     18 5/8                18 3/4    10 1/4
November ...............   43 1/8     18 5/8                20 5/8    14 3/8

Based upon transfer agent records, the Company's common shares were held by
approximately 2,500 shareholders as of February 26, 1999.
<PAGE>

                           CONSOLIDATED BALANCE SHEETS
                           NOVEMBER 30, 1998 AND 1997
                                 (IN THOUSANDS)

ASSETS                                                          1998      1997
                                                              --------  --------

CURRENT ASSETS:
  Cash and cash equivalents ................................  $  2,076  $  4,858
  Accounts receivable, less allowance for doubtful accounts
   of $775 in 1998 and $500 in 1997 ........................    36,581    28,078
  Deferred income taxes ....................................     3,049     1,864
  Inventories ..............................................    19,606    14,493
  Prepaid expenses and other current assets ................       784       679
                                                              --------  --------
      Total current assets .................................    62,096    49,972
                                                              --------  --------

PROPERTY, PLANT AND EQUIPMENT, NET .........................    18,146    10,988
                                                              --------  --------
OTHER NONCURRENT ASSETS:
  Investment in Elcat, Inc. ................................     3,102     6,640
  Patents, trademarks and other purchased
    product rights, net ....................................   272,226   104,972
  Debt issuance costs, net .................................    10,091     3,118
  Other ....................................................     3,351     3,054
                                                              --------  --------
      Total other noncurrent assets ........................   288,770   117,784
                                                              --------  --------

         TOTAL ASSETS ......................................  $369,012  $178,744
                                                              ========  ========

                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>

                           CONSOLIDATED BALANCE SHEETS
                           NOVEMBER 30, 1998 AND 1997
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY                              1998        1997
                                                               ---------   ---------
<S>                                                            <C>         <C>      
CURRENT LIABILITIES:
  Current maturities of long-term debt ......................  $  17,444   $   8,919
  Accounts payable ..........................................     12,733       9,319
  Payable to bank ...........................................      1,026       2,618
  Accrued liabilities .......................................     30,209      13,596
                                                               ---------   ---------
    Total current liabilities ...............................     61,412      34,452
                                                               ---------   ---------

LONG-TERM DEBT, less current maturities .....................    273,913     133,475
                                                               ---------   ---------

DEFERRED INCOME TAXES .......................................      6,826       3,290
                                                               ---------   ---------

OTHER NONCURRENT LIABILITIES ................................      2,110       3,157
                                                               ---------   ---------

COMMITMENTS AND CONTINGENCIES  (Notes 5, 10 and 12)

SHAREHOLDERS' EQUITY:
  Preferred shares, without par value, authorized 1,000,
    none issued .............................................         --          --
  Common shares, without par value, authorized 20,000, issued
    9,574 in 1998 and 9,082 in 1997 .........................      1,994       1,945
  Paid-in surplus ...........................................     69,068      63,975
  Accumulated deficit .......................................    (44,960)    (60,229)
                                                               ---------   ---------
                                                                  26,102       5,691
  Foreign currency translation adjustment ...................     (1,351)     (1,321)
                                                               ---------   ---------
     Total shareholders' equity .............................     24,751       4,370
                                                               ---------   ---------
          TOTAL LIABILITIES AND SHAREHOLDERS'
          EQUITY ............................................  $ 369,012   $ 178,744
                                                               =========   =========
</TABLE>

                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>

                        CONSOLIDATED STATEMENTS OF INCOME
              FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                       1998        1997        1996
                                                    ---------   ---------   ---------
<S>                                                 <C>         <C>         <C>      
NET SALES ........................................  $ 220,064   $ 143,235   $ 118,903
                                                    ---------   ---------   ---------

COSTS AND EXPENSES:
  Cost of sales ..................................     60,889      39,253      35,120
  Advertising and promotion ......................     86,592      56,176      45,512
  Selling, general and administrative ............     27,364      22,303      21,582
                                                    ---------   ---------   ---------
    Total costs and expenses .....................    174,845     117,732     102,214
                                                    ---------   ---------   ---------

INCOME FROM OPERATIONS ...........................     45,219      25,503      16,689
                                                    ---------   ---------   ---------

OTHER INCOME (EXPENSE):
  Interest expense ...............................    (26,676)    (15,934)    (13,394)
  Investment and other income, net ...............        881       1,679       1,450
  Gain on product divestitures ...................      9,548          --         875
                                                    ---------   ---------   ---------
    Total other income (expense) .................    (16,247)    (14,255)    (11,069)
                                                    ---------   ---------   ---------

INCOME BEFORE INCOME TAXES AND
    EXTRAORDINARY LOSS ...........................     28,972      11,248       5,620

PROVISION FOR INCOME TAXES .......................     10,844       3,993       1,816
                                                    ---------   ---------   ---------

INCOME BEFORE EXTRAORDINARY LOSS .................     18,128       7,255       3,804

EXTRAORDINARY LOSS ON EARLY
    EXTINGUISHMENT OF DEBT, NET OF INCOME
    TAXES (Note 5) ...............................     (2,859)     (1,370)       (532)
                                                    ---------   ---------   ---------

NET INCOME .......................................  $  15,269   $   5,885   $   3,272
                                                    =========   =========   =========

COMMON SHARES:

    Weighted average number outstanding (basic) ..      9,374       8,793       8,052
                                                    =========   =========   =========

    Weighted average and dilutive potential number
     outstanding .................................      9,735       9,123       8,143
                                                    =========   =========   =========

NET INCOME (LOSS) PER COMMON SHARE:
  Basic:
    Income before extraordinary loss .............  $    1.93   $     .83   $     .47
    Extraordinary loss ...........................       (.30)       (.16)       (.06)
                                                    ---------   ---------   ---------
          Total basic ............................  $    1.63   $     .67   $     .41
                                                    =========   =========   =========
  Diluted:
     Income before extraordinary loss ............  $    1.86   $     .80   $     .47
     Extraordinary loss ..........................       (.29)       (.15)       (.07)
                                                    ---------   ---------   ---------
          Total diluted ..........................  $    1.57   $     .65   $     .40
                                                    =========   =========   =========
</TABLE>

                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>

            CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
              FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                          Minimum      Foreign
                                                                          Pension      Currency      
                                           Common  Paid-in  Accumulated  Liability   Translation
                                           Shares  Surplus    Deficit    Adjustment   Adjustment    Total
                                           ------  -------    -------    ----------   ----------    -----
<S>                                        <C>     <C>       <C>           <C>         <C>         <C>      
Balance, November 30, 1995 ..............  $1,519  $52,099   $(69,386)     $  --       $(1,653)    $(17,421)
  Net income ............................      --       --      3,272         --            --        3,272
  Stock options exercised ...............      63      223         --         --            --          286
  Issuance of common shares .............     261    6,239         --         --            --        6,500
  Foreign currency translation adjustment      --       --         --         --           295          295
  Minimum pension liability adjustment ..      --       --         --       (112)           --         (112)
                                           ------  -------   --------      -----       -------     --------
Balance, November 30, 1996 ..............   1,843   58,561    (66,114)      (112)       (1,358)      (7,180)
  Net income ............................      --       --      5,885         --            --        5,885
  Stock options exercised ...............      25      962         --         --            --          987
  Stock warrants exercised ..............      15      464         --         --            --          479
  Issuance of common shares .............      62    3,988         --         --            --        4,050
  Foreign currency translation                                                                    
    adjustment ..........................      --       --         --         --            37           37
  Minimum pension liability                                                                       
    adjustment ..........................      --       --         --        112            --          112
                                           ------  -------   --------      -----       -------     --------
Balance, November 30, 1997 ..............   1,945   63,975    (60,229)        --        (1,321)       4,370
                                                                                                  
