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 December 27, 1998
                                       OR

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

                         Commission file number 1-11368

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

            DELAWARE                                     91-1554663
(State or other jurisdiction of          (I.R.S. employer identification no.)
 incorporation or organization)

      180 TECHNOLOGY PARKWAY
      NORCROSS, GEORGIA                                     30092
(Address of principal executive offices)                  (Zip code)

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

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

                                                NAME OF EACH EXCHANGE
       TITLE OF EACH CLASS                       ON WHICH REGISTERED
Common Stock, par value $.01 per share          New York Stock Exchange
Series A participating Cumulative               New York Stock Exchange
  Preferred Stock Purchase Rights

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

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports)  and  (2)  has  been  subject  to such  filing
requirements for the past 90 days. Yes  X     No 
                                       ---       ---

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

As of March 31, 1999, there were 11,946,226  shares of the  Registrant's  Common
Stock  outstanding,  and  the  aggregate  market  value  of such  stock  held by
nonaffiliates  of the Registrant was $29,865,565  (based on the closing price on
the New York Stock Exchange on March 31, 1999).


                                                        Exhibit Index on Page 86
<PAGE>

                           PARAGON TRADE BRANDS, INC.
                       TABLE OF CONTENTS TO ANNUAL REPORT
                                  ON FORM 10-K


                                     PART I                                 PAGE

Item 1:    BUSINESS                                                            1

Item 2:    PROPERTIES                                                          9

Item 3:    LEGAL PROCEEDINGS                                                  10

Item 4:    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                15


                                     PART II

Item 5:    MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
           STOCKHOLDER MATTERS                                                16

Item 6:    SELECTED FINANCIAL DATA                                            16

Item 7:    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS                                              18

Item 7A:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK         32

Item 8:    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                        33

Item 9:    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
           FINANCIAL DISCLOSURE                                               69


                                    PART III

Item 10:   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                 69

Item 11:   EXECUTIVE COMPENSATION                                             70

Item 12:   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT     79

Item 13:   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                     80


                                     PART IV

Item 14:   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K    80


                                     Page i
<PAGE>
                                     PART I

ITEM 1:    BUSINESS

GENERAL

Paragon Trade Brands, Inc. (the "Company") is the leading  manufacturer of store
brand  infant  disposable  diapers in the  United  States  and  Canada.  Paragon
manufactures a line of premium and economy diapers,  training pants and feminine
care and adult incontinence products which are distributed throughout the United
States  and  Canada,   primarily   through   grocery  and  food   stores,   mass
merchandisers,  warehouse  clubs,  toy stores and drug  stores  that  market the
Company's  products  under  their  own  store  brand  names.  Paragon  has  also
established international joint ventures in Mexico, Argentina,  Brazil and China
for the  manufacture and sale of infant  disposable  diapers and other absorbent
personal care products.

On February 9, 1996, the Company  completed the purchase of substantially all of
the  assets  of Pope &  Talbot,  Inc.'s  ("Pope  &  Talbot")  disposable  diaper
business.  The purchase price of $63.5 million was paid in a combination of cash
and stock. The Company closed all the acquired  disposable  diaper operations in
1996.  The plants and a major portion of the  manufacturing  equipment have been
sold. The remaining equipment is being held for sale. In 1996 the Company took a
charge of $8.1 million for the costs of integration and write-downs of duplicate
equipment owned by the Company prior to the purchase transaction.

REORGANIZATION CASE

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

On December 30, 1997,  the  District  Court issued a Judgment and Opinion  which
found,  in  essence,  two of P&G's  dual  cuff  diaper  patents  to be valid and
infringed by certain of the Company's  disposable  diaper  products,  while also
rejecting the Company's  patent  infringement  claims  against P&G. The District
Court had earlier  dismissed the  Company's  antitrust  counterclaim  on summary
judgment.  The Judgment  entitled P&G to damages based on sales of the Company's
diapers  containing  the  "inner-leg  gather"  feature.  While the final damages
number of  approximately  $178.4  million was not entered by the District  Court
until  June  2,  1998,  the  Company  originally  estimated  the  liability  and
associated  litigation costs to be approximately $200 million. The amount of the
award   resulted  in  violation  of  certain   covenants   under  the  Company's
then-existing  bank loan agreements.  As a result,  the issuance of the Judgment
and the uncertainty it created caused an immediate and critical  liquidity issue
for the Company.

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

In connection  with the Chapter 11 filing,  on January 30, 1998,  the Bankruptcy
Court  entered a Final Order  approving  the Credit  Agreement  (the "DIP Credit
Facility") as provided under the Revolving Credit and Guarantee  Agreement dated
as of January 7, 1998, among the Company, as Borrower,  certain  subsidiaries of


                                     Page 1
<PAGE>

the Company,  as  guarantors,  and a bank group led by The Chase  Manhattan Bank
("Chase").  Pursuant  to the terms of the DIP  Credit  Facility,  Chase has made
available to the Company a revolving  credit and letter of credit facility in an
aggregate principal amount of $75 million. The Company's maximum borrowing under
the DIP Credit Facility may not exceed the lesser of $75 million or an available
amount as determined by a borrowing base formula.  The borrowing base formula is
comprised of certain  specified  percentages  of eligible  accounts  receivable,
eligible inventory, equipment and personal and real property of the Company. The
DIP Credit Facility has a sublimit of $10 million for the issuance of letters of
credit.  The DIP Credit Facility  expires on the earlier of July 7, 1999, or the
date  of  entry  of an  order  by the  Bankruptcy  Court  confirming  a plan  of
reorganization.  The  Company  is  currently  negotiating  an  extension  of the
maturity date on the DIP Credit  Facility  with Chase.  As of December 27, 1998,
there were no outstanding  direct borrowings under the DIP Credit Facility.  The
Company had an aggregate  of $1.3 million in letters of credit  issued under the
DIP Credit  Facility at December  27,  1998.  The DIP Credit  Facility  contains
customary  covenants.  The Company for a period of time has been unable to fully
comply with certain  reporting  requirements of such covenants.  The Company has
obtained  waivers with respect to these  events of default  which are  effective
through May 10, 1999.  The Company  believes that it will be in compliance  with
the reporting requirements of the DIP Credit Facility by May 10, 1999.

The United States Trustee for the Northern  District of Georgia has appointed an
Official  Committee of Unsecured  Creditors (the "Creditors'  Committee") and an
Official  Committee  of Equity  Security  Holders (the  "Equity  Committee"  and
together with the  Creditors'  Committee,  the  "Committees").  The roles of the
Committees  include,  among  other  things:  (i)  consultation  with the Company
concerning the  administration of the Chapter 11 case, and (ii) participation in
the   formulation   of  a  plan  of   reorganization.   In   discharging   these
responsibilities,  the  Committees  have  standing  to  raise  issues  with  the
Bankruptcy  Court  relating  to the  business of the Company and the conduct and
course of the Chapter 11 case.  The Company is required to pay certain  expenses
of the  Committees,  including  professional  fees, to the extent allowed by the
Bankruptcy Court.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition  claim of $158.5  million  and an allowed  administrative
claim of $5 million.  As a part of the settlement,  the Company has entered into
License Agreements for the U.S. and Canada, which are exhibits to the Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for these  rights,  the Company has
agreed to pay P&G running  royalties on net sales of the licensed products equal
to 2 percent through October 2005, .75 percent  thereafter  through October 2006
and .375  percent  thereafter  through  March  2007 in the  U.S.;  and 2 percent
through  October  2008 and 1.25  percent  thereafter  through  December  2009 in
Canada.  The Settlement  Agreement also provides,  among other things,  that P&G
will grant the Company and/or its affiliates "most favored licensee" status with
respect to patents owned by P&G on the date of the  Settlement  Agreement or for
which an  application  was pending on that date.  In  addition,  the Company has
agreed with P&G that prior to litigating any future patent dispute,  the parties
will engage in good faith negotiations and will consider arbitrating the dispute
before resorting to litigation.

While the Company  believes  that the royalty rates being charged by P&G are the
same royalties that will be paid by the Company's major store brand  competitors
for similar patent rights,  these royalties,  together with royalties to be paid
to  Kimberly-Clark  Corporation  ("K-C")  described below,  will have a material
adverse  impact on the  Company's  future  financial  condition  and  results of
operations.  While these  royalty  costs are expected to be partially  offset by
projected  raw material  cost savings  related to the  conversion to a dual cuff
design, the Company's overall raw material costs are expected to increase. These
royalty  costs are also  expected  to be  partially  offset  by price  increases
announced by the Company in the fourth  quarter of 1998 to the extent such price
increases are realized.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G


                                     Page 2
<PAGE>

Settlement  Agreement,  once a Final Order, as defined therein, has been entered
by the Bankruptcy Court approving the settlement, the Company will withdraw with
prejudice its appeal of the Delaware  Judgment to the Federal  Circuit,  and P&G
will withdraw with  prejudice its motion in Delaware  District Court to find the
Company in contempt of the Delaware Judgment.  A hearing on the Company's motion
to seek approval from the Bankruptcy  Court of this  settlement was commenced on
March 22 and 23, 1999 and is  scheduled  to resume on April 13,  1999.  Both the
Equity  Committee  and K-C have  objected  to the P&G  settlement.  The  Company
intends to continue to pursue  approval of the P&G  Settlement by the Bankruptcy
Court.  Should the P&G Settlement  Agreement not be approved by a Final Order of
the Bankruptcy Court by July 31, 1999, however, the License Agreements described
above will become  terminable at P&G's option.  The Company cannot predict when,
or if, such approval will be granted.  See "ITEM 3: LEGAL  PROCEEDINGS:  --IN RE
PARAGON TRADE BRANDS,  INC.," and "ITEM 7: MANAGEMENT'S  DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES.".

On October 26, 1995,  K-C filed a lawsuit  against the Company in U.S.  District
Court in Dallas,  Texas,  alleging infringement by the Company's products of two
K-C patents  relating  to dual cuffs.  The  lawsuit  sought  injunctive  relief,
royalty  damages,  treble  damages and  attorneys'  fees and costs.  The Company
denied liability under the patents and  counterclaimed  for patent  infringement
and  violation  of antitrust  laws by K-C. In addition,  K-C sued the Company on
another patent issued to K-C which is based upon a further  continuation  of one
of the K-C dual cuff patents asserted in the case.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C an  allowed  unsecured  prepetition  claim of $110  million  and an  allowed
administrative claim of $5 million. As a part of the settlement, the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with respect to the patents  asserted by K-C in the
Texas action.  The patent rights licensed by the Company from K-C will allow the
Company to manufacture a dual cuff diaper  design.  In exchange for these patent
rights,  the Company has agreed to pay K-C annual running royalties on net sales
of the  licensed  products in the U.S.  and Canada  equal to: 2.5 percent of the
first $200 million of net sales of the covered  diaper  products and 1.5 percent
of such net sales in excess of $200  million in each  calendar  year  commencing
January 1999 through November 2004. In addition, the Company has agreed to pay a
minimum  annual  royalty for diaper sales of $5 million,  but amounts due on the
running royalties will be offset against this minimum. The Company will also pay
K-C  running  royalties  of 5 percent  of net  sales of  covered  training  pant
products  for the same  period,  but there is no minimum  royalty  for  training
pants. As part of the settlement, the Company has granted a royalty-free license
to K-C for three  patents  which the  Company in the Texas  action  claimed  K-C
infringed.

While the Company  believes  that,  based on its projected  level of sales,  the
overall effective royalty rate that the Company will pay to K-C is less than the
royalty rate that will be paid by the  Company's  major store brand  competitors
for similar patent rights,  these royalties will,  together with royalties to be
paid to P&G described  above,  have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff product,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of  super-absorbent  polymers ("SAP") in
diapers  and  training  pants,  so long as the Company  uses SAP which  exhibits
certain  performance  characteristics  (the "SAP Safe Harbor").  The Company has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased  marketing and selling,  general and administrative  expenses ("SG&A")
expenditures  in 1999 to address  product  performance  issues.  These increased
expenditures  are expected to have a material  adverse  impact on the  Company's
financial   position  and  results  of  operations  in  1999.   The  Company  is
encountering increased product costs due to the increased price and usage of the
new SAP.  While the  Company is working  diligently  with its SAP  suppliers  to
develop  a better  performing  alternative  which is still  within  the SAP Safe
Harbor,  the  Company  cannot  predict  at this  time  whether  or when  such an
alternative  SAP would be available.  The Company  expects that these  increased
product costs will have a 


                                     Page 3
<PAGE>

material adverse impact on its financial condition and results of operations for
at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted. See "ITEM 7: MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES."

