<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
--------------------------------------------------------------------------------

                                   FORM 10-K

              [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                 For the fiscal year ended: September 30, 1998
                                       OR
           [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                      For the transition period from    to

                         Commission file number 0-22018

                           CELESTIAL SEASONINGS, INC.
             (Exact name of Registrant as specified in its charter)

         Delaware                                        84-1097571
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)      

                  4600 Sleepytime Drive, Boulder CO 80301-3292
                    (Address of principal executive offices)

                                 (303) 530-5300
              (Registrant's telephone number, including area code)
          Securities registered pursuant to Section 12(b) of the Act:
                                 Not Applicable

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

                     COMMON STOCK, $.01 PAR VALUE PER SHARE
       RIGHTS TO PURCHASE JUNIOR PARTICIPATING PREFERRED STOCK, SERIES A,
                            PAR VALUE $.01 PER SHARE
                             (Title of Each Class)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                               Yes [X]    No [ ]

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

The approximate aggregate market value of voting and non-voting common equity
held by nonaffiliates of the registrant was $205,022,727 as of December 1, 1998.

Number of shares of Common Stock outstanding as of December 1, 1998: 8,325,796

DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement to be dated on or about January 15, 1999 - Incorporated into
Part III.
<PAGE>
 
PART I

ITEM 1. - BUSINESS

General

Celestial Seasonings, Inc. (the "Company") is the largest manufacturer and
marketer of herb teas in the United States, with an estimated 50% share of the
herb tea category. The Company developed and popularized the herb tea category
in the United States as a flavorful and non-caffeinated alternative to other hot
beverages. Currently the Company markets over 50 tea varieties under the
Celestial Seasonings brand. Celestial Seasonings products are sold in
substantially all of the major supermarkets, grocery stores and natural foods
markets in the United States.

The Company develops high-quality, flavorful, natural products as well as
attractive, colorful and thought-provoking packaging. The Company's products
include Sleepytime(R), Lemon Zinger(R), Peppermint, Chamomile, Mandarin Orange
Spice(R), Wild Cherry Blackberry, Cinnamon Apple Spice, Red Zinger(R), Raspberry
Zinger(R) and Wild Berry Zinger(R) herb teas, a line of green teas, a line of
wellness teas and a line of specialty black teas.

The Company's tea business began in the early 1970s. In 1984, the Company was
acquired by Kraft, Inc., and in 1988, the Company was acquired in a management
buyout. The Company completed its initial public offering of common stock during
1993.

During 1995, the Company entered the dietary supplement market. In 1997, the
Company introduced a line of herbal supplements under the Celestial(TM) Herbal
Extracts name. The Company developed a more extensive line of dietary supplement
products under the Celestial Seasonings(R) brand during 1998.

The Tea Industry

The domestic tea industry consists of a number of general product categories,
including herb tea, green tea, specialty black tea, commodity black tea, instant
tea and ready-to-drink tea. The Company believes, based on data derived from
Information Resources, Inc. reports and the Company's estimates, that annual
domestic retail tea sales, excluding ready-to-drink tea, are approximately $1.5
billion.

The Dietary Supplements Industry

The dietary supplements industry consists of three broad categories: vitamins,
minerals and herbal supplements. The Company believes, based on data from A. C.
Nielsen, Inc. reports and the Company's estimates, that annual domestic retail
sales of dietary supplements are approximately $11 billion. Based on these same
sources, the total dietary supplements industry growth rate over the past year
has been approximately 17%, while the herbal supplements category has
experienced a growth rate of approximately 35%.

Products

The Company's tea products contain no artificial preservatives, are made from
high-quality, natural ingredients and are generally offered in 20 and 40 count
packages sold in grocery, natural foods and other retail stores. Industry sales
of herb tea have grown only moderately in recent years, but green tea has
doubled over the past year to become a $42 million category.  By introducing new
teas, such as green and wellness teas, and overall category growth, the
Company's sales growth in the beverage segment was approximately 11% during
1998.

The following table sets forth the amounts and percentages of the Company's net
sales for each major business segment during the last three years. Changes in
net sales are affected by timing of promotional activities, consumer trends and
the development and introduction of new products. Historical results may not be
indicative of results in future years.

                                       2
<PAGE>
<TABLE> 
                                  Company Net Sales By Business Segment 
                                          Year Ended September 30,
                           ---------------------------------------------------
                                1998               1997              1996
                           ---------------    --------------    --------------
                                          (dollars in thousands)

<S>                        <C>       <C>      <C>       <C>     <C>       <C> 
Beverages                  $ 79,875   78.2%   $72,205   91.4%   $69,016   94.6%
 
Dietary supplements          18,739   18.3      3,789    4.8      1,917    2.6

Other                         3,583    3.5      3,045    3.8      2,065    2.8
                           --------  -----    -------  -----    -------  -----  
Total net sales            $102,197  100.0%   $79,039  100.0%   $72,998  100.0%
                           ========  =====    =======  =====    =======  =====
</TABLE>

BEVERAGES

Herb Tea. The Company's herb teas are made from all natural ingredients and  are
offered in a wide variety of flavors. The Company's top-selling herb tea
products include Sleepytime(R), Chamomile, Lemon Zinger(R), Peppermint,
Raspberry Zinger(R), Tension Tamer(R), Wild Berry Zinger(R), Country Peach
Passion(R), Mandarin Orange Spice(R) and Red Zinger(R).

Green Tea. The company introduced a new line of green teas during 1998.  The new
line includes Authentic Green Tea, Decaffeinated Green Tea, Emerald Gardens(R)
Green Tea, Honey Lemon Ginseng Green Tea, Misty Jasmine(TM) Green Tea and
Organic Green Tea.

Wellness Tea. During 1998, the Company developed a line of wellness teas, some
of which correspond to its line of dietary supplement products. These products
provide the healthful benefits of  the Company's dietary supplement line in an
alternative format. This product line includes Detox A.M.(TM), Diet Partner(R),
Echinacea, Echinacea Cold Season(TM), GingerEase(TM), GinkgoSharp(TM), Ginseng
Energy(TM), Heart Health(TM), LaxaTea(TM) and Mood Mender(TM).

Specialty Black Tea. The Company's specialty black teas are made exclusively
from natural ingredients.  Black tea products include Earl Grey, English
Breakfast, Estate Blend(TM), Fast Lane(R), Vanilla Maple, Ceylon Apricot Ginger,
Black Raspberry, Morning Thunder(R), Mountain Estate(TM) Decaffeinated Black Tea
and Organic Black Tea.

DIETARY SUPPLEMENTS

During 1998, the Company launched a line of herbal supplement products under the
Celestial Seasonings(R) brand. The current dietary supplement products include a
line of herbal blends and a line of single herb extracts, all of which contain
high-quality standardized herbs and extracts.  The Company's dietary supplement
products include St. John's Wort, Ginseng Energy(TM), Mood Mender(TM), Tension
Tamer(R), Sleepytime Extra(R), Ginkgo Biloba, GingkoSharp(R) and Echinacea
Cold Season(TM). Additionally, the Company is currently marketing a line of
Celestial Seasonings(R) Ultimate Blend nutritional supplements and Certified
Organic Standardized herbal supplements to the natural foods market.

OTHER

Other includes direct retail sales by the Company, royalty income and sales of
other miscellaneous products. Direct sales by the Company totaled $3,356,000 in
1998, primarily from its on-site retail store and mail order catalogue. Total
royalty income in 1998 was $227,000 primarily from a license agreement with
Warner-Lambert Company ("Warner-Lambert") entered into in 1994. Under the
agreement, Warner-Lambert manufactures and distributes throat drops under the
Celestial Seasonings Soothers(TM) and Herbal Comfort(TM) names. The agreement is
for a five-year period and Warner-Lambert has options to renew for one-year
periods thereafter.

                                       3
<PAGE>
 
Research and Development

The Company considers research and development of new products to be a
significant part of its overall philosophy and commitment to developing high-
quality products. A team of professional product developers works with a sensory
technologist to test product prototypes with consumers. The research and
development department incorporates product ideas from all areas of the Company
in order to formulate new products. In addition to developing new tea and
dietary supplement products, the research and development department routinely
reformulates and revises existing products. New blends of herbs and teas are
submitted for review and evaluation to tea-tasters and consumer focus groups.

Sales and Distribution

The Company's products are sold in all 50 states and approximately 40 countries.
The Company's sales are seasonal. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Seasonality" included in Part
II, Item 7. Net sales include total export sales of $9,672,000, $8,807,000 and
$7,579,000 in 1998, 1997 and 1996, respectively.

The major domestic channels of distribution for the Company's products are
supermarkets and grocery stores, natural foods markets and mass merchandisers.
During 1998, no single customer accounted for more than 10% of total Company
sales.

The Company's products are sold by the Company's sales staff and a network of
brokers who represent the Company in connection with sales to grocery, natural
foods and non-grocery businesses. Brokers represent the Company in presenting
marketing and sales programs, supporting retail stores, selling new items, and
establishing sales promotions with customers. The Company's policy is to grant
its brokers rights to sell the Company's products within a defined territory.
All of the Company's brokers also represent other food, beverage and herbal
supplement manufacturers.

Marketing

The Company uses a mix of consumer and trade promotions, as well as advertising,
to market its products. The Company's advertising and sales promotion
expenditures are for national and regional consumer promotion through television
advertising, couponing and other trial use programs, with the balance spent on
trade advertising and promotion, including slotting fees, cooperative
advertising and feature advertising.

Operations

Suppliers. The Company purchases its ingredients from numerous foreign and
domestic manufacturers, importers and growers, with the majority of those
purchases occurring outside of the United States. The Company maintains long-
term relationships with most of its suppliers. Purchase arrangements with
ingredient suppliers are generally made annually and in U.S. currency. Purchases
are made through purchase orders or contracts, and price, delivery terms and
product specifications vary.

The Company's botanical purchasers visit major suppliers around the world
annually to procure ingredients and to assure quality by observing production
methods and providing product specifications. Many ingredients are presently
grown in countries where labor-intensive cultivation is possible, and where the
Company often must educate the growers about product standards. The Company
performs laboratory analysis on incoming ingredient shipments for the purpose of
assuring that they meet the Company's quality standards and those of the U.S.
Food and Drug Administration ("FDA").