  Net income ............................      --       --     15,269         --            --       15,269
  Stock options exercised ...............      28    3,699         --         --            --        3,727
  Stock warrants exercised ..............      21    1,394         --         --            --        1,415
  Foreign currency translation                                                                    
    adjustment ..........................      --       --         --         --           (30)         (30)
                                           ------  -------   --------      -----       -------     --------
Balance, November 30, 1998 ..............  $1,994  $69,068   $(44,960)     $  --       $(1,351)    $ 24,751
                                           ======  =======   ========      =====       =======     ========
</TABLE>

                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                      1998       1997       1996
                                                                   ---------   --------   --------
<S>                                                                <C>         <C>        <C>     
OPERATING ACTIVITIES:
    Net income ..................................................  $  15,269   $  5,885   $  3,272
    ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
       OPERATING ACTIVITIES:
          Depreciation and amortization .........................      9,827      6,381      4,829
          Deferred income tax provision .........................      2,351      1,120      1,797
          Gain on product divestitures ..........................     (9,548)        --       (875)
          Gain on sale of trading securities ....................         --         --       (452)
          Gain on termination of interest rate cap ..............         --         --       (281)
          Extraordinary loss on early extinguishment of debt, net      2,859      1,370        532
          Dividend receivable from Elcat, Inc ...................       (462)      (656)      (656)
          Other, net ............................................        (28)      (106)      (379)
          CHANGES IN OPERATING ASSETS AND LIABILITIES:
              Accounts receivable ...............................    (12,054)    (5,140)    (3,063)
              Inventories .......................................      1,836     (2,401)       745
              Prepaid expenses and other current assets .........       (102)     3,034     (2,878)
              Accounts payable and accrued liabilities ..........     10,842        629       (185)
                                                                   ---------   --------   --------
      NET CASH PROVIDED BY OPERATING ACTIVITIES .................     20,790     10,116      2,406
                                                                   ---------   --------   --------
INVESTING ACTIVITIES:
   Purchases of property, plant and equipment ...................     (9,050)    (2,758)    (1,785)
   Proceeds from sale of investments ............................      4,000         --        452
   Proceeds from product divestitures ...........................     11,965         --      1,000
   Proceeds from notes and sales of assets ......................      1,085         75        253
   Purchases of patents, trademarks and other product rights ....   (168,402)   (29,293)   (43,048)
   Increase in other assets .....................................     (1,193)      (746)    (4,128)
                                                                   ---------   --------   --------
     NET CASH  USED IN INVESTING ACTIVITIES .....................   (161,595)   (32,722)   (47,256)
                                                                   ---------   --------   --------
FINANCING ACTIVITIES:
   Repayment of long-term debt ..................................   (145,028)   (76,636)   (15,032)
   Proceeds from long-term debt .................................    291,365     87,500     67,944
   Change in payable to bank ....................................     (1,592)       908        526
   Proceeds from issuance of common stock, net ..................         --         --      5,500
   Exercise of stock options and warrants .......................      3,316      1,274        286
   Debt issuance costs ..........................................     (9,971)    (1,612)    (2,099)
                                                                   ---------   --------   --------
      NET CASH PROVIDED BY  FINANCING ACTIVITIES ................    138,090     11,434     57,125
                                                                   ---------   --------   --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
    AND CASH EQUIVALENTS ........................................        (67)       (10)       129
                                                                   ---------   --------   --------
CASH AND CASH EQUIVALENTS:
   Increase (decrease) for the year .............................     (2,782)   (11,182)    12,404
   At beginning of year .........................................      4,858     16,040      3,636
                                                                   ---------   --------   --------
   At end of year ...............................................  $   2,076   $  4,858   $ 16,040
                                                                   =========   ========   ========
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE 
CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE: ALL MONETARY AMOUNTS ARE EXPRESSED IN THOUSANDS OF DOLLARS UNLESS
CONTRARILY EVIDENT.

(1) NATURE OF OPERATIONS

            Chattem, Inc. and its wholly-owned subsidiaries (the Company) 
manufacture and market branded consumer products consisting primarily of 
over-the-counter pharmaceuticals, antiperspirants and deodorants, toiletries 
and skin care, and dietary supplements. The consumer products are sold 
primarily through mass merchandisers, independent and chain drug stores, drug 
wholesalers, and food stores in the United States and in various markets in 
approximately 50 countries throughout the world.

            Geographic data for 1998, 1997 and 1996 is included in the 
schedule of geographical information on page 43 which is an integral part of 
these financial statements.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF CONSOLIDATION

            The accompanying consolidated financial statements include the 
accounts of Chattem, Inc. and its wholly-owned subsidiaries. All significant 
intercompany transactions and balances have been eliminated.

CASH AND CASH EQUIVALENTS

            For purposes of reporting cash flows, the Company considers all 
short-term deposits and investments with original maturities of three months 
or less to be cash equivalents.

INVENTORIES

            Inventory costs include materials, labor and factory overhead. 
Inventories in the United States are valued at the lower of last-in, 
first-out (LIFO) cost or market, while international inventories are valued 
at the lower of first-in, first-out (FIFO) cost or market.

PROPERTY, PLANT AND EQUIPMENT

            Property, plant and equipment are recorded at cost. Depreciation 
is computed using the straight-line method over the estimated useful lives of 
10 to 40 years for buildings and improvements and 3 to 12 years for machinery 
and equipment. Expenditures for maintenance and repairs are charged to 
expense as incurred. Depreciation expense for 1998, 1997 and 1996 was $1,597, 
$1,502 and $1,352, respectively. <PAGE>

PATENTS, TRADEMARKS AND OTHER PURCHASED PRODUCT RIGHTS

            The costs of acquired patents, trademarks and other purchased 
product rights are capitalized and amortized over periods ranging from 5 to 
40 years. Total accumulated amortization of these assets at November 30, 1998 
and 1997 was $17,382 and $11,246, respectively. Amortization expense for 
1998, 1997 and 1996 was $6,180, $2,877 and $2,086, respectively. Royalty 
expense related to other purchased product rights for 1998, 1997 and 1996 was 
$523, $522 and $1,140, respectively. Amortization and royalty expense are 
included in advertising and promotion expense in the accompanying 
consolidated statements of income.

DEBT ISSUANCE COSTS

            The Company has incurred debt issuance costs in connection with 
its long-term debt. These costs are capitalized and amortized over the term 
of the debt. Amortization expense related to debt issuance costs was $986, 
$490 and $498 in 1998, 1997 and 1996, respectively. Accumulated amortization 
of these costs was $1,814 and $1,004 at November 30, 1998 and 1997, 
respectively.

PAYABLE TO BANK

            Payable to bank includes checks outstanding in excess of certain 
cash balances.

REVENUE RECOGNITION

            Revenue is recognized when the Company's products are shipped to 
its customers.

RESEARCH AND DEVELOPMENT

            Research and development costs relate primarily to the 
development of new products and are expensed as incurred. Such expenses were 
$1,369, $1,207 and $1,117 in 1998, 1997 and 1996, respectively.