As a result of the Chapter 11 filing,  the Company is prohibited from paying any
prepetition liabilities without Bankruptcy Court approval. The Chapter 11 filing
resulted in a default under its prepetition revolving credit facility.  Pursuant
to the Bankruptcy  Code, the Company can seek Bankruptcy  Court approval for the
rejection of executory  contracts or unexpired  leases,  including real property
leases.  Any such rejection may give rise to a prepetition  unsecured  claim for
damages arising therefrom.

Substantially  all  liabilities  outstanding  as of the date of the  Chapter  11
filing are subject to resolution under a plan of reorganization to be voted upon
by  those of the  Company's  creditors  and  shareholders  entitled  to vote and
confirmed by the Bankruptcy Court.  Schedules were filed by the Company on March
3, 1998 with the  Bankruptcy  Court setting forth the assets and  liabilities of
the Company as of the date of the Chapter 11 filing,  as shown by the  Company's
accounting  records.  Amended  schedules  were filed by the Company on March 30,
1998 with the Bankruptcy  Court. The Bankruptcy Court set a date of June 5, 1998
by which time  creditors  had to have filed proofs of claims  setting  forth any
claims which arose prior to the Chapter 11 filing.

The ability of the Company to effect a successful reorganization will depend, in
significant   part,   upon  the  Company's   ability  to  formulate  a  plan  of
reorganization  that is approved by the  Bankruptcy  Court.  The Company  cannot
predict at this time the effect of the material  adverse  impact  related to the
increased costs described above on the Company's enterprise valuation and on the
Company's  ability to timely  formulate  a plan of  reorganization.  The Company
believes,  however,  that it may be  impossible  to  satisfy  in full all of the
claims against the Company. Investment in securities of, and claims against, the
Company,  therefore,  should be  regarded  as highly  speculative.  See "ITEM 7:
MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS:  RISKS AND UNCERTAINTIES."

The Company is unable to predict at this time when it will  emerge from  Chapter
11  protection.  See "Notes 1, 12 and 15 of Notes to Financial  Statements"  and
"ITEM 3: LEGAL PROCEEDINGS" herein.

PRODUCTS

The Company manufactures  several diaper product lines: a premium-quality  Ultra
line,  an  economy  line  ("Economy")  and a  Supreme  line.  The  Company  also
manufactures  a line  of  training  pants.  Ultra  diaper  sales  accounted  for
approximately 86 percent, 81 percent, and 78 percent of the Company's total unit
sales in 1998,  1997 and 1996,  respectively.  Economy diaper units  represented
approximately  7 percent,  9 percent and 12 percent of the Company's  total unit
sales in fiscal years 1998,  1997 and 1996,  respectively.  The Supreme  product
represented  approximately  4 percent,  5 percent and 4 percent of the Company's
total unit sales in fiscal  years 1998,  1997 and 1996,  respectively.  Training
pant sales represented approximately 4 percent of the Company's total unit sales
over the same periods.

The Company's  Ultra diaper  combines fluff pulp with SAP in the absorbent inner
core. SAP is significantly more absorbent and better able to retain liquids than
fluff pulp. To enhance performance and appearance, the Ultra diaper incorporates
a number of product features  comparable to those introduced by national branded
manufacturers.  The Company now produces its Ultra diaper in six different sizes
which are designed to fit babies better as they grow and develop.  Additionally,
the Company continued its agreement with Jim Henson Productions,  Inc., pursuant
to which the Company  reproduces the Muppet Babies(R) cartoon  characters on the
"tape landing zone" of its Ultra  diapers.  In 1998,  the Company  introduced an
improved  Ultra  diaper  which  


                                     Page 4
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incorporated  stretch tabs and a hook and loop closure system.  In late 1996 and
1997,  the Company  introduced  an improved  Ultra diaper which  incorporates  a
cloth-like backsheet and breathable side panels.

The Economy  diaper is designed to satisfy the needs of the more  cost-conscious
value  segment  shopper.  Its  absorbent  pad  contains  fluff pulp and SAP. Its
features   include  a  "tape  landing  zone"   allowing  for  easy  fitting  and
re-adjustment after fastening.  The Company produces the Economy diaper in three
unisex sizes.

The Company's Supreme diaper product is similar to its Ultra diaper but contains
a premium  absorbent  core and parts of the outer cover and closure  systems use
premium materials.

The  Company's  training pant is designed for use by children  primarily  during
their transition from diapers. The Company's training pant utilizes an absorbent
core of fluff pulp and SAP and a cloth-like  nonwoven  outer cover.  The Company
produces its training pant in two gender-specific sizes and two unisex sizes.

In 1996, the Company began  manufacturing  a line of feminine care products that
included ultra thin,  maxi and super maxi pads,  pantiliners,  panty shields and
regular and super absorbent tampons.  In 1997, the Company began manufacturing a
line of adult  incontinence  products that includes  guards,  undergarments  and
bladder  control pads. In 1998, the Company  curtailed its tampon  manufacturing
operations.

PRODUCT DEVELOPMENT

To enhance  the  Company's  objective  of  providing  its trade  customers  with
premium-quality store brand disposable diapers, training pants and feminine care
and adult incontinence  products,  the Company devotes significant  resources to
market  research  and  product  design and  development  to enable it to improve
product  performance and consumer  acceptance.  The Company believes that it has
the  largest  product  development  program  of any  manufacturer  in  the  U.S.
disposable  diaper market,  other than the national branded  manufacturers.  The
Company  spent  approximately  $4.2  million,  $5.1  million and $4.2 million on
research and development in fiscal years 1998, 1997 and 1996, respectively.

PATENT RIGHTS

Because  of the  emphasis  on  product  innovations  in the  disposable  diaper,
feminine care and adult  incontinence  markets,  patents and other  intellectual
property  rights are an  important  competitive  factor.  The  national  branded
manufacturers  have sought to vigorously  enforce their patent  rights.  Patents
held by the national  branded  manufacturers  could severely limit the Company's
ability to keep up with branded  product  innovations by prohibiting the Company
from introducing products with comparable  features.  To protect its competitive
position,  the Company has created an intellectual  property  portfolio  through
development,  acquisition and licensing that includes approximately 300 U.S. and
foreign  patents  relating  to  disposable  diaper,   feminine  care  and  adult
incontinence  product  features and  manufacturing  processes.  The Company also
subjects new product  innovations to a rigorous patent  clearance  process which
includes a review by the  Company's  outside  patent  counsel.  This  process is
designed to minimize patent risk related to the Company's products. See "ITEM 3:
LEGAL PROCEEDINGS."

MAJOR CUSTOMERS

The Company's net sales to its largest trade customer,  Wal-Mart  Stores,  Inc.,
and Sam's Club, a division of Wal-Mart Stores, Inc., represented an aggregate of
approximately 19 percent, 15 percent and 13 percent of total net sales in fiscal
years  1998,  1997  and  1996,  respectively.  As is  customary  in  the  infant
disposable  diaper  market,  the  Company in most cases does not have  long-term
contracts with its trade customers.  The Company estimates that  approximately 7
percent,  7 percent and 9 percent of net sales were to trade customers in Canada
in fiscal years 1998, 1997 and 1996, respectively.

FOREIGN OPERATIONS

On January  26,  1996,  the  Company  through its wholly  owned  subsidiary  PTB
International,  Inc. ("PTBI") completed the purchase of a 15 percent interest in
Grupo P.I. Mabe,  S.A. de C.V.  ("Mabesa"),  the second largest  manufacturer of
infant disposable  diapers in Mexico,  for $15.3 million in cash plus additional
consideration  based 


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<PAGE>

on Mabesa's future financial  results through 2001. The Company also acquired an
option  to  purchase  an  additional   34  percent   interest  in  Mabesa  at  a
contractually determined price. In 1998 and 1997, based on Mabesa's prior year's
financial results, the Company paid additional consideration of $2.8 million and
$3.4 million, respectively.

In  addition,  PTBI  acquired a 49 percent  interest for $1.6 million in cash in
Paragon-Mabesa  International  ("PMI"),  a joint venture that developed a diaper
manufacturing  facility in Tijuana,  Mexico.  The Company sold certain assets to
PMI as part of the  development  of PMI's  manufacturing  facility  in  Tijuana,
Mexico.   The  Company  has  assisted  in  financing  the  equipment,   building
construction  and start-up of the Tijuana,  Mexico  facility which is completely
operational.  The Company  has signed a Product  Supply  Agreement  with PMI and
purchases  substantially  all of PMI's  production for sale to U.S. and European
retail customers.

On August 26, 1997, PTBI purchased a 49 percent interest in Stronger Corporation
S.A.  ("Stronger"),   a  financial  investment  corporation  incorporated  under
Uruguayan  law. An affiliate of Mabesa owns the  remaining 51 percent.  Stronger
has been used to establish  joint  ventures in  Argentina  and Brazil and can be
used to establish additional Latin American joint ventures.

On August 26, 1997,  Stronger  acquired 70 percent of Serenity  S.A.,  the third
largest diaper  manufacturer in Argentina,  for  approximately  $11.6 million in
cash plus additional  consideration based on Serenity's future financial results
through  2000.  Stronger  also  acquired an option to purchase the  remaining 30
percent  interest  in Serenity by 2002 at a  contractually  determined  exercise
price.  Serenity  manufactures infant disposable  diapers,  sanitary napkins and
adult  incontinence  products in two  facilities.  PTBI advanced $5.7 million to
Stronger,  its  pro-rata  share  of the  purchase  price,  and  paid  additional
consideration of $.6 million in 1998. PTBI has guaranteed  Stronger's additional
consideration obligations which are estimated not to exceed an aggregate of $2.3
million through 2000.

On November  10, 1997,  Stronger  acquired 99 percent of the  disposable  diaper
business of MPC Productos  para Higiene Ltda.  ("MPC") for  approximately  $10.5
million in cash from Cremer  S.A.,  a  Brazilian  textile  manufacturer.  MPC is
engaged in the manufacture,  distribution,  and sale of disposable diapers, skin
lotions for  children and other  personal  care  products.  PTBI  advanced  $5.1
million to Stronger,  its pro-rata share of the purchase price in 1997. In 1998,
PTBI  converted  $2.0 million of outstanding  notes  receivable and  accumulated
interest for equipment sales into an additional capital contribution.

In 1998  Paragon  established  Goodbaby  Paragon  Hygienic  Products Co. Ltd., a
manufacturing  and  marketing  joint  venture  in China with  Goodbaby  Group of
Kunshan City and First Shanghai  Investment of Hong Kong. Paragon purchased a 40
percent  interest in the joint  venture with Goodbaby  Group and First  Shanghai
Investment at 30 percent  each.  Initial  registered  capital of the venture was
approved by the Chinese government at $15 million,  to be funded over a two-year
period. A joint venture business license was approved by the Chinese  government
on December  31, 1997.  Groundbreaking  for a new factory took place in February
1998. The joint venture began production and  distribution of infant  disposable
diapers in October 1998.  Paragon advanced $4.0 million,  its pro-rata share, in
1998.

RAW MATERIALS

The principal raw material  components of the Company's  products are SAP, fluff
pulp,  polyethylene  backsheet,  polypropylene  nonwoven liner, adhesive closure
tape, hotmelt adhesive, elastic and tissue.

One of the primary raw materials used in the production of disposable diapers is
SAP.  In early  1998,  the  Company  entered  into an  agreement  with  Clariant
International  Ltd.  (subsequently  purchased  by BASF  Corporation)  whereby it
agreed,  subject  to  certain  limitations,  to  purchase  100  percent  of  its
requirements of SAP through  December 31, 2001.  Fluff pulp, a product made from
wood fibers,  is another  primary raw  material.  The Company's  agreement  with
Weyerhaeuser Company ("Weyerhaeuser") pursuant to which it purchased 100 percent
of its requirements of bleached chemical fluff pulp expired August 31, 1998. The
Company  has  continued   purchasing   substantially   all  of  its  fluff  pulp
requirements  from  Weyerhaeuser.  The Company  believes that at least two other
sources of supply exist for fluff pulp.

                                     Page 6
<PAGE>

The Company's gross margins are  significantly  impacted by raw material prices,
especially  the  price of fluff  pulp  which  can  fluctuate  dramatically.  The
Company's operating results benefited from favorable fluff pulp market prices in
1998  and  may be  adversely  affected  by  increases  in raw  material  prices,
primarily fluff pulp, in 1999. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: Risks and Uncertainties."