The Company's ability to ensure a continuing supply of ingredients at
competitive prices depends on many factors beyond its control, such as foreign
political situations, embargoes, changes in national and world economic
conditions, currency fluctuations and unfavorable climatic conditions. The
Company takes steps intended to lessen the risk of an interruption of botanical
supplies, including identification of alternative sources and maintenance of
appropriate inventory levels. The Company has, in the past, maintained
sufficient supplies for its ongoing operations.

                                       4
<PAGE>
 
The Company purchases most of its packaging materials domestically. The Fort
James Corporation, a packaging materials supplier, was the largest single
supplier in 1998. The ability of the Company to assure continuing production of
bagged tea depends upon the continuing access to tea bag paper. The Company
currently obtains most of its tea bag paper from a single domestic supplier,
which has proven to be a reliable source of quality paper. Alternative sources
for tea bag paper have been utilized in the past and are available for future
purchases.

Beverage Production. The Company uses more than 100 ingredients in its various
tea blends. The Company separates and cleans herbs upon receipt from suppliers
at its facilities in Boulder, Colorado. Individual herbs are combined in the
Company's blending system, and the blends are taste-tested to ensure flavor
consistency. Finally, the Company packages herb blends into finished products. A
continuous line of automated equipment deposits the blended herbs in tea bags
and packages the tea bags, first in cartons and then in cases. The Company is
currently taking steps to increase its production capacity which should provide
it with sufficient production capacity for the foreseeable future. The Company
believes that its tea bagging lines are among the most automated in the tea
industry.

Dietary Supplement Production. The Company's dietary supplement product lines
are manufactured by independent co-packers located in the United States. All co-
packing locations are inspected by the Company. All lots of finished product are
statistically sampled and tested for quality. This testing includes marker
compounds, microbiological load and packaging quality. The Company believes that
its network of co-packers has sufficient production capacity to meet its future
needs.

Trademarks and Copyrights

The Company has trademarks for most of its best-selling brands, including
Sleepytime(R), Lemon Zinger(R), Mandarin Orange Spice(R), Red Zinger(R), Wild
Berry Zinger(R) and GinkgoSharp(R). The Company has made various federal and
international filings with respect to its material trademarks, and intends to
keep these filings current and seek protection for new trademarks to the extent
consistent with business needs. The Company also copyrights certain of its
artwork and package designs. The Company is not aware of any material challenge
to the validity of any trademark or copyright material to its business. However,
due to the importance of product package design and artwork to the success of
its business, the Company intends to take vigorous action to protect against the
imitation of its products and packages and to protect its trademarks and
copyrights to the extent consistent with business needs.

Competition

The beverage market is large and highly competitive. The tea portion of the
beverage market is also highly competitive. Competitive factors in the tea
industry include product quality and taste, brand awareness among consumers,
variety of specialty tea flavors, interesting or unique product names, product
packaging and package design, supermarket and grocery store shelf space,
alternative distribution channels, reputation, price, advertising and promotion.
The Company currently competes in the specialty tea market segment which
consists of herb tea, green tea and specialty black tea. The Company's specialty
herb tea products, like other specialty tea products, are priced higher than
most commodity black tea products.

The Company's principal competitors on a national basis in the specialty tea
market segment are Thomas J. Lipton Company, a division of Unilever PLC, which
has substantially greater financial resources than the Company, and R.C.
Bigelow, Inc. Additional competitors include a number of regional specialty tea
companies. There may be potential entrants which are not currently in the
specialty tea market who may have substantially greater financial resources than
the Company. Private label competition in the specialty tea category is
currently minimal.

The market for the Company's dietary supplement products is highly competitive.
Competition is based principally upon price, quality of products, customer
service and marketing support. The Company currently competes in the herbal
supplement segment of the dietary supplement category. Herbal supplements are
presently a high growth market category consisting of several competitors in a
broad spectrum of distribution channels. Private label and Rexall Sundown, Inc.
dominate the market on a national basis. Direct mail, regional and private label
competition is significant.

                                       5
<PAGE>
 
Employees

As of September 30, 1998, the Company employed 261 full-time employees. Of this
number, 80 were in management and sales, 70 were in administrative or clerical
positions and 111 were production and service employees. The Company has
implemented a number of programs to maintain a high level of employee morale and
productivity, and believes its employee relations are satisfactory.

Government Regulation

The production and marketing of the Company's beverages and dietary supplements
are subject to the rules and regulations of various federal, state and local
food and health agencies, including the FDA and the Federal Trade Commission.
The Company believes it is currently in compliance with the Dietary Supplement
Health and Education Act of 1994 ("DSHEA"), which goes into effect in March of
1999. DSHEA defines dietary supplements as a new category of food, separate from
conventional food. DSHEA requires specific nutritional labeling requirements for
dietary supplements and permits substantiated, truthful and non-misleading
statements of nutritional support to be made in labeling, such as statements
describing general well-being resulting from consumption of a dietary
ingredient, or the role of a nutrient or dietary ingredient in affecting or
maintaining a structure or function of the body.

In addition to laws relating to food and dietary supplement products, the
Company is subject to various federal, state and local environmental laws and
regulations which limit the discharge, storage, handling and disposal of a
variety of substances. The Company's operations are also governed by laws and
regulations relating to workplace safety and worker health, principally the
Occupational Safety and Health Administration Act and applicable state laws. The
Company believes it presently complies, in all material respects, with the
foregoing laws and regulations and does not anticipate any material capital
expenditures in connection with any government regulations.

ITEM 2. - PROPERTIES

The Company owns a manufacturing and office facility in Boulder, Colorado built
in 1990 on 42 acres of Company-owned land. The facility has approximately
167,000 square feet, of which 50,000 square feet is office space and 117,000
square feet is manufacturing space. Management believes the property is in
satisfactory condition and suitable for the Company's purposes.

ITEM 3. - LEGAL PROCEEDINGS

The information in Note 6 to the Company's Consolidated Financial Statements
included in Part II is incorporated herein.

ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

                                       6
<PAGE>
 
                                    PART II

ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS

The Common Stock of the Company is traded on the Nasdaq-Amex Market Group
("Nasdaq-Amex") under the symbol "CTEA." The following table sets forth the high
and low sales prices for the Common Stock for the periods indicated as reported
by Nasdaq-Amex. On December 1, 1998, the last reported sale price of the Common
Stock was $24.63 per share.

 
<TABLE>
                                         High        Low
                                         ----        ---      
                1997:
 
                <S>                      <C>         <C>
                First Quarter            $12.25      $ 9.50
                Second Quarter           $11.88      $ 9.75
                Third Quarter            $12.50      $ 9.75
                Fourth Quarter           $14.32      $11.38
         
                1998:
 
                First Quarter            $16.25      $13.19
                Second Quarter           $20.63      $15.25
                Third Quarter            $28.81      $20.00
                Fourth Quarter           $26.75      $17.38
</TABLE>

As of December 1, 1998, there were approximately 304 holders of record of the
Company's Common Stock. The Company declared a two-for-one stock split effected
in the form of a 100% common stock dividend during September 1998. All sales
prices for the Company's Common Stock are adjusted for the stock dividend.

The Company did not pay cash dividends during the last five years. The Company
intends to retain earnings to fund the growth of its business and therefore does
not anticipate paying any cash dividends on shares of Common Stock in the
foreseeable future.

                                       7
<PAGE>
 
ITEM 6. - SELECTED FINANCIAL DATA

The following data for each of the five fiscal years ended September 30, 1998 is
derived from the consolidated financial statements of the Company. The following
data should be read in conjunction with the Company's financial statements,
related notes thereto and other financial information included elsewhere in this
Annual Report on Form 10-K.

<TABLE>
<CAPTION> 
                                                                              Year Ended September 30,
                                                                ----------------------------------------------------
                                                                       (in thousands, except per share amounts)
                                                                  1998       1997       1996       1995       1994
                                                                --------   --------   --------   --------   --------
<S>                                                             <C>        <C>        <C>        <C>        <C>
Summary of Operations:

Net sales                                                       $102,197   $ 79,039   $ 72,998   $ 70,104   $ 65,041
Cost of goods sold                                                36,638     29,606     28,545     27,349     24,322
                                                                --------   --------   --------   --------   --------
Gross profit                                                      65,559     49,433     44,453     42,755     40,719
Operating expenses:
 Selling and marketing                                            46,683     33,915     30,071     27,323     26,306
 General and administrative                                        6,127      4,556      3,899      4,429      3,861
 Amortization of intangibles                                       1,308      1,296      1,493      1,823      2,046
                                                                --------   --------   --------   --------   --------
Operating income                                                  11,441      9,666      8,990      9,180      8,506
Interest expense                                                     631        493        874      1,264      1,345
                                                                --------   --------   --------   --------   --------
Income before income taxes                                        10,810      9,173      8,116      7,916      7,161
Income taxes                                                       4,054      3,509      3,093      2,049        698
                                                                --------   --------   --------   --------   --------
Net income attributable to common stock                         $  6,756   $  5,664   $  5,023   $  5,867   $  6,463 
                                                                ========   ========   ========   ========   ========

Net income per common share-basic /1/                           $   0.82   $   0.70   $   0.62   $   0.73   $   0.80
                                                                ========   ========   ========   ========   ========
Net income per common share-assuming dilution /1/               $   0.77   $   0.68   $   0.61   $   0.72   $   0.79
                                                                ========   ========   ========   ========   ========

Weighted average common shares-basic /1/                           8,250      8,107      8,088      8,053      8,040
Weighted average common shares-assuming dilution /1/               8,732      8,281      8,230      8,172      8,211

Balance Sheet Data:

 Working capital                                                $ 23,131   $ 10,588   $  7,882   $  6,239   $  4,624
 Total assets                                                     82,647     58,371     54,903     53,327     51,705
 Long-term debt                                                   10,750      6,073      9,057     12,768     17,432
 Stockholders' equity                                             51,320     43,051     37,217     31,909     25,898

Other Data:

 Earnings before interest, taxes,
  depreciation and amortization (EBITDA)                        $ 14,055   $ 12,098   $ 11,551   $ 11,888   $ 11,280
</TABLE>

/1/  During September 1998 the Company declared a two-for-one stock split
     effected in the form of a 100% common stock dividend. All per share and
     weighted average common share information has been restated to reflect the
     stock dividend.