ADVERTISING EXPENSES

            The cost of advertising is expensed in the fiscal year in which 
the related advertising takes place. Advertising expense for 1998, 1997 and 
1996 was $44,386, $29,923 and $22,789, respectively. At November 30, 1998 and 
1997, the Company reported $646 and $1,066, respectively, of advertising paid 
for in 1998 and 1997 which will run or did run in the next fiscal year. These 
amounts are included in other noncurrent assets in the accompanying 
consolidated balance sheets. <PAGE>

NET INCOME PER COMMON SHARE

            In 1997, the Financial Accounting Standards Board issued SFAS No. 
128, "Earnings Per Share." SFAS No. 128 changes the criteria for reporting 
earnings per share (EPS) by replacing primary EPS with basic EPS and fully 
diluted EPS with diluted EPS. The Company adopted SFAS No. 128 on December 1, 
1997. All prior periods' EPS data have been restated. The impact of adopting 
SFAS No. 128 did not have a material impact on EPS for any period presented.

            For the years ended November 30, 1998, 1997 and 1996, the 
weighted average and dilutive potential common shares outstanding consisted 
of the following:

                                                          1998     1997     1996
                                                         -----    -----    -----
Weighted average common shares
   outstanding ......................................    9,374    8,793    8,052
Dilutive potential shares:
    Stock options ...................................      332      207       54
    Warrants ........................................       29      123       37
                                                         -----    -----    -----
Weighted average and dilutive potential common 
   shares outstanding ...............................    9,735    9,123    8,143
                                                         =====    =====    =====

FOREIGN CURRENCY TRANSLATION

            Assets and liabilities of the Company's Canadian and U.K. 
subsidiaries are translated to United States dollars at year-end exchange 
rates. Income and expense items are translated at average rates of exchange 
prevailing during the year. Translation adjustments are accumulated as a 
separate component of shareholders' equity. Gains and losses which result 
from foreign currency transactions are included in the accompanying 
consolidated statements of income.

USE OF ESTIMATES

            The preparation of financial statements in conformity with 
generally accepted accounting principles requires management to make 
estimates and assumptions that affect the reported amounts of assets and 
liabilities and disclosure of contingent assets and liabilities at the date 
of the financial statements and the reported amounts of revenue and expenses 
during the reporting period. Actual results could differ from those estimates.

DERIVATIVE FINANCIAL INSTRUMENTS

            The Company has entered into interest rate swap agreements as a 
means of managing its interest rate exposure and not for trading purposes. 
These agreements have the effect of converting a portion of the Company's 
variable rate obligations to fixed rate obligations. Net amounts paid or 
received are reflected as adjustments to interest expense.

<PAGE>

CONCENTRATIONS OF CREDIT RISK

            Financial instruments which subject the Company to concentrations 
of credit risk consist primarily of accounts receivable, short-term cash 
investments and the investment in Elcat, Inc. (Note 3). The Company's 
exposure to credit risk associated with nonpayment of accounts receivable is 
affected by conditions or occurrences within the retail industry. As a 
result, the Company performs ongoing credit evaluations of its customers' 
financial position but generally requires no collateral from its customers. 
The Company's largest customer accounted for 17%, 16% and 16% of sales in 
1998, 1997 and 1996, respectively. No other customer exceeded 10% of the 
Company's sales in 1998, 1997 or 1996. Short-term cash investments are placed 
with high credit-quality financial institutions or in low risk, liquid 
instruments. No losses have been experienced on such investments.

RECENT ACCOUNTING PRONOUNCEMENTS

            In June 1997, the Financial Accounting Standards Board issued 
SFAS No. 130, "Reporting Comprehensive Income." The statement must be adopted 
by the Company on December 1, 1998. Under provisions of this statement, the 
Company will be required to include a financial statement presentation of 
comprehensive income and its components to conform to these new requirements. 
As a consequence of this change, certain reclassifications will be necessary 
for previously reported amounts to achieve the required presentation of 
comprehensive income. Implementation of this disclosure standard will not 
affect the Company's financial position or results of operations.

            In June 1997, the Financial Accounting Standards Board issued 
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related 
Information." The statement must be adopted by the Company for fiscal 1999. 
Under provisions of this statement, the Company will be required to modify or 
expand the financial statement disclosures for operating segments, products 
and services and geographic areas. Implementation of this disclosure standard 
will not affect the Company's financial position or results of operations.

            In February 1998, the Financial Accounting Standards Board issued 
SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement 
Benefits". The statement amends SFAS Nos. 87, 88 and 106. SFAS No. 132 
revises employer's disclosures about pension and other post retirement 
benefit plans. The Company is required to adopt SFAS No. 132 for fiscal 1999.

            In June 1998, the Financial Accounting Standards Board issued 
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." 
SFAS No.133 established accounting and reporting standards requiring that 
every derivative instrument (including certain derivative instruments 
embedded in other contracts) be recorded in the balance sheet as either an 
asset or liability measured at its fair value. SFAS No. 133 requires that 
changes in the derivative's fair value be recognized currently in earnings 
unless specific hedge accounting criteria are met. Special accounting for 
qualifying hedges allow a derivative's gains and losses to offset related 
results on the hedged item in the income statement, and requires that a 
company must formally document, designate and assess the effectiveness of 
transactions that receive hedge accounting. SFAS No. 133 is effective for 
fiscal years beginning after June 15, 1999. A company may also implement SFAS 
No.133 as of the beginning of any fiscal quarter after issuance (that is, 
fiscal quarters beginning June 16, 1998 and thereafter). SFAS No. 133 cannot 
be applied retroactively. SFAS No. 133 must be applied to (a) derivative 
instruments and (b) certain derivative instruments embedded in hybrid 
contracts that were issued, acquired or substantively modified after December 
31, 1997 (and, at the Company's election, before January 1, 1999). 

<PAGE>

The Company has not yet quantified the impact of adopting SFAS No. 133 on its 
financial statements and has not determined the timing of or method of its 
adoption of SFAS No. 133. However, SFAS No. 133 could increase volatility in 
earnings and other comprehensive income.

RECLASSIFICATIONS

            Certain prior year amounts have been reclassified to conform to 
the current period's presentation.

(3) INVESTMENT IN ELCAT, INC.

            As part of the consideration for the sale of the Company's 
specialty chemicals division in 1995, the Company received 40,000 shares of 
13.125% cumulative, convertible preferred stock of Elcat, Inc. (the Elcat 
Preferred Shares) having a total par value of $5,000.

            In 1998, Elcat, Inc. (Elcat) redeemed 22,960 of these shares for 
$4,000 ($2,870 par value and $1,130 accumulated dividends). The remaining 
17,040 Elcat Preferred Shares are nonvoting and convertible, in whole or in 
part, into a 8.95% ownership interest in Elcat. At the option of Elcat, the 
Elcat Preferred Shares may be redeemed, in whole or in part, at par value 
($125 per share) plus any accrued and unpaid dividends. If all of the 
outstanding Elcat Preferred Shares are not converted or redeemed on or before 
April 1, 2005, Elcat is obligated to redeem all of the then outstanding Elcat 
Preferred Shares at par value plus any accrued and unpaid dividends.

            This investment is classified as held-to-maturity and is 
accounted for using the cost method of accounting. As Elcat stock is not 
publicly traded in the open market and a market price is not readily 
available, it is not practicable to estimate the fair value of the investment 
in Elcat at November 30, 1998. In the opinion of management, however, the 
fair value of this investment is in excess of its carrying value as of 
November 30, 1998.