COMPETITION-Disposable Diapers

National Branded Manufacturers

The principal aspects of competition from the national branded manufacturers are
price,  product  quality,  product  innovation  and customer  service.  The U.S.
disposable  diaper market is led by the national brands  manufactured by P&G and
K-C. The Company  estimates  that, in 1998, the national  branded  manufacturers
accounted for approximately 74 percent of all U.S.  disposable diaper sales. The
market position of these manufacturers, relative to the Company, varies from one
geographic region to another, but due to their substantial financial,  technical
and  marketing  resources,  each of these  companies  has the  ability  to exert
significant influence on the infant disposable diaper market.

The  market  for  disposable  diapers  is  divided  into the  premium  and value
segments.  The premium segment accounts for approximately 60 percent of the unit
volume. Both K-C and P&G dominate the premium segment.  The value segment of the
industry,  which the Company estimates accounted for approximately 40 percent of
unit volume in 1998, is highly  competitive.  The Company includes store brands,
control  labels,  P&G's Luvs(R),  Drypers(R),  Fitti(R),  and all other regional
brands in the value segment.

In total,  P&G is the dominant  manufacturer  in the U.S.  diaper  market,  with
approximately 40 percent market share. P&G manufactures two brands:  Pampers(R),
its premium brand with  approximately  26 percent  market share,  and Luvs,  its
value brand with 14 percent market share. K-C manufactures the number one diaper
brand, Huggies, with approximately 34 percent market share. K-C does not offer a
value  brand,  but  supplies  some store brand  training  pants within the value
segment.

Price  has  been a  significant  variable  in the  competitive  strategy  of the
national  branded  companies in the past three years.  In recent years,  pricing
pressure  by the  brands  has been most  evident  in the shift of volume to mass
merchants who aggressively  sell  multi-packs.  Multi-packs  represent a package
configuration  that  provides the consumer 2, 3 or 4 times the amount of diapers
found in a standard convenience count package.  These multi-packs sell at prices
10 to 15 percent below the branded convenience count package.  For most of 1998,
pricing  pressures  from store brand  competitors  and a shift of volume to mass
merchants  continued.  In October of 1998,  the national  brands  instituted a 5
percent price increase on certain of their product offerings.  The Company began
implementing  a similar price  increase on certain of its products in the fourth
quarter of 1998.  Competitive factors may prevent the Company from realizing the
full  benefit of the price  increase.  The Company  believes  that the  national
branded  manufacturers  have lower per unit costs and  higher  margins  than the
Company,  principally due to their higher volume and prices,  coupled with fewer
variations  in  product  and  packaging.   In  addition,  the  national  branded
manufacturers have access to substantially  greater financial resources than the
Company.   As  a  result,   the  Company  believes  that  the  national  branded
manufacturers  are  capable  of  maintaining  or  reducing  prices,  even  in an
environment of rising raw material prices.

Product  quality and  innovation  are critical  aspects of  competition  for the
national  branded  manufacturers.  They have  substantially  larger research and
development budgets than the Company and are able to develop product innovations
more rapidly than the Company and may thereby gain market share at the Company's
expense.   The  Company   estimates  that  since  1985,  the  national   branded
manufacturers have generally introduced a product innovation approximately every
12 months.

                                     Page 7
<PAGE>

While  in  recent  years  the  Company  has  been  able  to  introduce   product
enhancements   comparable   to  those   introduced   by  the  national   branded
manufacturers,  there  can be no  assurance  that  the  Company  will be able to
continue to introduce  such product  innovations  at the pace required to remain
competitive  with  the  national  branded  manufacturers.  Producing  comparable
products could  adversely  affect the Company's  gross margins,  particularly in
light of the  significant  royalty  costs the Company must pay under the P&G and
K-C  licenses  described  herein.  To the extent  that the  Company is unable to
introduce comparable products due to the patent landscape, it could experience a
decline in net sales and net earnings. See "ITEM 3: LEGAL PROCEEDINGS" and "ITEM
7:  MANAGEMENTS  DISCUSSION  AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF
OPERATIONS: RISKS AND UNCERTAINTIES."

Customer  service is another area where the national brands are able to compete.
The Company  believes  that each of the national  branded  manufacturers  has an
order-delivery   cycle  that  is   significantly   shorter  than  the  Company's
order-delivery  cycle. In addition,  the national branded  manufacturers  devote
substantially  greater  financial  resources than the Company to providing trade
customers with category expertise,  customized  promotional campaigns and market
support. The national branded  manufacturers have sophisticated  electronic data
interchange  systems  that  interface  directly  with their  customers'  product
information  systems.  In 1998, the Company  successfully  implemented a process
improvement and information  technology upgrading project to further enhance its
customer service capabilities. See "ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."

Value Segment

The Company  competes in the value  segment of the market  with  national  value
brands and store brand products.  The value segment is  characterized  by excess
capacity and vigorous price competition. The Company's largest competitor in the
value segment is P&G with its Luvs brand. The next largest competitor is Drypers
Corp. K-C also produces store brand training pants.

The Company  seeks to compete  against  other  value  segment  manufacturers  by
emphasizing  research  and  development  and by  striving  to maintain a leading
position among value segment competitors in product quality. Smaller competitors
of the Company are sometimes able to introduce new product features more quickly
than the Company, in part as a result of having fewer diaper machines to convert
to new production processes.

COMPETITION-Feminine Care & Adult Incontinence

The principal  bases of competition in the feminine care and adult  incontinence
market are price, product quality,  product innovation and customer service. The
U.S.  feminine  care and adult  incontinence  retail  market is led by  national
branded manufacturers including K-C, P&G, Johnson and Johnson, Inc., and Playtex
Products,  Inc.  The  Company  estimates  that in  1998,  the  national  branded
manufacturers  accounted for  approximately 92 percent of all U.S. feminine care
and  approximately 76 percent of all U.S. adult  incontinence  sales. The market
position  of these  manufacturers,  relative  to the  Company,  varies  from one
geographic region to another, but due to their substantial financial,  technical
and  marketing  resources,  each of these  companies  has the  ability  to exert
significant influence on the feminine care market and adult incontinence market.
Another  manufacturer  is the  dominant  supplier of store brand  feminine  care
products.  The Company experienced greater than anticipated  operating losses in
its feminine care and adult incontinence businesses in 1998 and 1997 and expects
these losses to continue  near-term.  The Company has  developed a business plan
that supports the  realization  of its investment in its feminine care and adult
incontinence business. Accordingly, the Company has not recorded any adjustments
in its  financial  statements  relating to the  recoverability  of the operating
assets  of the  feminine  care and adult  incontinence  business  The  Company's
ability to recover its  investment  is dependent  upon a prompt  emergence  from
Chapter 11 and the successful execution of the Company's feminine care and adult
incontinence business plan. The Company cannot predict at this time when it will
emerge from Chapter 11  protection.  The Company  believes  that once it emerges
from Chapter 11 the feminine  care and adult  incontinence  business will see an
increase in sales and improved  results.  The Company cannot  predict,  however,
whether or when such improved results will be realized. See "ITEM 7: MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:  RISKS
AND UNCERTAINTIES."

                                     Page 8
<PAGE>

EMPLOYEES

At December 27, 1998, the Company had approximately  1,211 full-time  employees,
including 1,021 employees located at its five manufacturing facilities.

ENVIRONMENT

The Company is subject to federal,  state,  local and foreign laws,  regulations
and ordinances  that (i) govern  activities or operations  that may have adverse
environmental  effects,  such as discharges to air and water as well as handling
and disposal  practices for solid and hazardous  wastes or (ii) impose liability
for the costs of cleaning up, and certain damages  resulting from, sites of past
spills and  disposals  or other  releases  of  hazardous  substances  (together,
"Environmental Laws").

The Company  uses  certain  substances  and  generates  certain  wastes that are
regulated by or may be deemed hazardous under applicable Environmental Laws. The
Company believes that it currently conducts its operations,  and in the past has
conducted  its   operations,   in   substantial   compliance   with   applicable
Environmental  Laws. From time to time, however,  the Company's  operations have
resulted or may result in certain  noncompliance  with applicable  requirements.
The Company  believes,  however,  that it will not incur  compliance  or cleanup
costs  pursuant  to  applicable  Environmental  Laws that  would have a material
adverse effect on the Company's results of operations or financial condition.

The Company  monitors  Environmental  Laws and  regulations,  as well as pending
legislation,  in each of the markets in which its products are sold. A number of
states have passed or are considering legislation intended to discourage the use
of disposable products, including disposable diapers, or to encourage the use of
nondisposable or recyclable products. The Company does not believe that any such
laws  currently in effect will have a material  adverse effect on its results of
operations or financial condition.

See "ITEM 7:  MANAGEMENTS  DISCUSSION AND  ANALYSIS OF  FINANCIAL CONDITION  AND
RESULTS  OF OPERATIONS:  FORWARD-LOOKING STATEMENTS."


ITEM 2:    PROPERTIES

As of December 27, 1998,  the Company  operated five  manufacturing  facilities,
with  plants  located  in  the  United  States  at  Macon,   Georgia;   Harmony,
Pennsylvania;  Gaffney,  South  Carolina;  and  Waco,  Texas;  and in  Canada at
Brampton, Ontario. The Company owns four of its manufacturing facilities.

The following  table  summarizes the physical  properties  that were held by the
Company at December 27, 1998:

<TABLE>
<CAPTION>
                                                       APPROXIMATE
                                                           SIZE                            NUMBER OF
           LOCATION                      USE            (SQ. FEET)       OWNED/LEASED      MACHINES
--------------------------------  ------------------  ----------------  ----------------  ------------
<S>                                <C>                     <C>              <C>               <C>

INFANT CARE:
    Brampton, Ontario               Manufacturing           76,000           Owned             3
    Harmony, Pennsylvania           Manufacturing          173,000           Owned             9
    Macon, Georgia                  Manufacturing          308,000           Owned             8
    Oneonta, New York               Held for Sale           93,000           Owned            --
    Porterville, California         Held for Sale           69,000           Owned            --
    Waco, Texas                     Manufacturing          151,000           Owned             7
FEMININE CARE AND ADULT
INCONTINENCE:
    Gaffney, South Carolina         Manufacturing          213,000          Leased             6
CORPORATE AND OTHER:
    Norcross, Georgia               Headquarters            69,000           Owned            --
</TABLE>

The facilities in Oneonta,  New York and  Porterville,  California  were sold in
February 1999.

                                     Page 9
<PAGE>


ITEM 3:    LEGAL PROCEEDINGS

THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC. - P&G filed a lawsuit
in January 1994 in the District Court for the District of Delaware alleging that
the Company's "Ultra" infant  disposable diaper products  infringed two of P&G's
dual cuff diaper patents.  The lawsuit sought injunctive relief, lost profit and
royalty  damages,  treble  damages and  attorneys'  fees and costs.  The Company
denied liability under the patents and  counterclaimed  for patent  infringement
and  violation  of  antitrust  laws by P&G. In March 1996,  the  District  Court
granted  P&G's motion for summary  judgment to dismiss the  Company's  antitrust
counterclaim.  The trial was completed in February 1997,  the parties  submitted
post-trial  briefs and closing  arguments  were  conducted  on October 22, 1997.
Legal fees and costs for this litigation have been significant.

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

The Company had previously  filed with the District Court a motion under Rule 59
for a new trial or to alter or amend the  Judgment.  The  District  Court denied
Paragon's motion by order entered August 4, 1998. The District Court also denied
a motion by P&G seeking to recover  attorneys'  fees it  expended  in  defending
itself against Paragon's patent  infringement  counterclaim.  On August 4, 1998,
the Company filed with the Federal  Circuit Court of Appeals its amended  notice
of appeal.  The appeal was fully  briefed,  and oral  argument was scheduled for
February 5, 1999.

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

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

P&G filed alleged claims in the Company's Chapter 11  reorganization  proceeding
ranging from approximately $2.3 billion (without trebling) to $6.5 billion (with
trebling),  which included a claim of $178.4 million for the Delaware  Judgment.
See "--IN RE PARAGON TRADE BRANDS,  INC.," below.  The remaining  claims include
claims for, among other things,  alleged patent  infringement  by the Company in
foreign countries where it has operations.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition  claim of $158.5  million  and an allowed  administrative
claim of $5 million.  As a part of the settlement,  the Company has entered into
License Agreements for the U.S. and Canada, which are exhibits to the Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for


                                    Page 10
<PAGE>

these rights,  the Company has agreed to pay P&G running  royalties on net sales
of the licensed  products equal to 2 percent  through  October 2005, .75 percent
thereafter  through October 2006 and .375 percent  thereafter through March 2007
in the U.S.;  and 2 percent  through  October 2008 and 1.25  percent  thereafter
through December 2009 in Canada. The Settlement  Agreement also provides,  among
other  things,  that P&G will  grant the  Company  and/or its  affiliates  "most
favored licensee" status with respect to patents owned by P&G on the date of the
Settlement  Agreement or for which an  application  was pending on that date. In
addition,  the Company has agreed with P&G that prior to  litigating  any future
patent  dispute,  the parties  will engage in good faith  negotiations  and will
consider arbitrating the dispute before resorting to litigation.