                                       8
<PAGE>
 
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Results of Operations

The following table is derived from the Company's Consolidated Income Statements
for the periods indicated and presents (i) the results of operations as a
percentage of net sales and (ii) the percentage change in the dollar amounts of
each item from the prior period.

<TABLE>
<CAPTION>
                                                                                   Period-to-Period
                                          Percentage of Net Sales                 Increase/(Decrease)
                                   -------------------------------------------------------------------------
                                                                               1998                  1997
                                         Year Ended September 30,            Compared              Compared
                                       1998        1997       1996            to 1997               to 1996
                                   ------------------------------------------------------------------------- 
     <S>                            <C>          <C>          <C>            <C>                <C>
     Net sales                         100.0 %     100.0 %     100.0 %           29.3 %                 8.3 %
     Cost of goods sold                 35.8        37.5        39.1             23.8                   3.7
                                   -----------------------------------
     Gross profit                       64.2        62.5        60.9             32.6                  11.2
     Selling and marketing              45.7        42.9        41.2             37.6                  12.8
     General and administrative          6.0         5.8         5.3             34.5                  16.9
     Amortization of intangibles         1.3         1.6         2.1              0.9                 (13.2)
                                   -----------------------------------
     Operating income                   11.2        12.2        12.3             18.4                   7.5
     Interest expense                    0.6         0.6         1.2             28.0                 (43.6)
                                   -----------------------------------
     Income before income taxes         10.6        11.6        11.1             17.8                  13.0
     Income taxes                        4.0         4.4         4.2             15.5                  13.4
                                   -----------------------------------
     Net income                          6.6 %       7.2 %       6.9 %           19.3                  12.8
                                   ===================================
</TABLE>                                                                 
                                                                         
Fiscal 1998 Compared to Fiscal 1997                                      
                                                                         
Net sales. Net sales for 1998 increased 29.3% to $102.2 million from $79.0
million in 1997. Net sales growth was primarily the result of increased sales of
the Company's dietary supplement products and the introduction of a line of
green tea products. The Company's dietary supplement products contributed net
sales of $18.7 million for 1998, as compared to $3.8 million in 1997. This
increase was partially offset by a decrease in sales of the Company's iced and
specialty black tea products.

Gross profit. As a result of the Company's increase in net sales, gross profit
for 1998 increased 32.6% to $65.6 million from $49.4 million in 1997. The
Company's gross profit margin increased to 64.2% from 62.5%. The increase in
gross margin was primarily due to decreased sales of the Company's iced tea
products, which have lower margins than the Company's hot tea and dietary
supplement products, favorable pricing on key herbs used in the Company's
products, and the impact of greater utilization of the Company's manufacturing
facility.

Selling and marketing expenses. Selling and marketing expenses for 1998
increased 37.6% to $46.7 million from $33.9 million in 1997, and increased as a
percentage of net sales to 45.7% from 42.9%. The increase in selling and
marketing expenses primarily was due to increased personnel costs and trade and
consumer promotion expenses associated with the introduction of the Company's
dietary supplements line.

General and administrative expenses. General and administrative expenses for
1998 increased 34.5% to $6.1 million from $4.6 million in 1997, and increased as
a percentage of net sales to 6.0% from 5.8%. The increase was primarily due to
increased personnel costs, legal fees associated with a shareholder's lawsuit
(see note 6 of Notes to Consolidated Financial Statements) and increased
expenses associated with the support of accounts receivable.

Amortization. Amortization expense for 1998 remained relatively unchanged from
1997.

Operating income. Operating income for 1998 increased 18.4% to $11.4 million
from $9.7 million in 1997. The increase was primarily due to increased net sales
and improved gross profit margins, and was partially offset by increased selling

                                       9
<PAGE>
 
and marketing, and general and administrative expenses. Operating income as a
percentage of net sales decreased to 11.2% from 12.2% primarily due to increased
selling and marketing expenses.

Interest expense. Interest expense for 1998 increased 28.0% from 1997 primarily
as a result of increased borrowings under the Company's credit facility.
Borrowings were necessary to fund increased working capital requirements,
primarily in the form of accounts receivable and inventory, associated with the
introduction of the Company's dietary supplements line.

Income taxes. Income tax expense for 1998 increased 15.5% from 1997 due to
increased pretax income.

Net income.  Net income for 1998 increased 19.3% to $6.8 million from $5.7
million in 1997.  This increase was primarily attributable to increased net
sales and improved gross profit margins.  Net income as a percentage of net
sales decreased to 6.6% from 7.2% primarily due to increased selling and
marketing expenses.

Fiscal 1997 Compared to Fiscal 1996

Net sales. Net sales for 1997 increased 8.3% to $79.0 million from $73.0 million
in 1996. The increase primarily was attributable to an increase in case sales of
2.4% to 4,441,000 cases from 4,338,000 cases. Net sales and case sales growth
was the result of increased sales of the Company's herb and specialty black hot
tea products in the Company's traditional channels of distribution,  as well as
expansion in international markets. The increase was partially offset by a
decrease in sales of the Company's iced tea products.  Fiscal 1997 net sales of
the Company's dry tea products also reflect a price increase implemented during
the third quarter of fiscal 1996. The Company's dietary supplement products
contributed net sales of $3.8 million for 1997, a 97.7% increase from 1996.

Gross profit. As a result of the Company's increase in net sales, gross profit
for 1997 increased 11.2% to $49.4 million from $44.5 million in 1996. The
Company's gross profit margin increased to 62.5% from 60.9%. The increase in
gross margin was primarily due to increased sales of the Company's higher margin
hot herb tea products, along with a decrease in sales of the Company's lower
margin iced tea products. In addition, the Company realized higher gross margins
from its dietary supplement products during 1997, as compared to 1996, due to
increased operating efficiencies and more competitive inventory pricing.

Selling and marketing expenses. Selling and marketing expenses for 1997
increased 12.8% to $33.9 million from $30.1 million in 1996, and increased as a
percentage of net sales to 42.9% from 41.2%. The increase in selling and
marketing expenses primarily was due to increased trade promotion expenses. This
increase was partially offset by a decrease in consumer promotion expenses.

General and administrative expenses. General and administrative expenses for
1997 increased 16.9% to $4.6 million from $3.9 million in 1996, and increased as
a percentage of net sales to 5.8% from 5.3%. This increase was primarily due to
costs incurred for the recruitment of a new executive officer.

Amortization of intangibles. Amortization of intangibles, including amortization
of goodwill and other intangible assets for 1997, decreased 13.2% to $1.3
million from $1.5 million in 1996. Amortization of intangibles was lower for
1997, as compared to 1996, as certain intangible assets became fully amortized
or were written off. These reductions were partially offset by increases in
amortization on new additions to artwork and plates resulting from the Company's
continued development of new products and improved packaging.

Operating income. Operating income for 1997 increased 7.5% to $9.7 million from
$9.0 million in 1996. The increase was primarily due to increased net sales and
improved gross profit margins, and was partially offset by increased selling and
marketing expenses. Operating income as a percentage of net sales remained
relatively unchanged.

Interest expense. Interest expense for 1997 decreased 43.6% from 1996 primarily
as a result of reduced outstanding borrowings. The Company extinguished its bank
debt during the first quarter of fiscal 1997. Interest expense for 1997
primarily relates to Industrial Revenue bonds which are secured by the Company's
facility and fees relating to continued availability of the Company's bank
credit facility.

                                       10
<PAGE>
 
Income taxes. Income tax expense for 1997 increased 13.4% from 1996. The
increase in income tax expense primarily was due to increased pretax income.

Net income.  Net income for 1997 increased 12.8% to $5.7 million from $5.0
million in 1996, and as a percentage of net sales was 7.2% in 1997 compared to
6.9% in 1996.  This increase was primarily attributable to increased net sales
and improved gross profit margins.

Seasonality

The Company's business is seasonal and its quarterly results of operations
reflect seasonal trends resulting from increased demand for the Company's hot
tea products in the cooler months of the year. The following table sets forth
selected unaudited quarterly consolidated financial and operational data for the
eight most recent quarters.

<TABLE>
<CAPTION> 
 
                                                                         1998 Quarters Ended 
                                                       --------------------------------------------------
                                                                    dollars and cases in thousands
                                                       --------------------------------------------------
                                                       Sept. 30       June 30       Mar. 31       Dec. 31
                                                       --------       -------       -------       -------
      <S>                                              <C>            <C>           <C>           <C>       
      Case sales                                          1,120           857         1,611         1,491
      Net sales                                        $ 23,073       $19,395       $32,329       $27,400
      Gross profit                                       14,586        12,573        21,131        17,269
      Operating income                                    1,782           355         5,549         3,755
      Operating margin                                      7.7%          1.8%         17.2%         13.7%
      Net income                                       $  1,053       $   124       $ 3,341       $ 2,238
      Net sales as a percent of annual net sales           22.6%         19.0%         31.6%         26.8%


                                                                         1997 Quarters Ended 
                                                       --------------------------------------------------
                                                                    dollars and cases in thousands
                                                       --------------------------------------------------
                                                       Sept. 30       June 30       Mar. 31       Dec. 31
                                                       --------       -------       -------       -------
      <S>                                              <C>            <C>           <C>           <C>       
      Case sales                                            855           656         1,491         1,439
      Net sales                                        $ 15,916       $11,589       $25,861       $25,673
      Gross profit                                        9,439         6,401        16,994        16,599
      Operating income                                      898           221         4,969         3,578
      Operating margin                                      5.6%          1.9%         19.2%         13.9%
      Net income                                       $    545       $    74       $ 3,007       $ 2,038
      Net sales as a percent of annual net sales           20.1%         14.7%         32.7%         32.5%

</TABLE> 

Quarterly fluctuations in the Company's sales volume and operating results are
due to a number of factors, including the timing of trade promotions,
advertising and consumer promotions. The impact on sales volume and operating
results, due to the timing and extent of these factors, can be significant.