<PAGE>

(4) PENSION PLANS

            The Company has a noncontributory defined benefit pension plan 
(the Plan) which covers substantially all employees. The Plan provides 
benefits based upon years of service and the employee's compensation. The 
Company's contributions are based on computations by independent actuaries. 
Plan assets at November 30, 1998 and 1997 were invested primarily in United 
States government and agency securities and corporate debt and equity 
securities.

            Pension cost for the years ended November 30, 1998, 1997 and 1996 
included the following components:

                                                          1998    1997    1996
                                                        -------   -----   -----

Service cost (benefits earned during the
  period) ............................................  $   661   $ 545   $ 610
Interest cost on projected benefit obligation ........      739     741     775
Actual return on plan assets .........................   (3,226)   (845)   (637)
Net amortization and deferral ........................    2,677     365     107
                                                        -------   -----   -----
Net pension cost .....................................  $   851   $ 806   $ 855
                                                        =======   =====   =====

            In addition to net pension cost, a net lump-sum settlement loss 
of $598 was recorded in 1996 related to lump-sum distributions to certain 
employees. This expense is included in selling, general and administrative 
expenses in the accompanying consolidated statements of income.

            The following table sets forth the funded status of the Plan as 
of November 30, 1998 and 1997:

                                                              1998       1997
                                                            --------   --------

Actuarial present value of benefit obligations:
  Vested benefit obligation ..............................  $  7,462   $  7,108
  Nonvested benefit obligation ...........................       103         57
                                                            --------   --------
    Accumulated benefit obligation .......................  $  7,565   $  7,165
                                                            ========   ========

Plan assets at fair market value .........................  $  9,879   $  6,471
Projected benefit obligation .............................   (11,275)   (11,072)
                                                            --------   --------
Plan assets less than projected benefit obligation .......    (1,396)    (4,601)
Unrecognized net loss ....................................     1,043      4,186
Unrecognized prior service cost ..........................      (115)      (131)
Unrecognized initial asset ...............................      (227)      (369)
                                                            --------   --------
Pension liability recognized in balance sheets
  at end of year .........................................  $   (695)  $   (915)
                                                            ========   ========

            The discount rates used in determining the actuarial present 
value of the projected benefit obligation were 6.75% and 7.5% in 1998 and 
1997, respectively. The rates of increase in future compensation levels used 
were 4.0% and 5.0% in 1998 and 1997, respectively. The expected long-term 
rate of return on plan assets was 9.0% in 1998 and 1997. <PAGE>

            In accordance with the provisions of SFAS No. 87, "Employers' 
Accounting for Pensions," the Company recorded an additional liability at 
November 30, 1996 representing the excess of the accumulated benefit 
obligation over the fair value of plan assets and accrued pension liability 
for its pension plan. At November 30, 1997, the unrecognized prior service 
cost exceeded the minimum liability, and the minimum pension liability was 
eliminated.

            The Company has a defined contribution plan covering 
substantially all employees. Eligible participants can contribute up to 10% 
of their annual compensation and receive a 25% matching employer contribution 
up to 6% of their annual compensation. The defined contribution plan expense 
was $148, $155 and $120 in 1998, 1997 and 1996, respectively.

(5) LONG-TERM DEBT

            Long-term debt consisted of the following at November 30, 1998 and
1997:

                                                               1998       1997
                                                             --------   --------
Revolving line of credit payable to banks at variable
   rates (8.23% at November 30, 1998) ....................   $  2,000   $ 13,000
Term loans payable to banks at variable rates
   (8.34% weighted average at November 30, 1998) .........     40,514     63,683
8.875% Senior Subordinated Notes, due 2008 ...............    200,000         --
12.75% Senior Subordinated Notes, due 2004, net
   of unamortized discount of $808 for 1998 and
   $1,289 for 1997 .......................................     48,843     65,711
                                                             --------   --------
Total long-term debt .....................................    291,357    142,394
Less: current maturities .................................     17,444      8,919
                                                             --------   --------
Total long-term debt, net of current maturities ..........   $273,913   $133,475
                                                             ========   ========

            On March 24, 1998, the Company issued at par value $200,000 of
8.875% Senior Subordinated Notes due 2008 (the 8.875% Notes). The proceeds of
the note offering were used to fund the BAN purchase and related fees and
expenses, repay revolving bank indebtedness and provide additional working
capital.

            The 8.875% Notes mature on April 1, 2008 and interest is payable
semi-annually on April 1 and October 1 of each year. The 8.875% Notes are senior
subordinated obligations of the Company and are subordinated in right of payment
to all existing and future senior debt of the Company. The 8.875% Notes, which
were registered under the Securities Act of 1933, are not callable until April
1, 2003, after which they may be redeemed at the option of the Company. Upon the
occurrence of certain events constituting a change of control, the holders of
the 8.875% Notes may require the Company to repurchase the 8.875% Notes at a
purchase price equal to 101% of the principal amount thereof, plus accrued and
unpaid interest. The 8.875% Notes are guaranteed by Signal Investment &
Management Co., a wholly-owned subsidiary of the Company.
<PAGE>

            The 8.875% Notes are issued under an indenture with an indenture
trustee, which restricts, among other things, the ability of the Company and its
subsidiaries to (i) incur additional indebtedness, (ii) pay dividends, (iii)
sell or issue capital stock of a subsidiary, (iv) create encumbrances on the
ability of any subsidiary to pay dividends or make other restricted payments,
(v) engage in certain transactions with affiliates, (vi) dispose of certain
assets, (vii) merge or consolidate with or into, or sell or otherwise transfer
all or substantially all their properties and assets as an entirety to another
person, or (viii) create additional liens.

            In conjunction with the acquisition of BAN, the Company entered into
a credit agreement with a syndicate of banks, also on March 24, 1998 (the New
Credit Agreement). This credit agreement was divided into a $30,000 revolving
line of credit for working capital purposes, a $27,540 Term A loan, maturing on
June 26, 2002, and a $34,825 Term B loan, maturing on June 14, 2003.

            The combined Term A and B loans are payable in remaining quarterly
installments as follows:

            December 31, 1998 to September 30, 1999 ......    $1,488
            December 31, 1999 to March 31, 2001 ..........    $1,738
            June 30, 2001 ................................    $  777
            September 30, 2001 ...........................    $1,000
            December 31, 2001 to March 31, 2003 ..........    $3,250
            June 30, 2003 ................................    $2,861

            The Company may elect either the greater of (i) the prime rate or
federal funds rate plus .5% or (ii) a floating rate or Eurodollar interest rate
option applicable to the term and revolving line loans under the New Credit
Agreement. The prime rate and Eurodollar interest rate options are based on a
base rate plus a rate margin that fluctuates on the basis of the Company's
leverage ratio.

            The New Credit Agreement is secured by substantially all of the
Company's assets. The more restrictive financial covenants require the
maintenance of minimum amounts of consolidated tangible net worth, fixed charge
coverage, interest coverage and leverage ratios. The provisions of the New
Credit Agreement also include restrictions on capital expenditures and the
payment of dividends. The New Credit Agreement is guaranteed by one of the
Company's subsidiaries, Signal Investment & Management Co.

            The revolving line of credit is available to the Company up to
$30,000 or such lesser amount as is determined to be available under the terms
of the New Credit Agreement, and is due and payable on June 26, 2002. The
availability of credit under the revolver is determined based on the Company's
accounts receivable and inventories.