While the Company  believes  that the royalty rates being charged by P&G are the
same royalties that will be paid by the Company's major store brand  competitors
for similar patent rights,  these royalties,  together with royalties to be paid
to K-C described  herein,  will have a material  adverse impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff  design,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have
objected  to the P&G  settlement.  The  Company  intends to  continue  to pursue
approval  of the  P&G  Settlement  by  the  Bankruptcy  Court.  Should  the  P&G
Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by
July 31,  1999,  however,  the License  Agreements  described  above will become
terminable  at P&G's  option.  The  Company  cannot  predict  when,  or if, such
approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS:  --IN RE PARAGON TRADE
BRANDS,  INC.," and "ITEM 7:  MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES" below.

KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC. -- On October 26, 1995,
K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas,
alleging  infringement by the Company's  products of two K-C patents relating to
dual cuffs.  The lawsuit  sought  injunctive  relief,  royalty  damages,  treble
damages and attorneys'  fees and costs.  The Company denied  liability under the
patents and  counterclaimed  for patent  infringement and violation of antitrust
laws by K-C.  Several  pre-trial  motions were filed by each party,  including a
motion for summary judgment filed by K-C with respect to the Company's antitrust
counterclaim  and a motion for summary  judgment  filed by the Company on one of
the patents asserted by K-C. In addition, K-C sued the Company on another patent
issued to K-C which is based upon a further  continuation of one of the K-C dual
cuff patents asserted in the case. That action was consolidated with the pending
action.  The Court  appointed a special  master to rule on the  various  pending
motions.  Legal  fees and costs in  connection  with this  litigation  have been
significant.

As a result of the  Company's  Chapter 11  filing,  the  proceedings  in the K-C
litigation were stayed.  The Bankruptcy  Court issued an order on April 10, 1998
permitting,  among  other  things,  a partial  lifting  of the stay to allow the
issuance of the special  master's  report on the items under his  consideration.
K-C  filed  with  the  Bankruptcy  Court a  motion  for  reconsideration  of the
Bankruptcy  Court's April 10, 1998 order, which was denied on June 15, 1998. K-C
has  appealed  this  denial of  reconsideration  to the  District  Court for the
Northern District of Georgia. The Company objected to K-C's appeal and sought to
have it dismissed. K-C also filed a motion with the District Court in Atlanta to
withdraw the  reference  with respect to all matters  pertaining to its proof of
claim from the jurisdiction of the Bankruptcy  Court. By order executed February
18, 1999,  the appeal,  K-C's motion for  withdrawal  of the  reference  and the
Company's  motion to dismiss the appeal were  dismissed  by the  District  Court
without  prejudice to the right of either party within sixty days to re-open the
actions if a settlement was not consummated.  See "--IN RE PARAGON TRADE BRANDS,
INC." below.

                                    Page 11
<PAGE>

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

Effective September 1, 1998, the Texas action was reassigned to Judge Lindsey, a
newly-appointed  judge on the Dallas  District Court bench.  Judge Lindsey asked
the  parties  to  report  on the  status  of the  case  and  the  likelihood  of
settlement.  The parties  responded on November 6, 1998, that  negotiations were
underway and that they believed considerable progress was being made.

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

K-C filed alleged claims in the Company's Chapter 11  reorganization  proceeding
ranging from approximately $893 million (without trebling) to $2.3 billion (with
trebling). See "--IN RE PARAGON TRADE BRANDS, INC.," below.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C an  allowed  unsecured  prepetition  claim of $110  million  and an  allowed
administrative claim of $5 million. As a part of the settlement, the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with respect to the patents  asserted by K-C in the
Texas action.  The patent rights licensed by the Company from K-C will allow the
Company to manufacture a dual cuff diaper  design.  In exchange for these patent
rights,  the Company has agreed to pay K-C annual running royalties on net sales
of the  licensed  products in the U.S.  and Canada  equal to: 2.5 percent of the
first $200 million of net sales of the covered  diaper  products and 1.5 percent
of such net sales in excess of $200  million in each  calendar  year  commencing
January 1999 through November 2004. In addition, the Company has agreed to pay a
minimum  annual  royalty for diaper sales of $5 million,  but amounts due on the
running royalties will be offset against this minimum. The Company will also pay
K-C  running  royalties  of 5 percent  of net  sales of  covered  training  pant
products  for the same  period,  but there is no minimum  royalty  for  training
pants. As part of the settlement, the Company has granted a royalty-free license
to K-C for three  patents  which the  Company in the Texas  action  claimed  K-C
infringed.

While the Company  believes  that,  based on its projected  level of sales,  the
overall effective royalty rate that the Company will pay to K-C is less than the
royalty rate that will be paid by the  Company's  major store brand  competitors
for similar patent rights,  these royalties will,  together with royalties to be
paid to P&G described  above,  have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff product,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of  super-absorbent  polymers ("SAP") in
diapers  and  training  pants,  so long as the Company  uses SAP which  exhibits
certain  performance  characteristics  (the "SAP Safe Harbor").  The Company has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased  marketing and selling,  general and administrative  expenses ("SG&A")
expenditures  in 1999 to address  product  performance  issues.  These increased
expenditures  are expected to have a material  adverse  impact on the  Company's
financial   position  and  results  of  operations  in  1999.   The  Company  is
encountering increased product costs due to the increased price and usage of the
new 


                                    Page 12
<PAGE>

SAP. While the Company is working  diligently with its SAP supplier to develop a
better  performing  alternative  which is still within the SAP Safe Harbor,  the
Company  cannot  predict at this time  whether or when such an  alternative  SAP
would be available.  The Company expects that these increased product costs will
have a  material  adverse  impact on its  financial  condition  and  results  of
operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted. See "ITEM 7: MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES."

IN RE PARAGON TRADE BRANDS,  INC. -- As described  above,  on December 30, 1997,
the  Delaware  District  Court  issued a Judgment  and Opinion in the  Company's
lawsuit with P&G which  found,  in essence,  two of P&G's  diaper  patents to be
valid and infringed by the Company's "Ultra" disposable baby diapers, while also
rejecting  the Company's  patent  infringement  claim against P&G.  Judgment was
entered on January 6, 1998.  While a final damages number was not entered by the
District  Court  until  June 2,  1998,  the  Company  originally  estimated  the
liability and associated  litigation costs to be approximately $200 million. The
amount of the  award  resulted  in  violation  of  certain  covenants  under the
Company's bank loan  agreements.  As a result,  the issuance of the Judgment and
the uncertainty it created caused an immediate and critical  liquidity issue for
the Company which necessitated the Chapter 11 filing.

Subsequently,  damages of  approximately  $178.4  million were  entered  against
Paragon by the District  Court on June 2, 1998.  At the same time,  the District
Court entered  injunctive relief agreed upon by P&G and the Company.  See "--THE
PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above.

The Chapter 11 filing prevented P&G from placing liens on the Company's  assets,
permitted  the  Company to appeal the  District  Court's  decision in an orderly
fashion  and  affords the Company  the  opportunity  to resolve  liquidated  and
unliquidated  claims  against the  Company,  which arose prior to the Chapter 11
filing. The Company is currently operating as a  debtor-in-possession  under the
Bankruptcy  Code.  The bar date for the  filing of  proofs  of claim  (excluding
administrative  claims) by creditors was June 5, 1998.  P&G filed alleged claims
ranging from approximately $2.3 billion (without trebling) to $6.5 billion (with
trebling),  which included a claim of $178.4 million for the Delaware  judgment.
See "--THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS,  INC.," above.  The
remaining  claims  include  claims  for,  among  other  things,  alleged  patent
infringement by the Company in foreign countries where it has operations.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition  claim of $158.5  million  and an allowed  administrative
claim of $5 million.  As a part of the settlement,  the Company has entered into
License Agreements for the U.S. and Canada, which are exhibits to the Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for these  rights,  the Company has
agreed to pay P&G running  royalties on net sales of the licensed products equal
to 2 percent through October 2005, .75 percent  thereafter  through October 2006
and .375  percent  thereafter  through  March  2007 in the  U.S.;  and 2 percent
through  October  2008 and 1.25  percent  thereafter  through  December  2009 in
Canada.  The Settlement  Agreement also provides,  among other things,  that P&G
will grant the Company and/or its affiliates "most favored licensee" status with
respect to patents owned by P&G on the date of the  Settlement  Agreement or for
which an  application  was pending on that date.  In  addition,  the Company has
agreed with P&G that prior to litigating any future patent dispute,  the parties
will engage in good faith negotiations and will consider arbitrating the dispute
before resorting to litigation.

                                    Page 13
<PAGE>

While the Company  believes  that the royalty rates being charged by P&G are the
same royalties that will be paid by the Company's major store brand  competitors
for similar patent rights,  these royalties,  together with royalties to be paid
to K-C described  below,  will have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff  design,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have
objected  to the P&G  settlement.  The  Company  intends to  continue  to pursue
approval  of the  P&G  Settlement  by  the  Bankruptcy  Court.  Should  the  P&G
Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by
July 31,  1999,  however,  the License  Agreements  described  above will become
terminable  at P&G's  option.  The  Company  cannot  predict  when,  or if, such
approval will be granted. See "ITEM 3: LEGAL PROCEEDINGS:  --IN RE PARAGON TRADE
BRANDS,  INC.," and "ITEM 7:  MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES" below.

K-C filed  alleged  claims  ranging from  approximately  $893  million  (without
trebling) to $2.3  billion  (with  trebling),  including  claims  related to the
litigation in the Dallas District Court described above.  See  "--KIMBERLY-CLARK
CORPORATION  V.  PARAGON  TRADE  BRANDS,  INC.,"  above.  K-C's  claims  in  the
Bankruptcy  case  include  an  attempt  to  recover  alleged  lost  profits  for
infringement of the patents  asserted in the Dallas District Court,  despite the
fact that a lost profits  theory of damages was not pursued by K-C in the Dallas
District Court.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C an  allowed  unsecured  prepetition  claim of $110  million  and an  allowed
administrative claim of $5 million. As a part of the settlement, the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with respect to the patents  asserted by K-C in the
Texas action.  The patent rights licensed by the Company from K-C will allow the
Company to manufacture a dual cuff diaper  design.  In exchange for these patent
rights,  the Company has agreed to pay K-C annual running royalties on net sales
of the  licensed  products in the U.S.  and Canada  equal to: 2.5 percent of the
first $200 million of net sales of the covered  diaper  products and 1.5 percent
of such net sales in excess of $200  million in each  calendar  year  commencing
January 1999 through November 2004. In addition, the Company has agreed to pay a
minimum  annual  royalty for diaper sales of $5 million,  but amounts due on the
running royalties will be offset against this minimum. The Company will also pay
K-C  running  royalties  of 5 percent  of net  sales of  covered  training  pant
products  for the same  period,  but there is no minimum  royalty  for  training
pants. As part of the settlement, the Company has granted a royalty-free license
to K-C for three  patents  which the  Company in the Texas  action  claimed  K-C
infringed.

While the Company  believes  that,  based on its projected  level of sales,  the
overall effective royalty rate that the Company will pay to K-C is less than the
royalty rate that will be paid by the  Company's  major store brand  competitors
for similar patent rights,  these royalties will,  together with royalties to be
paid to P&G described  above,  have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff product,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

                                    Page 14
<PAGE>

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of SAP in diapers and training pants, so
long  as the  Company  stays  within  the  SAP  Safe  Harbor.  The  Company  has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased marketing and SG&A expenditures in 1999 to address product performance
issues.  These increased  expenditures  are expected to have a material  adverse
impact on the  Company's  financial  position and results of operations in 1999.
The Company is encountering  increased  product costs due to the increased price
and usage of the new SAP. While the Company is working  diligently  with its SAP
suppliers to develop a better  performing  alternative which is still within the
SAP Safe Harbor, the Company cannot predict at this time whether or when such an
alternative  SAP would be available.  The Company  expects that these  increased
product costs will have a material adverse impact on its financial condition and
results of operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted. See "ITEM 7: MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS: RISKS AND UNCERTAINTIES."