Liquidity and Capital Resources

The operations of the Company historically have been funded with a combination
of internally generated funds and external borrowings.  Other than funding
ongoing operations, the Company's principal uses of funds in the future will be
the development of new or existing tea and dietary supplement products and the
possible acquisition of brands, product lines or other assets.  The Company
expects its primary sources of financing for its future business activities will
be funds from operations plus borrowings under the Company's credit facility.
The Company currently believes that funds from operations and funds expected to
be available under the Company's credit facility are likely to be sufficient to
meet operating and capital requirements unless a significant acquisition is
made.

                                       11
<PAGE>
 
On November 2, 1998 the Company entered into a new three year credit facility
which includes a revolving credit loan of up to $15,000,000 (the "Revolving
Loan"), and a standby letter of credit commitment in the approximate amount of
$7,000,000 (the "Letter of Credit Facility") to support outstanding Economic
Development Revenue Bonds issued to finance the Company's manufacturing
facility. Borrowings under the credit facility currently bear interest at rates
ranging from LIBOR plus 0.75% to the Federal Funds Rate plus 1.00%, subject to
increases if the Company fails to achieve certain future operating results. The
Letter of Credit Facility includes annual financing fees of 0.50%, and loans
resulting from a draw under the Letter of Credit Facility bear interest at a
rate equal to the interest rate then applicable to the Revolving Loan. The
Revolving Loan is due on November 2, 2001 and the Letter of Credit Facility
expires on November 2, 2002. The credit facility imposes certain ratio
maintenance requirements on the Company, including minimum EBITDA levels,
interest coverage, current ratio and net worth, and certain restrictive
covenants including limitations on indebtedness, liens, sales of assets, mergers
and investments. Future borrowings under the credit facility will provide for
working capital and may be used for acquisition financing.

Cash and cash equivalents decreased by $0.3 million in 1998. Cash used in
operating activities of the Company was $7.2 million. The Company's investing
activities used cash of $3.2 million for 1998, primarily for capital
expenditures, including $3.5 million primarily for factory and computer
equipment and $0.4 million for the design and development of new packaging
artwork. The Company anticipates making capital expenditures of approximately
$3.25 million in 1999. Financing activities of the Company provided cash of
$10.1 million for 1998.


Year 2000 Compliance

A number of computer programs are written using two digits rather than four to
define the applicable year. As a result, computer programs that have time-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.

The Company, after an inventory of its business systems and business
interactions, is currently executing a plan to prepare its systems and business
relationships for the Year 2000. Although the exact steps and timing vary
depending upon component type, the Company expects to complete its plan of
preparation for all components on or around July 1, 1999. In the event there is
a delay in the completion of the Year 2000 compliance plan, the Company is in
the process of developing a contingency plan which will include some non-
computerized backup systems. The ability for the Company to achieve Year 2000
compliance is, however, highly dependent upon compliance of the systems of the
Company's customers, suppliers and other third parties with which the Company
has business relationships.

The total cost to the Company of Year 2000 compliance activities has not yet
been, and is not anticipated to be, material to its financial position or
results of operations in any given year. These costs, and the date on which the
Company plans to complete the Year 2000 modification and testing processes, are
based on management's best estimates, which were derived using numerous
assumptions of future events including the continued availability of certain
resources, third party modification plans and other factors. However, there can
be no guarantee that these estimates will be achieved and actual results could
differ from those plans.

Forward-Looking Statements

The statements contained in this Annual Report on Form 10-K which are not
historical facts, including, but not limited to, certain statements found under
the captions "Business," "Results of Operations," "Liquidity and Capital
Resources" and "Year 2000 Compliance" above, are forward-looking statements that
involve a number of risks and uncertainties. The actual results of the future
events described in such forward-looking statements could differ materially from
those stated in such forward-looking statements. Among the factors that could
cause actual results to differ materially are the risks and uncertainties
discussed in this Annual Report on Form 10-K, including, without limitation, the
portions of such reports under the captions referenced above, and the
uncertainties set forth from time to time in the Company's filings with the
Securities and Exchange Commission, and other public statements. Such risks and
uncertainties include, without limitation, seasonality, interest in the
Company's products, consumer acceptance of new products, general economic
conditions, consumer trends, costs and availability of raw materials and
management information systems, competition, 

                                       12
<PAGE>
 
litigation and the effect of governmental regulation. The Company disclaims any
intention or obligation to update any forward-looking statements, whether as a
result of new information, future events or otherwise.

ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

Not applicable.

                                       13
<PAGE>
 
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

                          INDEPENDENT AUDITORS' REPORT

To the Stockholders and Board of Directors of Celestial Seasonings, Inc.:

We have audited the accompanying consolidated balance sheets of Celestial
Seasonings, Inc. and subsidiaries (the "Company," Note 2) as of September 30,
1998 and 1997 and the related consolidated statements of income, stockholders'
equity and cash flows for each of the three years in the period ended September
30, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Celestial Seasonings, Inc. and its
subsidiaries at September 30, 1998 and 1997 and the results of their operations
and their cash flows for each of the three years in the period ended September
30, 1998, in conformity with generally accepted accounting principles.


Deloitte & Touche LLP
Denver, Colorado
November 10, 1998

                                       14
<PAGE>
 
                           Celestial Seasonings, Inc.
                         Consolidated Income Statements
                    (in thousands, except per share amounts)

<TABLE> 
<CAPTION> 
                                                         Year Ended September 30,
                                                     --------------------------------
                                                       1998        1997        1996
                                                     --------    --------    --------  
<S>                                                  <C>         <C>         <C> 
Net sales                                            $102,197    $ 79,039    $ 72,998

Cost of goods sold                                     36,638      29,606      28,545
                                                     --------    --------    --------  
 Gross profit                                          65,559      49,433      44,453

Operating expenses:                                                         
 Selling and marketing                                 46,683      33,915      30,071
 General and administrative                             6,127       4,556       3,899
 Amortization of intangibles                            1,308       1,296       1,493
                                                     --------    --------    --------  
   Total operating expenses                            54,118      39,767      35,463

Operating income                                       11,441       9,666       8,990
                                                                            
Interest expense                                          631         493         874
                                                     --------    --------    --------                            
                                                                            
Income before income taxes                             10,810       9,173       8,116
                                                                            
Income taxes                                            4,054       3,509       3,093
                                                     --------    --------    --------  

Net income                                           $  6,756    $  5,664    $  5,023
                                                     ========    ========    ========    
                                                                   
Earnings per share-basic:                                          
   Net income per common share                       $   0.82    $   0.70    $   0.62
                                                     ========    ========    ========    

   Weighted average common shares                       8,250       8,107       8,088
                                                     ========    ========    ========    

Earnings per share-assuming dilution:                              
   Net income per common share                       $   0.77    $   0.68    $   0.61
                                                     ========    ========    ========    

   Weighted average common shares                       8,732       8,281       8,230
                                                     ========    ========    ========    
</TABLE> 

          See accompanying notes to consolidated financial statements.

                                       15
<PAGE>
 
                           Celestial Seasonings, Inc.
                          Consolidated Balance Sheets
                             (dollars in thousands)

<TABLE> 
<CAPTION>  

                                    ASSETS
                                                                                         September 30,
                                                                             -------------------------------------
                                                                                 1998                     1997 
                                                                             ------------             ------------
<S>                                                                          <C>                      <C> 
Current assets:    
  Cash and cash equivalents                                                  $      2,533             $      2,829
  Accounts receivable, net of allowance (1998 - $534, 1997 - $165)                 15,156                    7,755
  Inventory                                                                        23,185                    8,410
  Deferred income taxes                                                                93                      200
  Prepaid income taxes                                                                630                        -
  Prepaid expenses                                                                  2,111                      641
                                                                             ------------             ------------
    Total current assets                                                           43,708                   19,835

Property, plant and equipment, net                                                 19,240                   17,085
Intangible assets, net                                                             12,598                   13,236
Goodwill, net                                                                       5,870                    6,150
Deferred income taxes                                                                 217                      263
Other assets                                                                        1,014                    1,802
                                                                             ------------             ------------
Total assets                                                                 $     82,647             $     58,371
                                                                             ============             ============ 

                      LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
  Accounts payable                                                           $      8,656             $      4,160
  Accrued liabilities and wages                                                     7,551                    4,584
  Accrued income taxes                                                                  -                       99
  Accrued interest payable                                                             47                       31
  Current portion of long-term debt                                                 4,323                      373
                                                                             ------------             ------------
    Total current liabilities                                                      20,577                    9,247

Long-term debt                                                                     10,750                    6,073

Commitments

Stockholders' equity:
  Preferred stock, $.01 par value - authorized 1,000,000 shares;
    none issued and outstanding                                                         -                        -
  Common stock, $.01 par value - authorized 15,000,000 shares;
    1998-issued 8,322,528 shares, outstanding 8,304,728 shares;
    1997-issued 8,136,982 shares, outstanding 8,119,182 shares                         83                       81
  Capital surplus                                                                  35,011                   33,500
  Retained earnings                                                                16,401                    9,645
  Treasury stock, 17,800 shares of common stock at cost                              (175)                    (175)
                                                                             ------------             ------------
    Total stockholders' equity                                                     51,320                   43,051
                                                                             ------------             ------------
Total liabilities and stockholders' equity                                   $     82,647             $     58,371
                                                                             ============             ============  
</TABLE> 
          See accompanying notes to consolidated financial statements.