            In 1994, the Company issued $75,000 of 12.75% Senior Subordinated
Notes due 2004 (the 12.75% Notes) with five year warrants to purchase 417,182
shares of common stock (the Warrants). The 12.75% Notes consisted of 75,000
units, each consisting of $1,000 principal amount of the 12.75% Notes and a
warrant to purchase shares of the Company's common stock (Note 9). The price of
the 12.75% Notes was $73,967, or 98.6% of the original principal amount of the
12.75% Notes, resulting in a discount of $1,033. The value assigned to the
Warrants was $955 (Note 9), resulting in a total original issue discount of
$1,988. The proceeds of the 12.75% Notes were used to repay amounts outstanding
under a prior credit agreement.

<PAGE>

            The 12.75% Notes mature on June 15, 2004, and interest is payable
semi-annually on June 15 and December 15 of each year. The 12.75% Notes are
senior subordinated obligations of the Company and are subordinated in right of
payment to all existing and future senior debt of the Company. The 12.75% Notes,
which were registered under the Securities Act of 1933, are not callable until
June 15, 2001, after which they may be redeemed at the option of the Company.
Upon the occurrence of certain events constituting a change of control, the
holders of the 12.75% Notes may require the Company to repurchase the 12.75%
Notes at a purchase price equal to 101% of the principal amount thereof, plus
accrued and unpaid interest. The 12.75% Notes are guaranteed by Signal
Investment & Management Co., a wholly-owned subsidiary of the Company.

            The 12.75% Notes are issued under an indenture with an indenture
trustee. The indenture places on the Company restrictions similar to those
required under the terms of the indenture associated with the 8.875% Notes.

            During 1998, 1997 and 1996, the Company prepaid previously
outstanding long-term debt, with funds received from refinancings, the sale of
CORNSILK (Note 12) and the redemption of the Elcat Preferred Shares. During
1998, the Company also repurchased $17,349 of the 12.75% Notes. In connection
with the repurchase of those borrowings, the Company incurred extraordinary
losses, net of income taxes, in 1998, 1997 and 1996 of $2,859, $1,370 and $532,
respectively, or $.29, $.15 and $.07 per share, respectively. These losses
related to the write-off of debt issuance and other deferred costs. The 1997
amount includes costs associated with the termination of two interest rate swap
agreements.

            Future maturities of long-term debt are as follows:
            1999 ..............................................  $  17,444
            2000 ..............................................      6,950
            2001 ..............................................      5,252
            2002 ..............................................     15,000
            2003 ..............................................      9,361
            Thereafter ........................................    238,158
                                                                 ---------
                                                                   292,165
            Less: unamortized discount ........................       (808)
                                                                 ---------
                                                                 $ 291,357
                                                                 =========

            The 2002 maturities include the amount outstanding under the
revolving line of credit which was $2,000 as of November 30, 1998.

            Cash interest payments during 1998, 1997 and 1996 were $23,669,
$15,259 and $12,710, respectively.
<PAGE>

(6) DERIVATIVE FINANCIAL INSTRUMENTS

            On July 21, 1997, the Company entered into two interest rate swap
agreements with NationsBank, N.A. in notional amounts of $40,000 and $5,000. The
Company entered into these agreements as hedges on its variable rate debt and
not for trading purposes. The term of the $40,000 swap is for a five year period
ending July 22, 2002. The Company will receive interest payments on the notional
amount at a rate equal to the one month London Interbank Offered Rate (LIBOR)
(5.62% as of November 30, 1998) and will pay interest on the same notional
amount at a fixed interest rate of 6.38%. The term of the $5,000 swap is for a
five year period ending July 22, 2002. The agreement may be terminated by
NationsBank, N.A. at each quarterly date. The Company will receive interest
payments on the notional amount at a rate equal to the three month LIBOR (5.28%
as of November 30, 1998) and will pay interest on the same notional amount at a
fixed interest rate of 5.62%.

            The Company is exposed to credit losses in the event of
nonperformance by the counterparty to its interest rate swap agreements but has
no off-balance sheet credit risk of accounting loss. The Company anticipates,
however, that the counterparty will be able to fully satisfy its obligations
under the agreements.

            At November 30, 1996, the Company had two interest rate swap
agreements outstanding with financial institutions, each in a notional amount of
$15,000. Both of these interest rate swaps were terminated in 1997 in connection
with the refinancing of long-term debt (Note 5). The resulting extraordinary
loss, net of tax, is included in the 1997 consolidated statement of income as
part of the extraordinary loss on the early extinguishment of debt.

(7) FAIR VALUE OF FINANCIAL INSTRUMENTS

            SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," and SFAS No. 119, "Disclosure about Derivative Financial
Instruments and Fair Value of Financial Instruments" require the disclosure of
the fair value of all financial instruments. Unless otherwise indicated
elsewhere in the notes to the consolidated financial statements, the carrying
value of the Company's financial instruments approximates fair value.

            At November 30, 1998, the estimated fair values of the revolving
line of credit and the term loans payable to banks approximate the carrying
amounts of such debt because the interest rates change with market interest
rates.

            The estimated fair values of the 12.75% and 8.875% notes at November
30, 1998 exceeded their carrying values by approximately $6,400 and $6,082,
respectively. The fair value was estimated based on quoted market prices for the
same or similar issues.

            The fair values of the interest rate swap agreements are the
estimated amounts that the Company would receive or pay to terminate the
agreements at the reporting date, taking into account current interest rates and
the current credit worthiness of the counterparties. At November 30, 1998, the
Company estimates it would have paid $1,888 to terminate the agreements.
<PAGE>

(8) INCOME TAXES

            The provision for income taxes from income before extraordinary loss
includes the following components for the years ending November 30, 1998, 1997
and 1996:

                                       1998       1997        1996 
                                     -------     ------     -------
            Current:
              Federal ..........     $ 8,034     $2,639     $  (203)
              State ............         459        234         222
            Deferred ...........       2,351      1,120       1,797
                                     -------     ------     -------
                                     $10,844     $3,993     $ 1,816
                                     =======     ======     =======

            Deferred income tax assets and liabilities for 1998 and 1997 reflect
the impact of temporary differences between the amounts of assets and
liabilities for financial reporting and income tax reporting purposes. Temporary
differences and carryforwards which give rise to deferred tax assets and
liabilities at November 30, 1998 and 1997 are as follows:

                                                       1998      1997
                                                     -------   -------
            Deferred tax assets:
                 Allowances and accruals ..........  $ 2,303   $ 2,005
                 Accrued promotional expenses .....    1,316       720
                 Accrued postretirement health care
                   benefits .......................      558       559
                 Repriced stock option expense ....       --       251
                 Other ............................      643       310
                                                     -------   -------
                   Gross deferred tax assets ......    4,820     3,845
                                                     -------   -------
            Deferred tax liabilities:
                 Depreciation and amortization ....    7,829     4,486
                 Prepaid advertising ..............      252       318
                 Inventory ........................      196       190
                 Other ............................      320       277
                                                     -------   -------
                   Gross deferred tax liabilities .    8,597     5,271
                                                     -------   -------
                   Net deferred liability .........  $(3,777)  $(1,426)
                                                     =======   =======
<PAGE>

            The difference between the provision for income taxes and the amount
computed by multiplying income before income taxes and extraordinary loss by the
U.S. statutory rate for the years ended November 30, 1998, 1997 and 1996 is
summarized as follows:

                                                  1998      1997      1996 
                                                --------   -------   -------

            Expected tax provision ...........  $ 10,140   $ 3,837   $ 1,911
            Dividend exclusion benefit .......       (85)     (178)     (140)
            State income taxes, net of federal
              income tax benefit .............       298       154       147
            Other, net .......................       491       180      (102)
                                                --------   -------   -------
                                                $ 10,844   $ 3,993   $ 1,816
                                                ========   =======   =======

            Income taxes paid in 1998, 1997 and 1996 were $1,980, $2,162 and
$2,459, respectively. The Company received income tax refunds of $350, $2,719
and $215 during 1998, 1997 and 1996, respectively.