On  February  17,  1999,  the  Company,  P&G,  K-C,  the  Creditors'  and Equity
Committees  stipulated  to an extension of the Company's  exclusivity  period to
April  19,  1999  during  which  time  only the  Company  can  propose a plan of
reorganization.  On March 29, 1999, the Company filed a motion seeking to extend
this period,  initially, to May 19, 1999 and, subsequently,  to June 19, 1999. A
hearing on this motion is scheduled to occur on April 16, 1999.

On January 30, 1998,  the Company  received  Bankruptcy  Court approval of a $75
million  financing  facility with a bank group led by The Chase  Manhattan Bank.
This facility is designed to supplement the Company's cash on hand and operating
cash flow and to permit the Company to  continue to operate its  business in the
ordinary  course.  As of December 27,  1998,  there were no  outstanding  direct
borrowings under this facility.  The Company had an aggregate of $1.3 million in
letters of credit issued under the DIP Credit Facility at December 27, 1998. The
DIP Credit Facility contains  customary  covenants.  The Company for a period of
time has been unable to fully comply with certain reporting requirements of such
covenants.  The Company has  obtained  waivers  with  respect to these events of
default which are effective  through May 10, 1999. The Company  believes that it
will be in compliance with the reporting requirements of the DIP Credit Facility
by May 10, 1999. See "Note 12 of Notes to Financial  Statements." Legal fees and
costs in  connection  with the Chapter 11 case have been and will continue to be
significant.  The  Company is unable to predict at this time when it will emerge
from Chapter 11 protection.

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


ITEM 4:    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of the 1998 fiscal year.


                                    Page 15
<PAGE>

                                     PART II

ITEM 5:    MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
           STOCKHOLDER MATTERS

As of March 31, 1999,  there were 250 holders of record of the Company's  common
stock.  The Company has not paid  dividends  on its common  stock.  The Board of
Directors will determine future dividend policy based upon the Company's results
of   operations,   financial   condition,   capital   requirements   and   other
circumstances.  The  Company's  DIP Credit  Facility  prohibits the Company from
paying cash  dividends.  The  Company's  common  stock is listed on the New York
Stock  Exchange,  Inc.  under  the  symbol  "PTB."  See  "ITEM  7:  MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:  RISKS
AND UNCERTAINTIES." See "Note 19 of Notes to Financial Statements" regarding the
quarterly  high and low price range of the Company's  common stock.  The Company
did not sell any  securities of the Company that were not  registered  under the
Securities  Act of 1933, as amended,  during the fiscal year ended  December 27,
1998.


ITEM 6:    SELECTED FINANCIAL DATA

The  following  table sets forth  selected  consolidated  financial  data of the
Company on a historical  basis as  described  below.  The selected  consolidated
financial  data as of December 27, 1998 and December 28, 1997, and for the three
years in the period  ended  December 27, 1998 have been derived from the audited
consolidated financial statements of the Company which are included in Item 8 of
this annual report on Form 10-K. The selected consolidated  financial data as of
December  29, 1996,  December 31, 1995 and December 25, 1994,  and for the years
then ended have been derived from the audited consolidated  financial statements
of the  Company.  The Company  uses a 52/53-week  year for  financial  reporting
purposes.  The  fiscal  year  ended  December  31,  1995  reflects  53  weeks of
operations.

The audited consolidated  financial statements from which the selected financial
data has been derived have been prepared assuming that the Company will continue
as a going  concern.  As more  fully  described  in  "Notes 1 and 15 of Notes to
Financial  Statements"  and "ITEM 7:  MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF
FINANCIAL  CONDITION  AND RESULTS OF  OPERATIONS--RISK  FACTORS:  REORGANIZATION
CASE,"  the  Company  is  unable  to  predict  when  it  will  submit  a plan of
reorganization  that will be acceptable to the Bankruptcy  Court. In the event a
plan  of  reorganization  is  confirmed  and  consummated,  continuation  of the
business  thereafter  is  dependent  on the  Company's  ability to  execute  the
underlying business plan. The consolidated  financial  statements do not include
any adjustments  relating to the  recoverability  and classification of recorded
asset amounts or the amounts and  classification  of  liabilities  that might be
necessary should the Company be unable to continue as a going concern.

                                    Page 16
<PAGE>

(Dollar amounts in millions, except per share data)

<TABLE>
<CAPTION>
                                    1998            1997          1996          1995          1994
                                -------------- --------------- ------------ -------------- ------------
<S>                              <C>             <C>             <C>          <C>             <C>
EARNINGS STATEMENT DATA(1)
Net Sales                        $   535.2       $  562.0        $  581.9     $  518.8        $ 578.6
EBITDA(2)                        $    58.4       $   62.5        $   91.5     $   46.2        $  73.6
Operating profit (loss)          $   (58.0)(3)   $ (183.8)(4)    $   35.7(5)  $   (3.6)(6)    $  42.5
Net earnings (loss)              $   (65.4)(3)(7)$ (212.7)(4)(8) $   21.1(5)  $   (3.4)(6)    $  25.0

PER SHARE DATA(1)
Basic earnings (loss) per        $   (5.48)(3)(7)$(17.86)(4)(8)  $   1.76(5)  $   (.29)(6)    $  2.16
share

BALANCE SHEET DATA(1)
Total assets                     $   429.3       $  376.1        $  373.1     $  266.7        $ 275.4
Liabilities subject to
    compromise                   $   406.9           -              -             -             -
Long-term debt                   $     -         $   70.0        $   70.0         -           $   6.0
Shareholders' equity (deficit)   $   (61.8)      $    5.0        $  214.7     $  191.7        $ 195.7

OTHER DATA(1)
Capital spending                 $    28.3       $   49.4        $   48.9     $   17.4        $  74.9
Depreciation and amortization    $    34.5       $   35.5        $   38.8     $   36.0        $  31.1
Units sold (millions)               3,463          3,689           3,761         3,378         3,595

---------------
<FN>
(1)     See Notes 1, 3 and 15 of Notes to Financial Statements.

(2)  Operating   profit  (loss)  before   interest,   taxes,   depreciation  and
amortization and nonrecurring charges discussed in footnotes 3, 4, 5 and 6 below
("EBITDA").

(3) Includes  settlement  contingencies  of $78.5 for the  estimated  settlement
costs  of  P&G's  and  K-C's  claims  asserted  in  the  Company's   Chapter  11
reorganization  proceeding,  including the settlement of the P&G patent judgment
and the K-C Texas action,  and a $3.4 asset  impairment of the Company's  tampon
manufacturing  line. See Notes 1, 3 and 15 of Notes to Financial  Statements and
"ITEM 3: LEGAL PROCEEDINGS."

(4) Includes settlement  contingency of $200 for an adverse judgment in a patent
litigation  matter  with  P&G and  $10.6  of  asset  impairments  and  inventory
adjustments  related to the write-off of software and  consulting  costs and the
discontinuation of the Company's tampon manufacturing  operation. See Notes 1, 3
and 15 of Notes to Financial Statements.

(5) Includes  costs for the  integration  of Pope & Talbot's  disposable  diaper
business  purchased in February 1996 and costs related to the  relocation of the
corporate headquarters to Atlanta. Excluding these costs, operating profit would
be $52.7,  net  earnings  would be $31.7 and basic  earnings  per share would be
$2.64.

(6) Includes  restructuring  and charges  taken in the first quarter of 1995 for
the closure of the La Puente,  California plant,  corporate  headquarters  staff
reductions,  and other charges.  Excluding these charges, operating profit would
be $10.1, net earnings would be $5.4 and basic earnings per share would be $.46.

(7)     Includes a $32.9 reserve against deferred and other tax-related assets.

(8)     Includes a $100.2 reserve against deferred and other tax-related assets.
</FN>
</TABLE>

                                    Page 17
<PAGE>


ITEM 7:    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS

OVERVIEW

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

On December 30, 1997,  the  District  Court issued a Judgment and Opinion  which
found,  in  essence,  two of P&G's  dual  cuff  diaper  patents  to be valid and
infringed by certain of the Company's  disposable  diaper  products,  while also
rejecting the Company's  patent  infringement  claims  against P&G. The District
Court had earlier  dismissed the  Company's  antitrust  counterclaim  on summary
judgment.  The Judgment  entitled P&G to damages based on sales of the Company's
diapers  containing  the  "inner-leg  gather"  feature.  While the final damages
number of  approximately  $178.4  million was not entered by the District  Court
until  June  2,  1998,  the  Company  originally  estimated  the  liability  and
associated  litigation costs to be approximately $200 million. The amount of the
award   resulted  in  violation  of  certain   covenants   under  the  Company's
then-existing  bank loan agreements.  As a result,  the issuance of the Judgment
and the uncertainty it created caused an immediate and critical  liquidity issue
for the Company.

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

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition  claim of $158.5  million  and an allowed  administrative
claim of $5 million.  As a part of the settlement,  the Company has entered into
License Agreements for the U.S. and Canada, which are exhibits to the Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for these  rights,  the Company has
agreed to pay P&G running  royalties on net sales of the licensed products equal
to 2 percent through October 2005, .75 percent  thereafter  through October 2006
and .375  percent  thereafter  through  March  2007 in the  U.S.;  and 2 percent
through  October  2008 and 1.25  percent  thereafter  through  December  2009 in
Canada.  The Settlement  Agreement also provides,  among other things,  that P&G
will grant the Company and/or its affiliates "most favored licensee" status with
respect to patents owned by P&G on the date of the  Settlement  Agreement or for
which an  application  was pending on that date.  In  addition,  the Company has
agreed with P&G that prior to litigating any future patent dispute,  the parties
will engage in good faith negotiations and will consider arbitrating the dispute
before resorting to litigation.

While the Company  believes  that the royalty rates being charged by P&G are the
same royalties that will be paid by the Company's major store brand  competitors
for similar patent rights,  these royalties,  together with royalties to be paid
to K-C described  below,  will have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff  design,  the  Company's  overall raw
material  costs


                                    Page 18
<PAGE>

are expected to increase.  These royalty costs are also expected to be partially
offset by price increases announced by the Company in the fourth quarter of 1998
to the extent such price increases are realized.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have
objected  to the P&G  settlement.  The  Company  intends to  continue  to pursue
approval  of the  P&G  Settlement  by  the  Bankruptcy  Court.  Should  the  P&G
Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by
July 31,  1999,  however,  the License  Agreements  described  above will become
terminable  at P&G's  option.  The  Company  cannot  predict  when,  or if, such
approval will be granted.  See "--Risks and  Uncertainties"  below, and "ITEM 3:
LEGAL PROCEEDINGS: --IN RE PARAGON TRADE BRANDS, INC."

On October 26, 1995,  K-C filed a lawsuit  against the Company in U.S.  District
Court in Dallas,  Texas,  alleging infringement by the Company's products of two
K-C patents  relating  to dual cuffs.  The  lawsuit  sought  injunctive  relief,
royalty  damages,  treble  damages and  attorneys'  fees and costs.  The Company
denied liability under the patents and  counterclaimed  for patent  infringement
and  violation  of antitrust  laws by K-C. In addition,  K-C sued the Company on
another patent issued to K-C which is based upon a further  continuation  of one
of the K-C dual cuff patents asserted in the case.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C an  allowed  unsecured  prepetition  claim of $110  million  and an  allowed
administrative claim of $5 million. As a part of the settlement, the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with respect to the patents  asserted by K-C in the
Texas action.  The patent rights licensed by the Company from K-C will allow the
Company to manufacture a dual cuff diaper  design.  In exchange for these patent
rights,  the Company has agreed to pay K-C annual running royalties on net sales
of the  licensed  products in the U.S.  and Canada  equal to: 2.5 percent of the
first $200 million of net sales of the covered  diaper  products and 1.5 percent
of such net sales in excess of $200  million in each  calendar  year  commencing
January 1999 through November 2004. In addition, the Company has agreed to pay a
minimum  annual  royalty for diaper sales of $5 million,  but amounts due on the
running royalties will be offset against this minimum. The Company will also pay
K-C  running  royalties  of 5 percent  of net  sales of  covered  training  pant
products  for the same  period,  but there is no minimum  royalty  for  training
pants. As part of the settlement, the Company has granted a royalty-free license
to K-C for three  patents  which the  Company in the Texas  action  claimed  K-C
infringed.

While the Company  believes  that,  based on its projected  level of sales,  the
overall effective royalty rate that the Company will pay to K-C is less than the
royalty rate that will be paid by the  Company's  major store brand  competitors
for similar patent rights,  these royalties will,  together with royalties to be
paid to P&G described  above,  have a material  adverse  impact on the Company's
future financial condition and results of operations.  While these royalty costs
are expected to be  partially  offset by  projected  raw  material  cost savings
related to the  conversion  to a dual cuff product,  the  Company's  overall raw
material  costs are expected to increase.  These royalty costs are also expected
to be partially offset by price increases announced by the Company in the fourth
quarter of 1998 to the extent such price increases are realized.