                                       16
<PAGE>
 
                           Celestial Seasonings, Inc.
                     Consolidated Statements of Cash Flows
                                 (in thousands)
<TABLE> 
<CAPTION> 
                                                                              Year Ended September 30,
                                                                        ------------------------------------ 
CASH FLOWS FROM OPERATING ACTIVITIES:                                      1998         1997         1996
                                                                        ----------   ----------   ---------- 
<S>                                                                     <C>          <C>          <C> 
Net income                                                              $    6,756   $    5,664   $    5,023
 Adjustments to reconcile net income to net cash
 provided by operating activities:
   Depreciation                                                              1,306        1,136        1,068
   Amortization of intangibles                                               1,308        1,296        1,493
   Amortization of financing fees                                              194          196          223
   Deferred income taxes                                                       153         (169)         770
 Changes in operating assets and liabilities:
   Accounts receivable                                                      (7,401)         378       (2,835)
   Inventory                                                               (14,775)      (1,602)         913
   Prepaid expenses                                                         (1,470)         248         (229)
   Accounts payable                                                          4,496          406          238
   Accrued liabilities and wages                                             2,967          122         (570)
   Accrued and prepaid income taxes                                           (729)         569       (1,034)
   Accrued interest payable                                                     16          (21)          (2)
                                                                        ----------   ----------   ---------- 
Net cash (used in) provided by operating activities                         (7,179)       8,223        5,058
                                                                        ----------   ----------   ---------- 

CASH FLOWS FROM INVESTING ACTIVITIES:
 Capital expenditures                                                       (3,461)      (1,362)      (1,294)
 Increase in intangible assets                                                (390)        (738)        (636)
 Decrease (Increase) in other assets                                           594         (708)         121
                                                                        ----------   ----------   ---------- 
Net cash used in investing activities                                       (3,257)      (2,808)      (1,809)
                                                                        ----------   ----------   ---------- 

CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from common stock issuance                                         1,513          250          285
 Acquisition of treasury stock                                                   -          (80)           -
 Increase in long-term debt                                                  9,000        2,285       12,265
 Reduction in long-term debt                                                  (373)      (5,245)     (15,970)
                                                                        ----------   ----------   ---------- 
Net cash provided by (used in) financing activities                         10,140       (2,790)      (3,420)
                                                                        ----------   ----------   ---------- 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                          (296)       2,625         (171)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                             2,829          204          375
                                                                        ----------   ----------   ---------- 
CASH AND CASH EQUIVALENTS AT END OF PERIOD                              $    2,533   $    2,829   $      204
                                                                        ==========   ==========   ========== 

CASH PAID FOR INTEREST                                                  $      420   $      333   $      654
CASH PAID FOR INCOME TAXES                                              $    4,630   $    3,109   $    3,357
 
</TABLE> 

          See accompanying notes to consolidated financial statements.

                                       17
<PAGE>
 
                           Celestial Seasonings, Inc.
                Consolidated Statements of Stockholders' Equity
                             (dollars in thousands)

<TABLE> 
<CAPTION> 
                                                                             Retained
                                                                             Earnings
                                       Common Stock         Capital        (Accumulated      Treasury Stock       Total
                                  ----------------------                                  --------------------
                                     Shares    Amount       Surplus          Deficit)       Shares    Amount      Equity
                                  ----------  ----------  -----------     --------------  ---------  ---------  ----------
<S>                               <C>         <C>         <C>             <C>             <C>        <C>        <C>  
BALANCE, SEPTEMBER 30, 1995        8,082,756  $    80     $  32,966        $    (1,042)     (10,000)  $   (95)   $  31,909
Issuance of common stock              26,188        1           284                                                    285     
Net income                                                                       5,023                               5,023
                                  ----------  ----------  -----------     --------------  ---------  ---------  ----------
BALANCE, SEPTEMBER 30, 1996        8,108,944       81        33,250              3,981      (10,000)      (95)      37,217
Issuance of common stock              28,038        -           250                                                    250
Acquisition of treasury stock                                                                (7,800)      (80)         (80)
Net income                                                                       5,664                               5,664
                                  ----------  ----------  -----------     --------------  ---------  ---------  ----------
BALANCE, SEPTEMBER 30, 1997        8,136,982       81        33,500              9,645      (17,800)     (175)      43,051
Issuance of common stock             185,546        2         1,511                                                  1,513
Net income                                                                       6,756                               6,756
                                  ----------  ----------  -----------     --------------  ---------  ---------  ----------
BALANCE, SEPTEMBER 30, 1998        8,322,528  $    83     $  35,011        $    16,401      (17,800)  $  (175)   $  51,320
                                  ==========  ==========  ===========     ==============  =========  =========  ==========
</TABLE> 

          See accompanying notes to consolidated financial statements.

                                       18
<PAGE>
 
                           Celestial Seasonings, Inc.
                   Notes to Consolidated Financial Statements

1.  Nature of Operations

Celestial Seasonings, Inc. is the largest manufacturer and marketer of herb teas
in the United States, with an estimated 50% share of the herb tea category.  The
Company developed and popularized the herb tea category in the United States as
a flavorful and non-caffeinated alternative to other hot beverages. Currently
the Company markets over 50 tea varieties under the Celestial Seasonings(R)
brand. Celestial Seasonings tea products are sold in substantially all of the
major supermarkets, grocery stores and natural foods markets in the United
States. Additionally, the Company markets a line of dietary supplements under
the Celestial Seasonings brand. The Company currently markets approximately 30
products in major supermarkets, natural foods markets, drug stores and mass
merchandisers in the United States.

2.  Significant Accounting Policies

Basis of presentation. The consolidated financial statements include the
accounts of Celestial Seasonings, Inc. and subsidiaries (the "Company").  All
material intercompany balances and transactions have been eliminated in
consolidation. The Company declared a two-for-one stock split effected in the
form of a 100% common stock dividend during September 1998. All share and per
share data has been restated to reflect this dividend. Certain reclassifications
have been made to the Company's 1997 and 1996 financial statements to conform to
the 1998 classifications.  The Company's year ends on the last Saturday of each
September. For presentation purposes, however, such year is presented as if it
ended on September 30. All references to years refer to the Company's fiscal
years.

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
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses through the
reporting period.  Actual results could differ from these estimates.

Cash and cash equivalents. Cash and cash equivalents include cash on hand and on
deposit and investments in highly liquid, short-term financial instruments
purchased with a maturity of three months or less.

Inventory. Inventory is stated at the lower of cost or market using the first-
in, first-out (FIFO) method.

Earnings per share. In accordance with Statement of Financial Accounting
Standards No. 128, "Earnings per Share," the increase in weighted average common
shares-assuming dilution is due to the application of the treasury share method
for outstanding stock options. The application of the treasury share method
resulted in an additional 482,000, 174,000 and 142,000 weighted average shares
for 1998, 1997 and 1996, respectively.

Export sales. Net sales include total export sales of $9,672,000, $8,807,000 and
$7,579,000 in 1998, 1997 and 1996, respectively.

                                       19
<PAGE>
 
Depreciation and amortization. Depreciation and amortization of property, plant
and equipment is provided on the straight-line method over the following
estimated useful lives:


<TABLE>
<CAPTION>
                                                    Years
                                                    -----
<S>                                                 <C>
       Building                                      32
       Vehicles                                       3
       Factory equipment                              7
       Office and other equipment                     3
</TABLE>

Maintenance, repairs and renewals that neither materially add to the value of
the property nor appreciably prolong its life are charged to expense as incurred


Amortization of intangible assets is provided on the straight-line method over
the following estimated useful lives:

<TABLE>
<CAPTION>
                                                     Years
                                                  ------------
<S>                                             <C>
       Goodwill                                     15 to 40
       Trademarks and copyrights                       40
       Grocery shelf space                             40
       Manufacturing process and workforce              7
       Artwork and plates                               3
       Other                                         3 to 8
</TABLE>

Accumulated amortization of goodwill was $1,788,000 and $1,508,000 respectively,
at September 30, 1998 and 1997. 

In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," the Company periodically evaluates the recoverability of the
net carrying value of property, plant and equipment, intangible assets, and
goodwill based upon current and anticipated net income and undiscounted cash
flows, and if necessary an impairment is recorded. The Company has recorded no
such impairments in 1998, 1997 or 1996.

Research and development costs. Research and development costs are charged to
expense when incurred. During the years ended September 30, 1998, 1997 and 1996,
amounts expensed for Company-sponsored research and development activities were
$1,003,000, $790,000 and $653,000, respectively.

Concentrations of credit risk. Areas which potentially subject the Company to
significant concentrations of credit risk consist primarily of accounts
receivable.  Concentrations of credit risk associated with accounts receivable
are limited due to the Company's large number of customers and their dispersion
across many different geographic areas.  As of September 30, 1998, the Company
had no significant concentrations of credit risk.

Fair value of financial instruments. Statement of Financial Accounting Standards
No. 107, "Disclosures About Fair Value of Financial Instruments," requires
disclosure of the fair value of certain of the Company's assets and liabilities.
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable at September 30, 1998 and 1997 approximate fair value due to
their short-term maturities.  The carrying value of long-term debt at September
30, 1998 and 1997 also approximates fair value as interest rates are adjusted to
current market rates on a monthly basis.

Comprehensive income. In June 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Reporting Comprehensive Income." SFAS 130 requires companies to disclose
comprehensive income and its components. The Company currently has no items of
other comprehensive income and therefore SFAS 130 does not apply.

                                       20
<PAGE>
 
Operating segments. In June 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information."  SFAS 131
redefines how operating segments are determined and requires disclosure of
certain financial and descriptive information about a company's operating
segments. The Company has adopted SFAS 131 for the year ended September 30,
1998.

The Company has two reportable segments which are segregated by product line:
beverages and dietary supplements.  The beverages segment manufactures and sells
the Company's tea products.  The dietary supplements segment manufactures and
sells the Company's herbal supplement products. Depreciation and amortization
expense for the Company's dietary supplements segment is immaterial. The
Company's beverage products are sold in all 50 states and approximately 40
countries, while its dietary supplement products are primarily sold in the
United States.