(9) SHAREHOLDERS' EQUITY

STOCK OPTIONS

            The Company adopted SFAS No. 123, "Accounting For Stock-Based
Compensation," during 1997, and elected to continue to account for compensation
expense under its stock option plans under APB No. 25. Accordingly, no
compensation cost has been recognized for stock option grants having exercise
prices equal to or greater than the market value of the common stock at the date
of grant. Compensation expense for stock option grants with exercise prices
below the market price at the date of grant is recognized ratably over the
vesting period. Compensation expense recorded for stock option grants was $350
in 1998.

            The Company's 1993 Non-Statutory Stock Option Plan (1993 Plan)
provides for issuance of up to 350,000 shares of common stock to key employees.
In addition, the Company's 1994 Non-Statutory Stock Option Plan and the 1994
Non-Statutory Stock Option Plan for Non-Employee Directors (1994 Plans) provide
for the issuance of up to 350,000 and 80,000 shares, respectively, of common
stock. The Company's 1998 Non-Statutory Stock Option Plan (1998 Plan) provides
for issuance of up to 700,000 shares of common stock to key employees. Options
vest ratably over four years and are exercisable for a period of up to ten years
from the date of grant.

            For SFAS No. 123 purposes, the fair value of each option grant has
been estimated as of the date of grant using the Black-Scholes option-pricing
model with the following weighted average assumptions for grants in 1998 and
1997: expected dividend yield of 0%, expected volatility of 51% and 49%,
risk-free interest rates of 5.42% and 6.48%, and expected lives of 6 years.
<PAGE>

            Had compensation expense for 1998 and 1997 stock option grants been
determined based on the fair value at the grant dates consistent with the method
prescribed by SFAS No. 123, the Company's net income and net income per share
would have been adjusted to the pro forma amounts for the years ended November
30, 1998 and 1997 as indicated below:

                                               1998      1997 
                                            ---------  --------
            Net income:
               As reported ...............  $  15,269  $  5,885
               Pro forma .................  $  14,599  $  5,683

            Net income per share, basic:
               As reported ...............  $    1.63  $   0.67
               Pro forma .................  $    1.56  $   0.65

            Net income per share, diluted:
               As reported ...............  $    1.57  $   0.65
               Pro forma .................  $    1.50  $   0.62

            The pro forma effect on net income in this disclosure is not
representative of the pro forma effect on net income in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1996.
<PAGE>

            A summary of the activity of stock options during 1998, 1997, and
1996 is presented below (shares in thousands):

<TABLE>
<CAPTION>
                                                 1998                   1997                 1996
                                                      Weighted               Weighted              Weighted
                                           Shares     Average     Shares     Average    Shares     Average
                                           Under      Exercise    Under      Exercise   Under      Exercise
                                           Option      Price      Option      Price     Option      Price
                                            ----       ------      ----       ------     ----       ------
<S>                                        <C>         <C>         <C>        <C>        <C>        <C>   
Outstanding at beginning of
     year ............................       584       $ 6.75       613       $ 6.39      646       $ 7.60
          Granted ....................       470        13.89        91         9.01      318         5.07
          Exercised ..................      (292)        6.70      (120)        6.65      (44)        6.93
          Canceled ...................        --           --        --           --     (307)        7.48
                                            ----       ------      ----       ------     ----       ------
Outstanding at end of
     year ............................       762       $11.17       584       $ 6.75      613       $ 6.39
                                            ====       ======      ====       ======     ====       ======

Options exercisable at
     year-end ........................        96       $ 7.48       262       $ 7.43      221       $ 7.73
                                            ====       ======      ====       ======     ====       ======

Weighted average fair value 
     of options
     granted .........................                 $ 7.69                 $ 5.24                $ 2.62
                                                       ======                 ======                ======
</TABLE>

            A summary of the exercise prices for options outstanding under the
Company's stock-based compensation plans at November 30, 1998, is presented
below (shares in thousands):

<TABLE>
<CAPTION>
                                                                               Weighted
                                                                               Average
                                 Weighted        Weighted                      Exercise
   Exercise       Shares Under    Average         Average        Shares     Price of Shares
  Price Range       Option     Exercise Price  Remaining Life  Exercisable    Exercisable
---------------   -----------  --------------  --------------  -----------  ---------------
<C>                  <C>          <C>               <C>             <C>         <C>
$ 4.63 - $ 5.25      145          $ 4.87            7.15            24          $ 4.86
$ 7.50 - $ 9.50      143            8.37            6.67            71            8.19
$13.50 - $18.00      469           13.78            9.16             1           18.00
$25.63 - $26.31        5           25.90            9.55            --             N/A
                     ---          ------            ----            --          ------
                                                                             
  Total              762          $11.17            8.31            96          $ 7.48
                     ===          ======            ====            ==          ======
</TABLE>
<PAGE>

PREFERRED SHARES

            The Company is authorized to issue up to 1,000,000 preferred shares
in series and with rights established by the board of directors. At November 30,
1998 and 1997, no shares of any series of preferred stock were issued and
outstanding.

EMPLOYEE STOCK OWNERSHIP PLAN

            Effective June 1, 1989, the Company established an Employee Stock
Ownership Plan providing for the issuance of up to 360,000 shares of the
Company's common stock. At November 30, 1998, no contributions had been made to
the plan.

COMMON STOCK WARRANTS

            As described in Note 5, the Company issued the Warrants at an
assigned value of $955. The Warrants are exercisable for five years. In the
aggregate, 75,000 warrants were issued which, when exercised, would entitle the
holders thereof to acquire an aggregate of 417,182 shares of the Company's
common stock. The number of shares of common stock and the price per share at
which a warrant is exercisable are subject to adjustment upon the occurrence of
certain events. A warrant does not entitle the holder to receive any cash
dividends paid on common stock or to exercise any other rights as a shareholder
of the Company.

            During 1998, 35,568 warrants were exercised to acquire 208,337
shares. During 1997, 12,030 warrants were exercised to acquire 70,464 shares. At
November 30, 1998, 23,626 warrants were outstanding which, when exercised, would
entitle the holders thereof to acquire an aggregate of 138,386 shares of the
Company's common stock.

(10) CONTINGENCIES

GENERAL LITIGATION

            Claims, suits and complaints arise in the ordinary course of the 
Company's business involving such matters as patents and trademarks, product 
liability, environmental matters and other alleged injuries or damage. In 
February 1999 a complaint was filed by Genderm Corporation ("Genderm") in the 
U.S. District Court alleging, among other things, that the formulations of 
CAPZASIN-P, CAPZASIN-HP and ICY HOT Arthritis Therapy Gel infringe upon a 
patent licensed to Genderm. The complaint requests injunctive relief, 
compensatory and treble damages, costs and attorneys fees. A hearing on the 
injunctive relief is currently scheduled for April 1999. The outcome of such 
litigation cannot be predicted, but, in the opinion of management, based in 
part upon the opinion of counsel, all such pending matters (with the 
exception of the Genderm litigation as to which litigation management is not 
yet in a position to form an opinion) are without merit or are of such kind 
or involve such amounts as would not have a material adverse effect on the 
consolidated operating results or financial position of the Company if 
disposed of unfavorably.