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of  super-absorbent  polymers ("SAP") in
diapers  and  training  pants,  so long as the Company  uses SAP which  exhibits
certain  performance  characteristics  (the "SAP Safe Harbor").  The Company has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased  marketing and selling,  general and administrative  expenses 


                                    Page 19
<PAGE>

("SG&A")  expenditures  in 1999 to address  product  performance  issues.  These
increased  expenditures  are expected to have a material  adverse  impact on the
Company's  financial  position and results of operations in 1999. The Company is
encountering increased product costs due to the increased price and usage of the
new SAP.  While the  Company  is working  diligently  with its SAP  supplier  to
develop  a better  performing  alternative  which is still  within  the SAP Safe
Harbor,  the  Company  cannot  predict  at this  time  whether  or when  such an
alternative  SAP would be available.  The Company  expects that these  increased
product costs will have a material adverse impact on its financial condition and
results of operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted. See "--Risks and Uncertainties."

The Company is unable to predict at this time when it will  emerge from  Chapter
11 protection.  See "Notes 1 and 15 of Notes to Financial  Statements" and "ITEM
3: LEGAL PROCEEDINGS" herein.

The Company operates principally in two segments that are organized based on the
nature of the products  sold:  (i) infant care and (ii)  feminine care and adult
incontinence.  Each operating segment contains closely related products that are
unique to that  particular  segment.  The  results of Changing  Paradigms,  Inc.
("Changing  Paradigms"),  the  Company's  household  cleaners and air  freshener
business that was sold in 1998, and the Company's  international  investments in
joint  ventures  in  Mexico,  Argentina,  Brazil and China are  reported  in the
corporate and other segment.

YEAR ENDED DECEMBER 27, 1998 VS. YEAR ENDED DECEMBER 28, 1997

RESULTS OF OPERATIONS

A net loss of $65.4  million was incurred  during 1998 compared to a net loss of
$212.7 million in 1997. Included in the results for 1998 were accrued settlement
contingencies  of  $78.5  million  representing  the  balance  of the  estimated
settlement  costs  of  P&G's  and  K-C's  claims  in the  Company's  Chapter  11
reorganization  proceeding,  including the settlement of the P&G patent judgment
and the K-C Texas action. See "Notes 1 and 15 of Notes to Financial  Statements"
and "ITEM 3: LEGAL  PROCEEDINGS"  herein.  Also included in the results for 1998
was $6.3  million  of  bankruptcy  costs  and a $3.4  million  asset  impairment
writedown relating to the Company's tampon manufacturing line that was taken out
of  service  in early  1998 and is  currently  held for  sale.  The total of the
settlement  contingency,  bankruptcy  costs and asset  impairment  writedown was
$54.2 million,  net of the effect of income taxes. The results in 1998 were also
negatively  impacted by a reserve of $32.9  million  taken against the Company's
net deferred and other tax-related assets.

Included in the 1997 results was an estimated accrued settlement  contingency of
$200 million for the P&G patent  litigation  judgment and associated  litigation
costs. See "Notes 1 and 15 of Notes to Financial  Statements" and "ITEM 3: LEGAL
PROCEEDINGS"   herein.  Also  included  in  the  results  for  1997  were  asset
impairments and other write-offs totaling $10.6 million related to the write-off
of software and  consulting  costs  related to the  enterprise-wide  information
system installation and discontinuation of the Company's tampon production.  The
total of the loss contingency and asset  impairments was $129.5 million,  net of
the effect of income taxes. The results in 1997 were also negatively impacted by
a reserve of $100.2  million  taken against the Company's net deferred and other
tax-related assets.

Basic  loss per  share in 1998 was  $5.48  compared  to basic  loss per share of
$17.86 in 1997.  Basic earnings per share was $1.52 in 1998 compared to $1.43 in
1997, excluding charges discussed above in both periods and bankruptcy costs and
adjusting for the Company's contractual interest charges in 1998.

Infant  care  operating  loss  totaled  $42.2  million  in 1998  compared  to an
operating  loss of $155.0  million  in 1997.  The $78.5  million  of  settlement
contingencies  in 1998 and the $200.0  million  settlement  contingency  in 1997

                                    Page 20
<PAGE>

discussed above,  materially  impacted infant care operating results.  Excluding
these  contingencies,  infant care operating  profits were $36.3 million in 1998
compared to $45.0 million in 1997.  Reduced  volume and increased  SG&A were the
major factors contributing to this decline.

Feminine  care and adult  incontinence  operating  loss totaled $16.9 million in
1998  compared to an operating  loss of $23.7  million in 1997.  Operating  loss
includes asset impairments related to a tampon manufacturing  operation that was
shut  down in 1998 of $3.4  million  in 1998  and  $4.4  million  in  1997.  The
reduction  of  the  operating   loss  resulted  from   increased   volume,   the
discontinuation  of the  tampon  manufacturing  operation  and  cost  management
initiatives.

The  Company  experienced  greater  than  anticipated  operating  losses  in its
feminine  care and adult  incontinence  businesses  in 1998 and 1997 and expects
these losses to continue  near-term.  The Company has  developed a business plan
that supports the  realization  of its investment in its feminine care and adult
incontinence business. Accordingly, the Company has not recorded any adjustments
in its  financial  statements  relating to the  recoverability  of the operating
assets  of the  feminine  care and adult  incontinence  business  The  Company's
ability to recover its  investment  is dependent  upon a prompt  emergence  from
Chapter 11 and the successful execution of the Company's feminine care and adult
incontinence business plan. The Company cannot predict at this time when it will
emerge from Chapter 11  protection.  The Company  believes  that once it emerges
from Chapter 11 the feminine  care and adult  incontinence  business will see an
increase in sales and improved  results.  The Company cannot  predict,  however,
whether or when such improved results will be realized.

NET SALES

Overall net sales were $535.2 million in 1998, a 4.8 percent  decrease  from the
$562.0 million reported in 1997.

Infant  care net sales  decreased  5.9  percent to $512.8  million  from  $545.2
million in 1997.  Unit sales  decreased 7.5 percent to 3,413 million  diapers in
1998  compared  to 3,689  million  diapers in 1997.  The  decrease  in sales was
primarily due to  uncertainties  related to the Company's  Chapter 11 proceeding
and the temporary  discontinuation  of shipments to a customer during the second
half of the year due to product  design  issues  associated  with a new  product
rollout.  The Company  believes  these product design issues have been resolved.
The Company  resumed  shipments to that  customer in the first  quarter of 1999.
Volume  remained  under pressure from  discounts and  promotional  allowances by
branded  manufacturers  and value segment  competitors and by customer losses to
store  brand  diaper  competitors.  1999  infant care volume and sales price are
expected  to remain  under  pressure  due to product  performance  issues  until
remedied,  continued competitive  initiatives from store brand competitors and a
prolonged Chapter 11 case.

Excluding  the effect of a favorable  product mix,  average sales prices for the
Company's  products  during 1998 were lower  compared to 1997.  The  decrease in
prices was primarily due to the use of multi-packs by the branded  manufacturers
and value  segment  competitors,  competitive  pressure  from store brand diaper
competitors  and price  decreases  in Canada.  The Company  began to implement a
price increase of  approximately  5 percent during the fourth quarter of 1998 in
response to  increases  announced by K-C and P&G. It is difficult to predict the
amount  of the final  realization  of this  price  increase  due to  competitive
factors previously discussed.

Feminine  care and adult  incontinence  sales  increased to $6.6 million in 1998
from $4.3 million in 1997 due to the  initiation  of shipments of product to new
customers.  However,  the uncertainty  caused by the Company's Chapter 11 filing
has significantly  impacted the ability to attract additional sales. The Company
expects this condition to persist until the Company's emergence from Chapter 11.
See "--RISKS AND UNCERTAINTIES."

Corporate  and other net sales  increased  to $15.8  million  in 1998 from $12.5
million in 1997 and relate to Changing  Paradigms,  which was sold in October of
1998.

COST OF SALES

Overall cost of sales in 1998 was $428.6  million  compared to $454.9 million in
1997, a 5.8 percent  decrease.  As a percentage of net sales,  cost of sales was
80.1 percent in 1998 compared to 80.9 percent in 1997.

                                    Page 21
<PAGE>

Infant care costs were  $397.1  million in 1998  compared  to $423.4  million in
1997, a decrease of 6.4 percent.  As a percentage of net sales, infant care cost
of sales  was 77.4  percent  in 1998  compared  to 77.8  percent  in 1997.  This
improvement  was primarily due to lower raw material costs,  improved  operating
efficiencies  and lower overhead costs. The lower costs were partially offset by
the sourcing of products from PMI under a supply contract and charges related to
royalties payable to P&G under a product conversion  agreement.  Costs were also
higher due to the product design costs associated with the Company's  conversion
to a single leg cuff diaper in June of 1998.  Costs will increase  significantly
in 1999 due to the payment of royalties  in  accordance  with various  licensing
agreements included in the settlements of certain patent litigation with P&G and
K-C. See "ITEM 3: LEGAL PROCEEDINGS" and "Risks and Uncertainties."

Infant care raw  material  costs,  primarily  pulp and SAP,  were at lower price
levels in 1998 compared to 1997.  Raw material  prices,  primarily pulp and SAP,
are  expected  to  increase  in 1999.  Product  costs are  expected  to increase
significantly during 1999 due to the increased price and utilization of SAP, the
introduction of an improved Ultra diaper,  which incorporates stretch tabs and a
hook and loop  closure  system,  and rising  fluff pulp  prices.  See "Risks and
Uncertainties."

Infant care labor costs were lower during 1998 compared to 1997. The lower costs
reflect  increased  manufacturing  efficiencies  including  the use of automated
packaging.  Infant care  overhead  costs were lower during 1998 compared to 1997
due to cost management efforts. Labor costs are expected to increase during 1999
due to inefficiencies related to new product designs and product introductions.

Infant  care  depreciation  costs were $25.8  million in 1998  compared to $29.1
million in 1997.

Feminine  care and adult  incontinence  cost of sales were $18.6 million in 1998
compared to $20.4 million in 1997, a decrease of 4.1 percent. As a percentage of
net sales,  cost of sales was 281.8 percent in 1998 compared to 451.2 percent in
1997.  Increased  volume,  lower labor and overhead  costs  resulting  from cost
management initiatives and the shut down of tampon-related  production equipment
were  offset by an increase in  depreciation  to $4.7  million in 1998 from $2.3
million in 1997. Feminine care and adult incontinence cost of sales are expected
to remain  greater  than net sales until  volume is  significantly  increased to
absorb existing manufacturing capacity.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

SG&A expenses were $78.4 million in 1998 compared to $76.3 million in 1997. As a
percentage  of net sales,  these  expenses were 14.6 percent in 1998 compared to
13.6  percent in 1997.  The increase in costs is  primarily  attributable  to an
increase in trade  merchandising  expenses,  incentive-based  accruals,  selling
expenses and  information  system costs related to the Company's new information
system  installation,  which  is part of the  Company's  Year  2000  remediation
project  discussed  below.  These increased costs were partially offset by lower
legal expenses,  excluding  bankruptcy  costs, and packaging  artwork and design
costs. It is anticipated that SG&A expenses will increase  significantly in 1999
due to increased  marketing  expenditures and packaging costs due to new product
introductions.

RESEARCH AND DEVELOPMENT

Research and  development  expenses  were $4.2 million in 1998  compared to $5.1
million in 1997.  The decrease was  primarily  due to a reduction of infant care
product development and testing in the second half of 1998.

SETTLEMENT CONTINGENCIES

The  settlement  contingencies  of  $78.5  million  recorded  in 1998  represent
additional  accruals for the balance of the estimated  settlement costs of P&G's
and  K-C's  claims  in  the  Company's  Chapter  11  reorganization  proceeding,
including the  settlement  of the P&G patent  judgment and the K-C Texas action.
The settlement contingency of $200 million in 1997 represents the accrual of the
estimated liability and associated litigation costs from the adverse judgment in
the P&G patent litigation. See "Notes 1 and 15 of Notes to Financial Statements"
and "ITEM 3: LEGAL PROCEEDINGS" herein.