Financial data related to the Company's reportable segments is as follows (in
thousands):

<TABLE> 
                                             Dietary
                               Beverages   Supplements     Other      Total
                               ---------   -----------     -----      -----
    <S>                        <C>         <C>            <C>      <C>      
    Net sales:              
               1998            $  79,875      $ 18,739    $3,583   $102,197
               1997               72,205         3,789     3,045     79,039
               1996               69,016         1,917     2,065     72,998
                                                       
    Operating income (loss):                           
               1998               14,927        (3,971)      485     11,441
               1997                9,721          (612)      557      9,666
               1996                9,302          (786)      474      8,990
                                                       
    Inventory:                                         
               1998                8,674        13,981       530     23,185
               1997                6,513         1,629       268      8,410
               1996                6,056           614       138      6,808

    Total assets:
               1998               60,480        21,637       530     82,647
               1997               54,121         3,982       268     58,371
               1996               51,469         3,296       138     54,903
 
</TABLE>


Effective beginning in 1999, the Company intends to redefine its reportable
segments as a line of wellness products and a line of beverage products. The
wellness segment will include dietary supplement and related tea products, while
the beverage segment will include the Company's core tea products.

                                       21
<PAGE>
 
3. Detail of Certain Balance Sheet Accounts
   (in thousands)

                                                September 30,
                                            ---------------------
                                              1998         1997
                                            --------     --------
Inventory:
Raw materials & supplies                    $ 10,941     $  4,924
Work in process                                2,047        1,393
Finished goods                                10,406        2,431
                                            --------     --------
                                              23,394        8,748
Less inventory reserves                          209          338
                                            --------     -------- 
  Total                                     $ 23,185     $  8,410
                                            ========     ======== 

Property, plant & equipment:
Land                                        $  5,931     $  5,931
Building                                       9,125        8,771
Machinery & equipment                         15,592       12,585
Furniture & fixtures                             414          303
                                            --------     --------
                                              31,062       27,590
Less accumulated depreciation                 11,822       10,505
                                            --------     --------
  Total                                     $ 19,240     $ 17,085
                                            ========     ========

Intangible assets:
Trademarks & copyrights                     $  9,848     $  9,848
Grocery shelf space                            5,700        5,700
Manufacturing process & workforce              4,879        4,879
Artwork & plates                               5,362        4,972
Other                                          1,570        1,570
                                            --------     --------
                                              27,359       26,969
Less accumulated amortization                 14,761       13,733
                                            --------     --------
  Total                                     $ 12,598     $ 13,236
                                            ========     ======== 

Other assets:
Financing fees                              $  1,830     $  1,830
Less accumulated amortization                  1,234        1,040
                                            --------     --------
                                                 596          790
Long-term note receivable from
   executive officer                               -          898
Other                                            418          114
                                            --------     --------
  Total                                     $  1,014     $  1,802
                                            ========     ======== 


                                       22
<PAGE>
 
4. Long-term Debt
Long-term debt consists of the following (in thousands):

 
                                                        September 30,
                                                   -----------------------
                                                      1998         1997
                                                   ----------   ----------
Revolving Credit Facility payable to banks         $    9,000   $        -
Borrowings related to Economic Development
 Revenue Bonds due in monthly installments
 through November 1, 2009, interest payable
 monthly at variable rates                              6,050        6,350
Other                                                      23           96
                                                   ----------   ----------
                                                       15,073        6,446
Less current portion                                    4,323          373
                                                   ----------   ----------
 Total                                             $   10,750   $    6,073
                                                   ==========   ========== 


The Company's 1993 bank credit facility (the "Facility") includes a revolving
working capital facility, a reducing revolving facility and a letter of credit
facility. The commitment under the revolving working capital facility was
$8,000,000, subject to a borrowing base which is based on the Company's accounts
receivable and inventory, and expired on July 20, 1998. The commitment under the
reducing revolving facility ($9,000,000 outstanding at September 30, 1998) is
$9,000,000 at September 30, 1998, with semi-annual reductions of the commitment
until final maturity at July 19, 2000. Borrowings under these facilities bear
interest at rates ranging from LIBOR plus 1.00% to prime. The commitment under
the letter of credit facility is $6,429,000 and was scheduled to expire July 19,
2000, with fees of 1.00% per annum of the total commitment. Borrowings under
this facility (none at September 30, 1998) bear interest at the prime rate plus
1.00%.

The Facility imposes certain ratio maintenance requirements on the Company,
including minimum EBITDA levels, interest coverage, current ratio, net worth and
fixed charge coverage, and certain restrictive covenants including limitations
on indebtedness, liens, capital expenditures, sales of assets, mergers,
investments and dividends. Borrowings under the Facility are secured by
substantially all of the assets of the Company.

On November 2, 1998, the Company entered into a new bank credit facility and
paid off the 1993 Facility. The new credit facility includes a revolving credit
loan of up to $15,000,000, which matures in 2002 and a standby letter of credit
commitment of approximately $7,000,000. The new facility currently bears
interest at rates ranging from LIBOR plus 0.75% to the Federal Funds Rate plus
1.00% and is unsecured.

Borrowings related to Economic Development Revenue Bonds (the "Bonds") bear
interest at a variable rate (3.50% at September 30, 1998) and are secured by a
letter of credit issued under the  Facility. The Bonds mature December 1, 2009.
The Bonds can be tendered monthly to the Bond trustee at face value plus accrued
interest, with payment for tendered Bonds made from drawdowns under the letter
of credit. Drawdowns under the letter of credit bear interest at prime plus
1.00%, and are repaid through resale of the Bonds. Any outstanding drawdowns
must be repaid on July 19, 2000. The standby letter of credit commitment
associated with the new credit facility currently secures the Bonds.

Prior to the termination of the 1993 Facility, the aggregate annual maturities
of long-term debt, during the five years subsequent to September 30, 1998 are:
1999 - $4,323,000; 2000 - $5,375,000; 2001 - $400,000; 2002 - $475,000; and 2003
- $500,000.


5. Commitments

The Company leases various office and manufacturing equipment. Total rental
expense for the equipment for the years ended September 30, 1998, 1997 and 1996
was $419,000, $397,000 and $367,000, respectively. At September 30, 1998,
minimum rental commitments by year under noncancelable operating leases are:
1999 - $417,000; 2000 - $299,000; 2001 - $116,000; and 2002 - $23,000.

                                       23
<PAGE>
 
6. Legal Proceedings

On May 5, 1995, a purported stockholder of the Company filed a lawsuit, Schwartz
v. Celestial Seasonings, Inc. et al., in the United States District Court for
the District of Colorado (Civil Action Number: 95-K-1045), in connection with
disclosures by the Company concerning the Company's license agreement with
Perrier Group of America, Inc. which was terminated on January 1, 1995. In
addition to the Company, the complaint names as defendants certain of the
Company's present and former directors and officers, PaineWebber, Inc.,
Shearson/Lehman Brothers, Inc., and Vestar/Celestial Investment Limited
Partnership. The complaint, which was pled as a class action on behalf of
persons who acquired the Company's common stock from July 12, 1993 through May
18, 1994, sought money damages from the Company and the other defendants for the
class in the amount of their loss on their investment in the Company's common
stock, punitive damages, costs and expenses of the action, and such other relief
as the court may order.

On November 6, 1995, the federal district court granted a motion by the Company
and the other defendants to dismiss the case.  The court's order became final on
December 11, 1995, after the plaintiff failed to amend the complaint within the
time permitted by the district court.

The plaintiff appealed the district court's decision to the United States Court
of Appeals for the Tenth Circuit.  On September 5, 1997, the court of appeals
reversed the decision of the district court. The court of appeals found that the
plaintiff's complaint alleged sufficient facts to support his claim. The case
has been returned to the district court for further proceedings and has been
certified as a class action.  Due to the uncertainties inherent in the
litigation process, the Company is unable to predict the outcome of this matter.

The Company is also a party to ordinary routine litigation incidental to its
business. The Company does not expect any of such incidental litigation to have
a material adverse effect on the Company's results of operations or financial
condition.

7. Stockholders' Equity

Preferred stock. In July 1993, the Company authorized the issuance of 1,000,000
shares of $0.01 par value Preferred Stock and designated 10,000 shares as a
Series A Junior Participating Preferred Stock in connection with the adoption of
a rights agreement. No shares were outstanding at September 30, 1998.

Stock-based compensation plans. At September 30, 1998, the Company has four
stock-based compensation plans. The Company applies APB  Opinion 25 ("APB 25"),
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its plans. Under APB 25, no compensation expense is recognized
for options granted to employees which are at or above market value.
Accordingly, no compensation cost has been recognized for the stock option and
stock purchase plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with the method of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") the Company's pro forma net income and earnings per
share would have been as follows (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                           1998               1997               1996
                                                                     -----------------  -----------------  -----------------
<S>                                                  <C>             <C>                <C>                <C>
Net income                                           As reported           $6,756             $5,664             $5,023
                                                     Pro forma             $5,483             $5,153             $4,896
 
Net income per common share--basic                   As reported           $ 0.82             $ 0.70             $ 0.62
                                                     Pro forma             $ 0.66             $ 0.64             $ 0.61
 
Net Income per common share--assuming dilution       As reported           $ 0.77             $ 0.68             $ 0.61
                                                     Pro forma             $ 0.64             $ 0.63             $ 0.60
</TABLE>

The amounts reflected in the pro forma disclosure are not indicative of future
amounts, as SFAS 123 is applicable only to options granted subsequent to
September 30, 1995. The pro forma effect will not be fully reflected until 2000.

                                       24
<PAGE>
 
Stock option plans. During 1991, the Company adopted an incentive and non-
qualified stock option plan that provided for the granting of options to
purchase up to 92,224 shares of the Company's common stock to employees. The
options generally vested over a four year period and expired ten years from the
grant date. No further grants will be made under the plan.

In 1991, the Company granted options to an executive officer to purchase 191,260
shares of the Company's common stock in connection with capital contributions
made by the officer and certain other agreements. Such options were immediately
vested at the grant date, are exercisable half at $4.13 per share and half at
$5.73 per share, and expire in 2031.

During 1993, the Company adopted an incentive and non-qualified stock option
plan that provided for the granting of awards  for up to 262,000 shares of the
Company's common stock. Options granted at the time of the Company's initial
public offering in 1993 vested over one year and five year periods. Options
granted subsequent to the Company's initial public offering generally vest over
a five year period. Options expire ten years from the grant date. During 1995,
the Company approved an increase in the number of awards that may be granted to
450,000 shares and in 1998 the Company approved a further increase of up to
1,250,000 shares which may be granted under the plan.