REGULATORY

            The manufacturing, processing, formulation, packaging, labeling and
advertising of the Company's products are subject to regulation by federal
agencies, including the United States Food and Drug Administration (FDA). As
part of its regulatory authority, the FDA may periodically conduct audits of the
physical facilities, machinery, processes and procedures which the Company uses
to manufacture products. In December 1998, the FDA conducted an audit of the
Company's manufacturing facility in Chattanooga, Tennessee. The FDA issued a
report citing certain processes and procedures it requires the Company to change
or improve. The Company has responded to the FDA's report and is in the process
of complying with its requirements.
<PAGE>

YEAR 2000 (Unaudited)

            The Company is in the process of replacing its current 
information technology (IT) systems with a new fully integrated computer 
system to replace all hardware and software that the Company uses in its 
financial, manufacturing and customer service functions. The new IT system 
will be year 2000 compliant. As a result, the year 2000 compliance 
requirements are considered only a portion of the Company's systems 
replacement effort. This replacement is expected to be completed by December 
1, 1999 at a total cost of $1,500 to $2,000. Such costs are being capitalized 
as incurred.

            The Company is also reviewing the possible impact of the year 2000
problem on its customers and suppliers and has requested and received from a
majority of its principal customers and suppliers written statements regarding
their knowledge of and plans for meeting the year 2000 compliance requirements.

            The Company's business could be adversely affected should the
Company or other entities with whom the Company does business be unsuccessful in
completing critical modifications in a timely manner.
<PAGE>

(11) SUPPLEMENTAL FINANCIAL INFORMATION

            Inventories consisted of the following at November 30, 1998 and
1997:

                                                            1998         1997 
                                                         ---------    ---------
Raw materials and work in process ....................   $   7,903    $   9,107
Finished goods .......................................      14,113        7,850
Excess of current cost over LIFO value ...............      (2,410)      (2,464)
                                                         ---------    ---------
  Total inventories ..................................   $  19,606    $  14,493
                                                         =========    =========

            International inventories included above, valued on a lower of FIFO
cost or market at November 30, 1998 and 1997, were $3,004 and $2,546,
respectively.

            Property, plant and equipment consisted of the following at November
30, 1998 and 1997:

                                                            1998         1997 
                                                         ---------    ---------
Land .................................................   $     140    $     138
Buildings and improvements ...........................       3,434        3,150
Machinery and equipment ..............................      29,678       23,416
Construction in progress .............................       2,900        2,221
Less -- accumulated depreciation .....................     (18,006)     (17,937)
                                                         ---------    ---------
  Property, plant and equipment, net .................   $  18,146    $  10,988
                                                         =========    =========

            Accrued liabilities consisted of the following at November 30, 1998
and 1997:

                                                            1998         1997 
                                                         ---------    ---------
Accrued interest expense .............................   $   5,969    $   4,119
Salaries, wages and commissions ......................       2,850        1,696
Promotion expense ....................................       8,896        2,840
Product acquisitions .................................       3,290        1,489
Accrued pension benefits .............................         700          435
Accrued royalties ....................................       2,889        1,670
Other ................................................       5,615        1,347
                                                         ---------    ---------
  Total accrued liabilities ..........................   $  30,209    $  13,596
                                                         =========    =========
<PAGE>

(12) ACQUISITION AND SALE OF BRANDS

            On March 24, 1998, the Company acquired the BAN line of
antiperspirant and deodorant products from Bristol-Myers Squibb Company for a
purchase price of approximately $165,000, plus assumed liabilities. The Company
acquired the BAN trademarks, formulae, certain patents pertaining to
antiperspirant /deodorant technology, technical information, inventory,
manufacturing equipment and packaging related assets used in the manufacture of
BAN, but not the right to sell BAN in Japan.

            The following unaudited consolidated pro forma information assumes
the acquisition of BAN and related long-term borrowings had occurred on December
1, 1998 and 1997, respectively:

            PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)

                                                     1998           1997
                                                   --------       --------

Net sales ..................................       $239,508       $239,387

Income before
  extraordinary loss (1) ...................         15,780         15,029

Net income .................................         12,921         13,659

Earnings per share (basic):

  Income before extraordinary
    loss ...................................           1.68           1.71

  Net income ...............................           1.38           1.55

Earnings per share (diluted):

  Income before extraordinary
    loss ...................................           1.62           1.65

  Net income ...............................           1.33           1.50

            (1) Includes gain on the sale of CORNSILK.

The pro forma consolidated results of operations include adjustments to give
effect to amortization of intangible assets, interest expense on acquisition
debt and certain other adjustments, together with related income tax effects.
The pro forma information is not necessarily indicative of the combined results
that would have occurred had the acquisition and borrowings occurred at the
beginning of the periods presented, nor is it indicative of the results that may
occur in the future.
<PAGE>

            On May 12, 1998, the Company sold the CORNSILK oil control makeup
brand to Del Laboratories, Inc. for $10,750, plus inventories and the assumption
of certain liabilities. The Company sold, at a gain of $9,548, CORNSILK
trademarks, formulae, technical information, inventory and other related assets
but will continue to operate the CORNSILK business in the United Kingdom
pursuant to a license agreement. The Company used the net proceeds from the sale
to reduce bank indebtedness.

            On June 26, 1997, the Company purchased certain assets of Sunsource
International, Inc. and an affiliated company (SUNSOURCE) including the
exclusive worldwide rights to five leading branded dietary supplement products.
The purchase price for the trademarks, inventory and receivables was
approximately $32,000, net of certain assumed liabilities. Financing of the
SUNSOURCE acquisition was provided by an expansion of the Company's senior bank
credit agreement (Note 5) and the issuance of 300,000 shares of Chattem, Inc.
common stock to SUNSOURCE. Additional payments may be earned by SUNSOURCE over a
six year period from the date of closing if sales exceed certain levels as
defined in the purchase agreement. In 1998, the Company paid the former owners
of SUNSOURCE $2,500 and forgave $5,625 of amounts due the Company, in exchange
for a 50% reduction in any future additional payments under the purchase
agreement. Under the amended agreement, future additional payments may not
exceed $7,875 in the aggregate.

            On April 29, 1996, the Company purchased the worldwide rights for
the GOLD BOND line of medicated powders and anti-itch cream for approximately
$40,000. The assets acquired consisted of the trademarks ($38,000) and
inventory. Additionally, the Company assumed certain liabilities of
approximately $500. The Company financed the GOLD BOND acquisition with bank
borrowings (Note 5) and issuance of common stock (Note 9).