                                    Page 22
<PAGE>

ASSET IMPAIRMENTS

Asset  impairments  were $3.4 million in 1998  compared to $9.4 million in 1997.
The 1998 asset  impairment  related  to the  Company's  feminine  care and adult
incontinence  business tampon  manufacturing line which was removed from service
in early  1998  and is  currently  held for  sale.  The 1997  asset  impairments
included a $5.0 million  write-off of software and associated  consulting  costs
related to the Company's enterprise-wide information system installation,  which
was charged to the  corporate  and other  segment.  The write-off was due to the
inability  of the  software  to  perform  as  represented  during  the  software
selection process.  The Company is currently  evaluating its options,  including
legal action, to recover the costs of the software and consulting. Also included
in 1997 was a write-down  of $4.4 million for the shut down of the feminine care
and  adult  incontinence  business'  tampon-related   production  equipment.  In
conjunction with the shut down of the tampon manufacturing  operation write-offs
of $.9  million  were  taken for raw  material,  finished  goods and  spare-part
inventories which were charged to cost of sales.

INTEREST EXPENSE

Interest  expense was $.5 million in 1998 compared to $4.7 million in 1997.  The
decrease  resulted from the suspension of interest on the Company's  prepetition
credit facilities due to the Chapter 11 filing.  There were no direct borrowings
under the DIP Credit Facility during 1998. 1997 included interest on approximate
average  borrowings  of $80.2  million under the  prepetition  revolving  credit
facility and lines of credit.

EQUITY IN EARNINGS OF UNCONSOLIDATED SUBSIDIARIES

The equity in earnings of unconsolidated subsidiaries,  which is included in the
corporate and other  segment,  was $4.1 million in 1998 compared to $1.0 million
in 1997. The increase  primarily  reflects improved operating results of PMI and
earnings of Stronger Corporation S.A.

DIVIDEND INCOME

Dividend  income of $.9 million was recorded in 1998 compared to $1.1 million in
1997. The dividend  represented a distribution  from Mabesa,  an  unconsolidated
subsidiary accounted for using the cost method and included in the corporate and
other segment.

BANKRUPTCY COSTS

Bankruptcy  costs were $6.3  million  during  1998.  These costs were  primarily
related to  professional  fees and are  expected to  continue at similar  levels
until the Company emerges from Chapter 11 protection. The Company cannot predict
at this time when it will emerge from  Chapter 11  protection.  See "--RISKS AND
UNCERTAINTIES."

INCOME TAXES

Income tax expense was $8.1 million in 1998 as the Company recorded a reserve of
$32.9 million against its net deferred and other tax-related assets. The reserve
is necessary as the utilization of the Company's loss carryforwards is dependent
upon  sufficient  future  taxable income to offset the loss  carryforwards.  See
"FUTURE REALIZATION OF NET DEFERRED TAX ASSET."

YEAR ENDED DECEMBER 28, 1997 VS. YEAR ENDED DECEMBER 29, 1996

RESULTS OF OPERATIONS

A net loss of $212.7 million was incurred during 1997 compared with net earnings
of $21.1  million  in 1996.  Included  in the  results  for 1997 was an  accrued
settlement  contingency of $200 million for the P&G patent  litigation  judgment
and  associated  litigation  costs.  See  "Notes 1 and 15 of Notes to  Financial
Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein. Also included in the results
for 1997 were asset  impairments  and other  write-offs  totaling  $10.6 million
related  to the  write-off  of  software  and  consulting  costs  related to the
enterprise-wide  information  system  installation  and  discontinuation  of the
Company's tampon production.  The 


                                    Page 23
<PAGE>

total of the settlement  contingency  and asset  impairments was $129.5 million,
net of the effect of income  taxes.  The  results  in 1997 were also  negatively
impacted by a reserve of $100.2 million taken against the Company's net deferred
and other tax-related assets.

Included in the results in 1996 were charges of $10.6 million, net of the effect
of income taxes,  associated  with  integrating the acquisition of Pope & Talbot
and costs to relocate the corporate  headquarters to Atlanta.  Excluding charges
discussed here and in the preceding  paragraph,  net earnings in 1997 were $17.0
million  compared  to $31.7  million in 1996.  This  decrease in profits in 1997
compared to 1996 was  primarily  due to continued  price  pressure in the infant
care  business,  operating  losses  associated  with the feminine care and adult
incontinence business, sourcing of products from PMI under a supply contract and
legal costs  associated  with patent  litigation  with P&G and K-C. See "ITEM 3:
LEGAL  PROCEEDINGS."  These  negative  impacts  were  partially  offset by lower
overall raw  material  prices,  lower  trade  merchandising  expenses  and lower
manufacturing overhead in the infant care business.

Basic loss per share in 1997 was $17.86  compared to basic earnings per share of
$1.76 in 1996.  Basic  earnings per share was $1.43 in 1997 compared to $2.64 in
1996, excluding the charges discussed above for both periods.

Infant  care  operating  loss  totaled  $155.0  million in 1997  compared  to an
operating  profit  of $52.8  million  in 1996.  The  $200.0  million  settlement
contingency in 1997 discussed  above and $8.1 million of costs  associated  with
the integration of the Pope & Talbot  acquisition in 1996,  materially  impacted
infant  care  operating  results.   Excluding  the  settlement  contingency  and
integration costs,  infant care operating profits were $45.0 million compared to
$60.9 million in 1996. Reduced selling price and volume and higher product costs
were the major factors contributing to this decline.

Feminine  care and adult  incontinence  operating  loss totaled $23.7 million in
1997  compared to $8.0 million in 1996.  1997  operating  loss includes an asset
impairment and other charges of $4.4 million related to the  discontinuation  of
the tampon  manufacturing  operation.  1997 was the first full year of operation
for the feminine care and adult incontinence business.

NET SALES

Overall net sales were $562.0 million in 1997, a 3.4 percent  decrease  from the
$581.9 million reported in 1996.

Infant  care net sales  decreased  5.0  percent  to  $545.2 in 1997 from  $574.3
million in 1996. Infant care unit sales decreased 1.9 percent from 3,689 million
diapers in 1997 compared to 3,761 million diapers in 1996. Infant care volume in
the first  half of 1997 was  negatively  impacted  by  increased  discounts  and
promotional   allowances  by  the  branded   manufacturers   and  value  segment
competitors,  especially  the use of  multi-packs.  Infant  care volume was also
further negatively impacted during the same period by product improvements added
by the branded manufacturers.  Infant care volume during the second half of 1997
was positively  impacted by the rollout of the Company's  breathable baby diaper
product which increased the  competitiveness of the Company's  products.  Infant
care volume, however, was negatively impacted during the second half of the year
by the loss of a major customer in Canada.

Excluding the effect of a more favorable  product mix, average infant care sales
prices during 1997 decreased approximately 5.0 percent compared to 1996, despite
price increases  associated with reduced count packages on some of the Company's
products.  The decrease in prices was primarily  due to the increased  discounts
and  promotional  allowances  discussed  above,  the use of  multi-packs  by the
branded  manufacturers and value segment  competitors and the existence of a new
competitor to the store brand baby diaper business.

Feminine care and adult  incontinence  sales  increased to $4.3 million in 1997.
Sales were negligible in 1996.

Corporate  and  other net sales  increased  to $12.5  million  in 1997 from $7.1
million  in 1996 and relate to Changing Paradigms.

                                    Page 24
<PAGE>

COST OF SALES

Overall cost of sales in 1997 was $454.9  million  compared to $449.9 million in
1996, a 1.1 percent  increase.  As a percentage of net sales,  cost of sales was
80.9 percent in 1997 compared to 77.3 percent in 1996.

Infant care cost of sales was $423.4  million in 1997 compared to $438.7 million
in 1996.  As a  percentage  of net  sales,  infant  care  cost of sales was 77.8
percent in 1997 compared to 76.4 percent in 1996.  1996 included $5.4 million in
charges for costs  primarily  associated with the integration of the acquisition
of Pope & Talbot into the Company's  existing  business.  As a percentage of net
sales,  excluding  such  charges,  infant care cost of sales was 75.5 percent in
1996. Costs were higher in 1997 compared to 1996 due to the sourcing of products
from PMI under a supply  contract,  a higher cost product mix and higher product
design costs associated with the breathable baby diaper product introduction.

These  higher  costs were  partially  offset by lower  overall raw  material and
packaging costs. Pulp prices were approximately 7 percent lower in 1997 compared
to 1996.  Packaging costs,  including bags and corrugated boxes, were also lower
in 1997 compared to 1996.  Other raw material  prices were  generally at similar
price levels in 1997  compared to 1996,  except for those  materials  associated
with the higher product design costs  associated with the breathable baby diaper
product.

Infant care labor costs were lower in 1997 compared to 1996. The higher costs of
inefficiencies related to the new product rollouts during the first half of 1997
were more than offset by improved  operating  results  during the second half of
the year.  Infant care overhead costs,  excluding the charges  discussed  below,
were lower  during 1997  compared to 1996 due to the closure  during 1996 of the
manufacturing  facilities  acquired  from  Pope &  Talbot  and  cost  management
efforts.  During  1996,  $2.9  million of charges  were  incurred to support the
integration of the acquisition of Pope & Talbot.

Infant care  depreciation  costs,  excluding charges discussed below, were $29.1
million in 1997 compared to $36.5 million in 1996. The decrease is partially due
to  the  closure  during  1996  of  the  acquired  Pope  &  Talbot   facilities.
Depreciation  costs  were  higher  in  1996  due  to  accelerated   depreciation
attributable to obsolescence  caused by product  innovations.  During 1996, $1.6
million of charges were incurred due to the accelerated depreciation of existing
infant care equipment that was to be replaced by equipment  acquired from Pope &
Talbot.

Feminine  care and adult  incontinence  cost of sales was $20.4  million in 1997
compared to $4.7 million in 1996.  Operating  inefficiencies due to the start-up
nature of this operation resulted in a cost of sales  significantly in excess of
net sales in 1997 and 1996.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

SG&A expenses were $76.3 million in 1997 compared to $92.2 million in 1996. As a
percentage  of net sales,  these  expenses were 13.6 percent in 1997 compared to
15.8 percent in 1996.  Included in 1996 were charges of $11.7 million,  of which
$9.0  million  related to the  corporate  headquarters  relocation  to  Atlanta,
including  severance,  outplacement  and relocation  expenses.  The charges also
included $2.7 million in costs  associated  with the  integration  of the Pope &
Talbot acquisition.

Excluding the charges  discussed above, SG&A expenses were $76.3 million in 1997
compared to $80.5 million in 1996. As a percentage of net sales, these expenses,
excluding  the charges,  were 13.6  percent in 1997  compared to 13.8 percent in
1996.  The decrease in costs was primarily  attributable  to a decrease in trade
merchandising  expenses,  lower incentive-based  compensation accruals and lower
bad debt expenses. These decreases were partially offset by an increase in legal
expenses,  packaging artwork and design and information  system costs. The lower
trade   merchandising   expenses  were  primarily   related  to  a  decrease  in
coupon-related expenses.

The increase in legal expenses was related to the P&G and K-C patent litigation.
See "ITEM 3: LEGAL  PROCEEDINGS."  Information  system costs were higher in 1997
compared to 1996.  Packaging artwork and design costs in infant care were higher
during  1997  compared  to 1996 as a result of product  rollouts  and changes 


                                    Page 25
<PAGE>

in package counts.  Lower  incentive-based  compensation  accruals resulted from
lower operating results for 1997 compared to 1996.

RESEARCH AND DEVELOPMENT

Research and  development  expenses  were $5.1 million in 1997  compared to $4.2
million in 1996. The increase was primarily  attributable to a general  increase
in infant care product  development  activity and  increased  feminine  care and
adult incontinence business activity.

DIVIDEND INCOME

Dividend income of $1.1 million was recorded in 1997. The dividend represented a
distribution from Mabesa, an unconsolidated  subsidiary  accounted for using the
cost method, and is included in the corporate and other segment.

SETTLEMENT CONTINGENCY

The settlement  contingencies  of $200 million in 1997 represents the accrual of
the  estimated  liability  and  associated  litigation  costs  from the  adverse
judgment in the P&G patent litigation. See "Notes 1 and 15 of Notes to Financial
Statements" and "ITEM 3: LEGAL PROCEEDINGS" herein.

ASSET IMPAIRMENTS

Asset  impairments were $9.4 million in 1997. There were no asset impairments in
1996. The 1997 asset  impairments  included a $5.0 million write-off of software
and  associated  consulting  costs  related  to  the  Company's  enterprise-wide
information  system  installation,  which was charged to the corporate and other
segment.  The  write-off  was due to the inability of the software to perform as
represented  during the  software  selection  process.  The Company is currently
evaluating  its options,  including  legal  action,  to recover the costs of the
software and consulting.  Also included in 1997 was a write-down of $4.4 million
for  the  shut  down of the  feminine  care  and  adult  incontinence  business'
tampon-related  production  equipment.  Also  included  in the shut  down of the
tampon manufacturing  operation were write-offs of $.9 million for raw material,
finished goods and spare-part inventories which were charged to cost of sales.