In 1993, the Company granted options to purchase 20,000 shares of the Company's
common stock to a director of the Company. The options vested over a three year
period and expire ten years from the grant date.

In 1995, the Company adopted a non-qualified stock option plan for non-employee
directors. The plan provides for up to 150,000 shares of the Company's common
stock for issuance upon exercise of options granted to non-employee directors
and in lieu of meeting fees paid to non-employee directors. The options vest
over a one year period and expire ten years from the grant date.  During 1998,
the Company amended this plan to provide each non-employee director an initial
grant of an option to purchase 10,000 shares and an annual grant, commencing in
1999, of an option to purchase 4,000 shares.  In addition, non-employee
directors may elect to receive their annual retainer in shares of common stock
rather than cash.

In 1997, the Company granted options to an executive officer to purchase 330,000
shares of the Company's common stock. The options were granted in connection
with the officer's employment agreement, vest over a five year period, are
exercisable at $10.75 per share and expire ten years from the grant date.

In the above pro forma amounts, the fair value of each option grant is estimated
on the date of the grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in 1998, 1997 and 1996,
respectively: no estimated dividends for all years; expected volatility of 31
percent for all years; risk-free interest rates of between 5.2 and 6.0 percent,
between 6.0 and 6.8 percent and between 5.3 and 6.9 percent; and expected lives
of 6 years for all years.

Employee stock purchase plan. Under the Company's Employee Stock Purchase Plan
(the "Plan") the Company is authorized to issue up to 52,400 shares of common
stock to its full-time employees, nearly all of whom are eligible to
participate. Under the terms of the Plan, employees can choose each year to have
up to 10 percent of their annual base earnings withheld to purchase the
Company's common stock. The purchase price of the stock is 85 percent of the
lower of the market price at the beginning or end of each six month
participation period. Approximately 30 percent of eligible employees have
participated in the Plan in the last 3 years.  Under the Plan, the Company sold
4,740, 5,802 and 5,280 shares to employees in 1998, 1997 and 1996, respectively.
In the above pro forma amounts, compensation cost is recognized for the fair
value of the employees' purchase rights using the Black-Scholes model with the
following assumptions for 1998, 1997 and 1996, respectively: no estimated
dividends for all years; expected volatility of 31 percent for all years; risk-
free interest rates of 5.5 percent, between 5.3 and 5.7 percent and between 5.2
and 5.5 percent; and an expected life of 6 months for all years. The weighted
average fair value of those purchase rights granted in 1998, 1997 and 1996 were
$4.41, $2.41 and $2.39, respectively.

                                       25
<PAGE>
 
The following table summarizes the status of the Company's stock option plans as
of September 30, 1998, 1997 and 1996, and changes during the years ending on
those dates:

<TABLE> 
<CAPTION> 

                                                 1998                         1997                         1996
                                                 ----                         ----                         ----
                                                     Weighted Avg                  Weighted Avg                 Weighted Avg
                                          Shares     Exercise Price     Shares     Exercise Price    Shares     Exercise Price
                                        ---------    --------------    --------    --------------   --------    --------------
<S>                                     <C>          <C>               <C>         <C>              <C>         <C> 
Outstanding at beginning of year          959,580           $  9.14     512,382           $  7.52    561,022          $   7.47
Granted                                   287,876             18.56     497,200             10.75     90,308             10.23
Exercised                                 (98,734)             8.47     (18,018)             8.03    (14,720)             9.48
Forfeited                                 (41,836)            10.81     (31,984)             8.85   (124,228)             9.03
                                        ---------                      --------                     --------    
Outstanding at end of year              1,106,886           $ 11.58     959,580           $  9.14    512,382          $   7.52
                                        =========                      ========                     ========    

Options exercisable at year-end           437,526           $  7.86     374,392           $  6.88    336,976          $   6.55
Weighted average fair value of options
  granted during the year                 $  7.92                       $  4.85                      $  4.35       

</TABLE>


The following table summarizes information about stock options outstanding at
September 30, 1998:

<TABLE>
<CAPTION>
                           Options Outstanding                                      Options Exercisable
                  ------------------------------------------------               -----------------------------
                    Number        Weighted Avg                                     Number
   Range of       Outstanding      Remaining         Weighted Avg                Exercisable     Weighted Avg
Exercise Prices    at 9/30/98   Contractual Life    Exercise Price               at 9/30/98     Exercise Price
---------------   -----------   ----------------    --------------               -----------    --------------
<S>               <C>           <C>                 <C>                          <C>            <C> 
 
$ 4.13-$ 7.63         215,288         29.8 years            $ 5.22                   210,087           $  5.16
$ 8.00-$ 9.75          47,174          7.3 years            $ 9.41                    24,336           $  9.37
$10.00-$11.94         556,448          8.1 years            $10.65                   201,930           $ 10.46
$12.19-$15.38          55,900          9.4 years            $14.93                     1,173           $ 12.51
$17.63-$19.63         194,076          9.4 years            $18.80                         -           $     -
$21.19-$23.06          38,000          9.6 years            $22.17                         -           $     -
                  -----------                                                    -----------
$ 4.13-$23.06       1,106,886         12.6 years            $11.58                   437,526           $  7.86
                  ===========                                                    ===========

</TABLE> 
                                       26
<PAGE>
 
8. Income Taxes

The components of income taxes are as follows (in thousands):


                                        1998            1997            1996
                                      --------        --------        -------- 
                Federal:

                 Current              $  3,366        $  3,201        $  2,101

                 Deferred                  133            (150)            663
                                      --------        --------        -------- 
                                         3,499           3,051           2,764
                                      --------        --------        -------- 

                State:

                 Current                   535             477             222

                 Deferred                   20             (19)            107
                                      --------        --------        -------- 
                                           555             458             329
                                      --------        --------        --------  

                Total                 $  4,054        $  3,509        $  3,093
                                      ========        ========        ========




The Company's income tax expense in 1998, 1997 and 1996 differed from the
federal statutory provision as follows (in thousands):
 
 
                                                      1998      1997      1996
                                                    --------  --------  --------
        Income tax at statutory rates               $  3,675  $  3,119  $  2,759
                                                   
        Increase in deferred tax assets for which  
                                                   
         valuation allowances are provided                 -         -        59
                                                   
        State income taxes, net of federal benefit       366       302       217
                                                   
        Other                                             13        88        58
                                                    --------  --------  --------
        Total                                       $  4,054  $  3,509  $  3,093
                                                    ========  ========  ========


Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.

                                       27
<PAGE>
 
Components of the Company's net deferred tax assets at September 30 were as
follows (in thousands):

                                                        1998            1997
                                                      --------        -------- 
        Current deferred tax assets:

         Accruals                                     $    615        $    253

         Reserves                                          134               4

         Capitalized costs                                  61              39

         Prepayments                                      (717)            (96)
                                                      --------        -------- 
        Current deferred tax assets, net              $     93        $    200
                                                      ========        ========  


        Noncurrent deferred tax assets:

         Amortization                                 $  2,833        $  2,665

         Depreciation                                     (443)           (382)

         Valuation allowance                            (2,173)         (2,020)
                                                      --------        -------- 
        Noncurrent deferred tax assets, net           $    217        $    263
                                                      ========        ========  





At September 30, 1998, the potential future benefits from noncurrent deferred
tax assets relating to intangible assets, which are not amortizable for tax
purposes, are fully reserved by means of a valuation allowance, due to the
uncertainty of their future realization. The net change in the valuation
allowance in 1998 was $153,000.

9. Employee Benefit Plans

The Company has a contributory thrift plan covering all employees. Each year,
based on the achievement of certain targeted operating results, the Company can
contribute to the plan an amount equal to 1% to 2.5% of thriftable wages.
Additionally, the Company matches a portion (currently 50%) of participant
contributions up to limits provided in the plan. The Company's contributions are
funded currently and were $349,000, $334,000 and $323,000 for 1998, 1997 and
1996, respectively.

During 1989, the Company formed an employee stock ownership plan covering all
employees. The Company's contributions for 1998, 1997 and 1996 were $90,000,
$90,000 and $75,000, respectively. The plan held 53,318 shares of the Company's
common stock at September 30, 1998.

10. Related Party Transactions

During 1997, the Company, pursuant to an employment agreement, provided an
executive officer with an interest free loan of up to $1,500,000 to be used for
the purchase of a home associated with the executive's relocation. The loan was
payable upon the earlier of, the sale of executive's former home, or 18 months
after the purchase of a new home.  The loan was paid in full during 1998.

During 1998, the Company, pursuant to an employment agreement, provided a key
employee with an interest free loan of $280,000 associated with the employee's
relocation.  The loan is payable upon the earlier of the sale of, the employee's
former home, or five months.  As of September 30, 1998 the balance due from the
employee was $280,000 and is included in accounts receivable.

                                       28
<PAGE>
 
11. Quarterly Financial Data (Unaudited):
    (in thousands, except per share amounts)

<TABLE> 
<CAPTION> 
                                                          1998 Quarters Ended
                                                -----------------------------------------
                                                Sept. 30    June 30    Mar. 31    Dec. 31
                                                --------    -------    -------    -------
  <S>                                           <C>         <C>        <C>        <C> 
  Case sales                                       1,120        857      1,611      1,491
  Net sales                                      $23,073    $19,395    $32,329    $27,400
  Gross profit                                    14,586     12,573     21,131     17,269
  Operating income                                 1,782        355      5,549      3,755
  Net income                                       1,053        124      3,341      2,238
  Net income per share-basic                     $  0.13    $  0.02    $  0.40    $  0.28
  Net income per share-assuming dilution            0.12       0.01       0.38       0.26
  Net sales as a percent of annual net sales        22.6%      19.0%      31.6%      26.8%
</TABLE> 


<TABLE> 
<CAPTION> 
                                                          1997 Quarters Ended
                                                -----------------------------------------
                                                Sept. 30    June 30    Mar. 31    Dec. 31
                                                --------    -------    -------    -------   
  <S>                                           <C>         <C>        <C>        <C>  
  Case sales                                         855        656      1,491      1,439
  Net sales                                      $15,916    $11,589    $25,861    $25,673
  Gross profit                                     9,439      6,401     16,994     16,599
  Operating income                                   898        221      4,969      3,578
  Net income                                         545         74      3,007      2,038
  Net income per share-basic                     $  0.07    $  0.01    $  0.37    $  0.25
  Net income per share-assuming dilution            0.07       0.01       0.36       0.25
  Net sales as a percent of annual net sales        20.1%      14.7%      32.7%      32.5%
   
</TABLE>

ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

                                       29
<PAGE>
 
                                    PART III

ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The sections labeled "Election of Directors," "Section 16(a) Beneficial
Ownership Reporting Compliance" and "Executive Officers" appearing in the
Company's Proxy Statement in connection with the 1999 Annual Meeting of
Stockholders are incorporated herein by reference.