            On June 6, 1996, the Company purchased the rights for the HERPECIN-L
line of medicated lip balm for $5,607 plus a royalty payment equal to the
greater of $214 or 5% of net sales. The royalty payment is payable annually for
each of the seven twelve-month periods beginning July 1, 1996 and ending June
30, 2003. The assets acquired consisted primarily of the trademark ($5,159),
receivables and inventory. Additionally, the Company assumed certain liabilities
of approximately $500. The purchase was financed by the Company with additional
bank borrowings of $5,000 with the remaining $607 being funded by the Company
(Note 5).
<PAGE>

(13) ACCRUED POSTRETIREMENT HEALTH CARE BENEFITS

            The Company maintains certain postretirement health care benefits
for eligible employees. Employees become eligible for these benefits if they
meet certain age and service requirements. The Company pays a portion of the
cost of medical benefits for certain retired employees over the age of 65.
Effective January 1, 1993, the Company's contribution is a service-based
percentage of the full premium. The Company pays these benefits as claims are
incurred.

            Net periodic postretirement health care benefits cost for the years
ended November 30, 1998, 1997 and 1996, included the following components:

                                                           1998     1997    1996
                                                           ----     ----    ----

Service cost (benefits earned during the period) ......    $ 19     $ 29    $ 36
Interest cost on accumulated postretirement
  benefits obligation .................................      82      115     101
Amortization of net loss (gain) .......................     (18)       2      --
                                                           ----     ----    ----
Net periodic postretirement benefits cost .............    $ 83     $146    $137
                                                           ====     ====    ====

            The following table sets forth the funded status of the plan,
reconciled to the accrued postretirement health care benefits recognized in the
Company's balance sheets at November 30, 1998 and 1997:

                                                              1998        1997
                                                             ------     -------
Accumulated postretirement benefits obligation:
  Retirees .............................................     $  722     $   715
  Fully eligible active plan participants ..............        246         502
  Other active participants ............................        252         377
Unrecognized net gain (loss) ...........................        210        (160)
                                                             ------     -------
Accrued postretirement health care benefits ............     $1,430     $ 1,434
                                                             ======     =======

            For measurement purposes, a 6.0% annual rate of increase in the per
capita cost of covered health care benefits was assumed in 1998 and 1997. The
weighted-average discount rate used in determining the accumulated
postretirement benefit obligation was 7.5% at November 30, 1998 and 1997. A 1%
increase in the assumed health care cost trend rate would not affect the
accumulated postretirement benefit obligation as of November 30, 1998 or the
aggregate of the service and interest cost components of the net annual
postretirement benefit cost for the year ended November 30, 1998.

(14) SUBSEQUENT EVENT

            On December 21, 1998, the Company acquired the DEXATRIM,
SPORTSCREME, ASPERCREME, CAPZASIN-P, CAPZASIN-HP and ARTHRITIS HOT brands from
Thompson Medical Company, Inc. (Thompson) for $95,000. The purchase price
consisted of $90,000 cash and 125,500 shares of the Company's common stock. The
cash portion of the purchase price was financed by a new senior credit facility.
The new $165,000 senior credit facility consists of a $115,000 term loan and a
$50,000 working capital revolving line of credit of which $21,500 was initially
drawn. The proceeds of the new credit facility were used to fund the Thompson
acquisition and related fees and expenses and refinance existing bank
indebtedness. 
<PAGE>

            On December 21, 1998, the Company filed a shelf registration
statement with the Securities and Exchange Commission for $250,000 of debt and
equity securities.
<PAGE>

                              REPORT OF INDEPENDENT
                               PUBLIC ACCOUNTANTS

TO CHATTEM, INC.:

We have audited the accompanying consolidated balance sheets of Chattem, Inc. (a
Tennessee corporation) and subsidiaries as of November 30, 1998 and 1997 and the
related consolidated statements of income, shareholders' equity (deficit) 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 financial position of Chattem, Inc. and subsidiaries
as of November 30, 1998 and 1997, and the 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.


ARTHUR ANDERSEN LLP


Chattanooga, Tennessee
January 22, 1999
(except with respect to the
 matter discussed in the
 second paragraph of Note 10
 as to which the date is
 February 19, 1999)




<PAGE>

                              QUARTERLY INFORMATION
             (UNAUDITED AND IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                               QUARTER ENDED
                                               --------------------------------------------
                                      TOTAL    FEBRUARY 28  MAY 31   AUGUST 31  NOVEMBER 30
                                      -----    -----------  ------   ---------  -----------
<S>                                  <C>         <C>        <C>       <C>         <C>   
FISCAL 1998:
  Before extraordinary loss:
    Net sales ...................    $220,064    34,921     58,545    67,600      58,998
    Gross profit ................    $159,175    25,239     42,691    48,219      43,026
    Income (1) ..................    $ 18,128       609     10,069     4,391       3,059
    Income per share,                                                           
     diluted (1), (2) ...........    $   1.86       .06       1.02       .45         .31
 Total:                                                                         
    Net income (1) ..............    $ 15,269       609      8,168     3,433       3,059
    Net income per share,                                                       
     diluted (1), (2) ...........    $   1.57       .06        .83       .35         .31
                                                                                
FISCAL 1997:                                                                    
  Before extraordinary loss:                                                    
    Net sales ...................    $143,235    27,946     39,178    38,909      37,202
    Gross profit ................    $103,982    19,552     28,290    28,809      27,331
    Income ......................    $  7,255       136      3,057     2,847       1,215
    Income per share, diluted (2)    $    .80       .02        .35       .31         .13
 Total:                                                                         
    Net income ..................    $  5,885       136      3,057     1,477       1,215
    Net income per share,                                                       
     diluted (2) ................    $    .65       .02        .35       .16         .13
</TABLE>

            (1)   INCLUDES THE EFFECT OF THE DIVESTITURE OF CORNSILK.

            (2)   THE SUM OF THE QUARTERLY EARNINGS PER SHARE AMOUNTS MAY DIFFER
                  FROM ANNUAL EARNINGS PER SHARE BECAUSE OF THE DIFFERENCES IN
                  THE WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND DILUTIVE
                  POTENTIAL SHARES USED IN THE QUARTERLY AND ANNUAL
                  COMPUTATIONS.
<PAGE>

                        GEOGRAPHICAL SEGMENT INFORMATION
                                 (IN THOUSANDS)

                                                  YEAR ENDED NOVEMBER 30,
                                          -------------------------------------
                                             1998          1997          1996
                                          ---------     ---------     ---------

NET SALES:
  Domestic ...........................    $ 199,811     $ 128,024     $ 104,444
  International ......................       20,253        15,211        14,459
                                          ---------     ---------     ---------
     Consolidated ....................    $ 220,064     $ 143,235     $ 118,903
                                          =========     =========     =========

OPERATING INCOME:
  Domestic ...........................    $  47,482     $  27,393     $  18,929
  International ......................        2,902         1,710         1,613
                                          ---------     ---------     ---------
     Total ...........................       50,384        29,103        20,542
 Other unallocated expenses, net (1) .      (21,412)      (17,855)      (14,922)
                                          ---------     ---------     ---------
     Income before income taxes and
         extraordinary loss ..........    $  28,972     $  11,248     $   5,620
                                          =========     =========     =========

IDENTIFIABLE ASSETS:
  Domestic ...........................    $ 357,568     $ 164,175     $ 135,238
  International ......................        8,342         7,929        10,961
                                          ---------     ---------     ---------
     Total ...........................      365,910       172,104       146,199
  Investment in Elcat, Inc. ..........        3,102         6,640         5,984
                                          ---------     ---------     ---------
     Consolidated ....................    $ 369,012     $ 178,744     $ 152,183
                                          =========     =========     =========

(1) PRINCIPALLY INTEREST EXPENSE AND CORPORATE OVERHEAD NOT ALLOCATED.