ITEM 11. - EXECUTIVE COMPENSATION

The sections labeled "Compensation of Directors and Executive Officers,"
"Executive Compensation," "Option Grants in Last Fiscal Year," "Aggregated
Option Exercises in Last Fiscal Year and Year-end Option Values," "Employment
Agreements," "Compensation Committee Report" and "Performance Graph" appearing
in the Company's Proxy Statement in connection with the 1999 Annual Meeting of
Stockholders are incorporated herein by reference.

ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT

The section labeled "Principal Stockholders" appearing in the Company's Proxy
Statement in connection with the 1999 Annual Meeting of Stockholders is
incorporated herein by reference.

ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The section labeled "Certain Relationships and Related Transactions" appearing
in the Company's Proxy Statement in connection with the 1999 Annual Meeting of
Stockholders is incorporated herein by reference.

                                       30
<PAGE>
 
                                    PART IV
ITEM 14. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K

<TABLE>
(a)  1. Index to Financial Statements
                                                                    Page
                                                                    ----
<S>                                                             <C>
     Independent Auditors' Report                                    14
 
     Consolidated Income Statements for the years ended
      September 30, 1998, 1997 and 1996                              15
 
     Consolidated Balance Sheets at September 30, 1998 and 1997      16
 
     Consolidated Statements of Cash Flows for the years ended
      September 30, 1998, 1997 and 1996                              17
 
     Consolidated Statements of Stockholders' Equity for the
      years ended September 30, 1998, 1997 and 1996                  18
 
     Notes to Consolidated Financial Statements                    19-29
 
     Quarterly Financial Data (Unaudited)                            29
 
     2. Index to Financial Statement Schedule
 
     The following schedule is filed as part of this Form 10-K:
 
     II - Valuation and Qualifying Accounts for the years ended
           September 30, 1998, 1997 and 1996                         36
</TABLE>

All other schedules are omitted because they are not applicable, or not
required, or because the required information is included in the consolidated
financial statements or notes thereto.

                                       31
<PAGE>
 
     3. Exhibits
        The following exhibits are filed pursuant to Item 601 of Regulation S-K:

<TABLE>
<CAPTION>
Exhibit          Description
No.        
-----------------------------------------------------------------------------------------------------------------
<C>       <C>    <S>
(a)         3.1  Amended and Restated Certificate of Incorporation of Registrant.
            3.2  Bylaws of Registrant.
(a)         4.1  Common Stock certificate.
            4.2  Rights Agreement dated as of July 19, 1993 between Registrant and Harris Trust and Savings Bank, as Rights
                 agent, as amended and restated November 11, 1998.
(a)        10.1  Incentive and Non-Qualified Stock Option Plan of Registrant as Successor to Celestial Holdings, Inc.
                 adopted February 26, 1991.
(f)        10.2  1993 Long-Term Incentive Plan of Registrant adopted June 7, 1993, as amended.
(f)        10.3  1994 Non-Employee Director Compensation Plan adopted August 4, 1994, as amended.
(b)        10.4  Credit Agreement dated as of July 19, 1993, among Registrant and Fleet National Bank as a lender and agent.
(d)        10.5  Amendments 1, 2 and 3 to the Credit Agreement dated as of July 19, 1993, among Registrant and Fleet
                 National Bank as a lender and agent.
(a)        10.6  Loan Agreement dated as of December 1, 1989 between Registrant and Colorado Housing and Finance Authority.
(c)        10.7  Employment Agreement dated February 15, 1994 between Registrant and Marie A. Gambon.
(e)        10.8  Employment Agreement dated June 16, 1997 between Registrant and Stephen B. Hughes.
(e)        10.9  Executive Agreement dated June 16, 1997 between Registrant and Mo Siegel.
(e)       10.10  Stock Option Agreement dated June 16, 1997 between Registrant and Stephen B. Hughes.
(e)       10.11  Option Agreement dated June 13, 1997 between Registrant and Mo Siegel.
          10.12  Employment Agreement dated November 7, 1997 between Registrant and William Atchinson.
          10.13  Employment Agreement dated March 2, 1998 between Registrant and Richard Karl.
          10.14  Credit Agreement dated as of November 2, 1998, among Registrant and KeyBank National Association.
           23.1  Report of Deloitte & Touche LLP on consolidated financial statement schedule.
           23.2  Consent of Deloitte & Touche LLP.
           27.1  Financial Data Schedule.
</TABLE>

                                       32
<PAGE>
 
Exhibits identified above are incorporated by reference as follows:

(a)  Incorporated by reference to the Registrant's Registration Statement on
     Form S-1 No. 33-64012, as amended, filed with the Securities and Exchange
     Commission on June 7, 1993.
     
(b)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1993.
     
(c)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the year ended September 30, 1994.
     
(d)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the year ended September 30, 1996.
     
(e)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1997.
     
(f)  Incorporated by reference to the Registrant's Proxy Statement in connection
     with the 1998 Annual Meeting of Stockholders, filed with the Securities and
     Exchange Commission on January 13, 1998.



(b)   Reports on Form 8-K

      1. Current Report on Form 8-K filed on August 20, 1998, relating to the
      declaration of a 100% common stock dividend payable on September 25, 1998
      to stockholders of record as of September 11, 1998.


                                       33
<PAGE>
 
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, as amended, the Registrant has duly caused this Annual Report on Form 10-K
for the year ended September 30, 1998 to be signed on its behalf by the
undersigned, thereunto duly authorized.

CELESTIAL SEASONINGS, INC.

By:  /S/ DARRELL F. ASKEY
-------------------------
     Darrell F. Askey
     Vice President - Finance and Chief Financial Officer
Date: December 15, 1998

                                       34
<PAGE>
 
Pursuant to the requirements of the Securities Act of 1934, this Annual Report
on Form 10-K for the year ended September 30, 1998 has been signed below by the
following persons, on behalf of the Registrant and in the capacities indicated
on the date indicated.
<TABLE>
<CAPTION>
 
Signature                          Title                                 Date
---------                          -----                                 ----
<S>                                <C>                                   <C>
 
  /S/ MO SIEGEL                    Chairman                              December 15, 1998
---------------------------------
  Mo Siegel
 
  /S/ STEPHEN B. HUGHES            President,                            December 15, 1998
---------------------------------  Chief Executive Officer and Director
  Stephen B. Hughes                
 
  /S/ RONALD V. DAVIS              Director                              December 15, 1998
---------------------------------
  Ronald V. Davis
 
  /S/ MARINA HAHN                  Director                              December 15, 1998
---------------------------------
  Marina Hahn
 
  /S/ JOHN D. HOWARD               Director                              December 15, 1998
---------------------------------
  John D. Howard
 
  /S/ JAMES P. KELLEY              Director                              December 15, 1998
---------------------------------
  James P. Kelley
 
  /S/ LEONARD LIEBERMAN            Director                              December 15, 1998
---------------------------------
  Leonard Lieberman
 
  /S/ GREGG A. OSTRANDER           Director                              December 15, 1998
---------------------------------
  Gregg A. Ostrander
 
  /S/ DARRELL F. ASKEY             Vice President - Finance              December 15, 1998
---------------------------------  and Chief Financial Officer  
  Darrell F. Askey                 (Principal Financial Officer) 
                                   
 
  /S/ SANFORD D. GOLDBERG          Controller                            December 15, 1998
---------------------------------  (Principal Accounting Officer) 
  Sanford D. Goldberg              
</TABLE>

                                      35
<PAGE>
 
                                                                     SCHEDULE II
                           Celestial Seasonings, Inc.
                       Valuation and Qualifying Accounts
                                 (in thousands)



<TABLE>
<CAPTION>
                                                      Balance at         Charged to                       Balance at
             Classification                        Beginning of Year     Expenses       Write-offs       End of Year
             --------------                        -----------------     -------        ----------       -----------
<S>                                        <C>                          <C>          <C>              <C>
For the year ended September 30, 1996:
 Allowance for doubtful accounts                           $ 71            $ 77           $   -               $148
 Inventory reserves                                         879              68            (716)               231
 
For the year ended September 30, 1997:
 Allowance for doubtful accounts                            148              17               -                165
 Inventory reserves                                         231             372            (265)               338
 
For the year ended September 30, 1998:
 Allowance for doubtful accounts                            165             398             (29)               534
 Inventory reserves                                         338             468            (597)               209
</TABLE>

                                       36
<PAGE>
 
                   MANAGEMENT'S STATEMENT OF RESPONSIBILITIES

The accompanying consolidated financial statements of Celestial Seasonings, Inc.
and subsidiaries (the "Company") are prepared by the Company's management in
conformity with generally accepted accounting principles. Management is
responsible for the fairness of the financial statements, which include
estimates based on judgment.

The Company maintains accounting and other control systems which management
believes provide reasonable assurance that financial records are reliable for
the purposes of preparing financial statements, and that assets are properly
safeguarded and recorded. Underlying the concept of reasonable assurance is the
premise that the cost of control should not be disproportionate to the benefits
expected to be derived from control. The Company's internal control system is
reviewed by the independent auditors in connection with their audit of the
Company's consolidated financial statements.

The Audit Committee of the Board of Directors meets periodically with management
and the independent auditors to discuss the annual audit, internal control and
financial reporting matters. The independent auditors have direct access to the
Audit Committee.

Stephen B. Hughes
President and Chief Executive Officer


Darrell F. Askey
Vice President-Finance and Chief Financial Officer


                                      37