INTEREST EXPENSE

Interest  expense was $4.7 million in 1997 compared to $2.9 million in 1996. The
increase resulted from higher average borrowings during 1997.

OTHER INCOME

The corporate and other segment reported income of $1.7 million in 1997 compared
to $.6 million in 1996. The increase  reflects higher interest income from loans
to PMI, an unconsolidated subsidiary accounted for on the equity method.

INCOME TAXES

Income tax expense was $27.9  million in 1997 as the Company  recorded a reserve
of $100.2 million  against its net deferred and other  tax-related  assets.  The
reserve is necessary as the utilization of the Company's loss  carryforwards  is
dependent   upon   sufficient   future   taxable   income  to  offset  the  loss
carryforwards. See "FUTURE REALIZATION OF NET DEFERRED TAX ASSET."

LIQUIDITY AND CAPITAL RESOURCES

During 1998,  cash flow from earnings and noncash  charges to earnings was $60.7
million compared to $54.1 million in 1997. Cash flow was negatively  impacted by
reduced infant care operating profits and continues to be negatively impacted by
operating losses in the feminine care and adult incontinence  business.  Working
capital,  exclusive of cash, short-term  borrowings,  current deferred taxes and
the  settlement  contingencies  decreased  $6.1  million.  1998  cash  flow


                                    Page 26
<PAGE>

was  positively  impacted  by an  increase  of  approximately  $37.6  million in
postpetition  accounts payable and checks issued but not cleared.  Cash flow was
also  positively  impacted by a $6.8  million  increase in accrued  liabilities,
primarily related to incentive-based  compensation accruals.  Cash flow has been
negatively impacted by a $16.0 million increase in receivables  primarily due to
an  electronic  billing  issue  related  to a  few  large  customers  which  has
subsequently been resolved.  Cash was also used by an increase in finished goods
and prepaid expenses,  primarily prepaid insurance and deposits to suppliers due
to the bankruptcy  proceedings.  The Company expects the feminine care and adult
incontinence  business to continue to generate  operating losses and to use cash
throughout 1999.

The cash  produced  from  operations  supported  capital  expenditures  of $37.3
million  and  $55.0  million  in 1998  and  1997,  respectively.  These  capital
expenditures  include  approximately  $9.0  million and $5.6 million in 1998 and
1997,  respectively,  of computer  software and consulting  costs related to the
installation of a new business  information system, which is a primary component
of the Company's Year 2000 remediation efforts discussed below. Capital spending
is expected to be approximately $46.0 million in 1999, which the Company expects
will  be  funded  through  a  combination  of  internally-generated   funds  and
borrowings under the DIP Credit Facility.

Cash produced from operations  supported the initial  investment of $4.0 million
in the Company's  Goodbaby joint venture in China and  additional  consideration
payments of $2.8  million to Mabesa and $.6  million to Serenity  based on their
previous year's performance.

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

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

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

The Company may utilize,  in accordance with certain  covenants,  its DIP Credit
Facility for continued investments in its foreign  subsidiaries.  The DIP Credit
Facility, in combination with  internally-generated  funds, is anticipated to be
adequate  to  finance  these   investments   and  the  Company's   1999  capital
expenditures.

At December 27, 1998, there were no outstanding  direct borrowings under the DIP
Credit  Facility.  The Company had an  aggregate  of $1.3  million in letters of
credit issued under the DIP Credit Facility at December 27, 1998. The DIP Credit
Facility contains customary covenants. The Company for a period of time has been
unable to fully comply with certain  reporting  requirements  of such covenants.
The Company has obtained  waivers with 


                                    Page 27
<PAGE>

respect to these events of default which are effective through May 10, 1999. The
Company  believes that it will be in compliance with the reporting  requirements
of the DIP Credit  Facility by May 10, 1999.  See "Note 12 of Notes to Financial
Statements."

At December 28, 1997,  the Company  maintained a $150 million  revolving  credit
facility with a group of nine financial  institutions available through February
2001. At December 28, 1997,  borrowings  under this credit facility  totaled $70
million.  The  Company  also had  access  to  short-term  lines of  credit on an
uncommitted  basis with several major banks.  At December 28, 1997,  the Company
had approximately  $50 million in uncommitted lines of credit.  Borrowings under
these lines of credit totaled $12.8 million at December 28, 1997. As a result of
the Chapter 11 filing,  the Company is  prohibited  from paying any  prepetition
liabilities without Bankruptcy Court approval. The Chapter 11 filing resulted in
a default  under the Company's  prepetition  revolving  credit  facility and its
borrowings under uncommitted lines of credit. See "Note 12 of Notes to Financial
Statements."

FUTURE REALIZATION OF NET DEFERRED TAX ASSET

The  Company  accounts  for income  taxes  based on the  liability  method  and,
accordingly, deferred income taxes are provided to reflect temporary differences
between financial and tax reporting.  Significant  components of deferred income
taxes include temporary  differences due to goodwill ($7.2 million) and reserves
not currently  deductible  ($113.5 million).  To realize the full benefit of the
deferred tax asset, the Company needs to generate  approximately  $343.0 million
in future  taxable  income  before  considering  the  availability  of carryback
periods,  if any. The Company  currently has fully reserved its net deferred tax
asset of $131.9 million. See "--Income Taxes."

YEAR 2000

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

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

THE COMPANY'S STATE OF READINESS

Most of the Year 2000 issues arising with respect to the Business Systems of the
Company have been addressed by replacement of the majority of those systems with
SAP R/3 enterprise resource planning software.  The SAP software was implemented
and operating at the Company's  corporate  headquarters  and in its U.S.  infant
care plants in early November of 1998 and is warranted to be Year 2000 compliant
by its manufacturer.  The SAP implementation should help significantly  minimize
any Year 2000 related  disruptions for approximately 80 percent of the Company's
Business  Systems  at  those  locations.  The  Company  estimates  that  the SAP
implementation  and its  other  Year 2000  efforts  thus far have  addressed  75
percent of the critical Year 2000 exposures related to its Business Systems as a
whole.  The remaining  systems are being  addressed and are expected to be fully
assessed,  remediated or replaced,  tested and  implemented  prior to the fourth
quarter of 1999. With respect to Business  Systems that will not be addressed by
the overall SAP  implementation,  the Company is  currently  addressing  certain
issues with certain of its desktop  computer  operating  systems.  Approximately
half of the desktop  computers used by the Company have currently been addressed
and the Company  expects to complete the remaining half by the end of the second
quarter of 1999.  Overall,  the  Company  currently  anticipates  completion  of
remediation  and testing of all of its critical  Business  Systems by the end of
the third quarter of 1999.

                                    Page 28
<PAGE>

The Company has engaged the  GartnerGroup  to evaluate and analyze the Company's
overall Year 2000 preparedness. The Company has received formal reports from the
GartnerGroup  and has initiated  remediation/replacement  procedures for certain
processes and systems identified in such reports.

The Company has also internally evaluated certain of its Infrastructure  Systems
for Year 2000 related problems. These systems include the manufacturing capacity
for the Company's  products and are therefore  critical to the Company's ability
to produce products and realize revenue from sales. The  manufacturing  capacity
of the  Company  includes  any number of  automated  systems  which may  include
embedded chips that are difficult to identify and remediate in the event of Year
2000 related  problems.  While difficult to assess,  evaluation of these systems
currently  indicates  that the Company  should not  encounter  Year 2000 related
problems that would  significantly  affect the Company's  ability to manufacture
products.  As part of the evaluation process,  the Company has surveyed critical
machinery,  equipment and systems suppliers, and significant product and service
vendors for its material real estate facilities and security systems.  Responses
to such  surveys have not  indicated  any  problems  which,  taken on their own,
should  materially   adversely  affect  the  Company's  ability  to  manufacture
products.  The Company is continuing to follow up with suppliers and vendors who
have not yet  responded  to the  survey  and has also  addressed  Infrastructure
Systems in its contingency planning process.

Year 2000 problems with respect to certain  material  customers that prevent the
taking or filling of orders  for  products  or  interfere  with the  collections
process could have a material impact on the Company's revenues. Approximately 80
percent of the Company's  orders for products are delivered via electronic  data
interchange  facilities  ("EDI").  The SAP implementation is designed to address
Year 2000 related issues for Company  systems  required for these EDI exchanges,
but the Company is not able to control the EDI facilities of its customers.  The
Company  surveyed its customer base as to their EDI facilities and their overall
Year 2000 state of  preparedness  during the fourth quarter of 1998. The Company
has received  survey  responses from customers who, in the aggregate,  represent
more than 90 percent of its 1998  revenues.  The Company has also conducted Year
2000 testing of EDI with  approximately 60 percent of those  customers.  Neither
the survey  results  nor the  testing  revealed  significant  Year 2000  related
problems  which would  materially  impair the  Company's  ability to conduct EDI
exchanges with its  customers,  although such testing should not be considered a
conclusive  indicator  of how EDI  exchanges  will  perform in the  future.  The
Company is attempting to obtain survey  responses from those material  customers
who have not yet responded  and conduct  testing with those  remaining  material
customers  with whom it has not yet tested prior to the end of the third quarter
of 1999.  The Company has also prepared an inventory and surveyed those vendors,
service providers and raw materials suppliers that may have a material impact on
the Company in the event of Year 2000 problems.  Approximately 60 percent of the
suppliers  surveyed have responded and have not indicated any  anticipated  Year
2000 problems which, taken on their own, should  significantly  adversely affect
operations critical to the Company's ability to realize revenues. The Company is
continuing to follow up with  suppliers who have not yet responded to the survey
and is otherwise addressing related issues in its contingency planning process.

Contingency  planning for  Business  Systems,  Infrastructure  Systems and Third
Party Dependencies was substantially completed during the first quarter of 1999.
This process  attempted to address  critical Year 2000 issues presently known to
the Company and other currently unanticipated (but reasonably possible) internal
and  external  Year 2000 related  events that may have a material  impact on the
Company's ability to conduct its operations.  The Company expects to continue to
revise these contingency plans as circumstances dictate during 1999.

COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES

The total costs  associated  with  required  modifications  to address Year 2000
related  issues for the Company is  expected  to be  material  to the  Company's
financial position.  The cost of the project through December 27, 1998 was $18.6
million, all of which was related to the SAP implementation.  It is not possible
to identify what portion of the total SAP cost is  attributable to the Year 2000
remediation.  The Company planned to implement an enterprise  resource  planning
system for its Business Systems,  regardless of Year 2000 issues with respect to
its  former  Business  Systems.  The  future  cost of the Year 2000  project  is
estimated to be approximately $5.0 million.  All of the costs are expected to be
funded through operating cash flow and/or bank borrowings.

                                    Page 29
<PAGE>

RISKS PRESENTED BY YEAR 2000 ISSUES

The Year 2000 presents a number of risks and uncertainties that could affect the
Company.  These  include,  but are not  limited  to,  failure of the  Company to
identify and address  material issues  associated with non-SAP related  Business
Systems or with its Infrastructure Systems, failure or inability of customers to
place orders for Year 2000 related  reasons,  failure of necessary raw materials
manufacturers  to deliver their  products to the Company in a timely fashion and
the inability of either the Company to collect its  receivables or its customers
to process  payments for goods.  Survey  responses  submitted to the Company may
also be inaccurate or incomplete;  however,  the Company currently believes that
the SAP implementation and completion of the Year 2000 project as scheduled will
reduce the incidence and severity of Year 2000 related  disturbances  in systems
that are within  the  control  of the  Company.  The  Company  also has  certain
financial  investments  in foreign joint  ventures.  If the  operations of these
joint ventures were  significantly  affected by Year 2000 related  issues,  such
could have a material adverse impact on the Company's  results of operations and
its financial  position.  Information  currently known to the Company  indicates
that  internal  operations  of these  joint  ventures  should not be  materially
adversely  affected  by Year  2000  related  issues;  however,  the  Company  is
attempting to further confirm this information.

Problems in public  utilities and  infrastructure  systems such as power supply,
telecommunications,  transportation and other possible  disturbances  related to
the Year 2000 in the United  States and  abroad  may have  unexpected,  material
impacts  on the  Company's  ability  to do  business  in the  normal  course and
therefore may also have a material  adverse  impact on the Company's  results of
operations and financial  position.  Public  infrastructure  and utility systems
outside of the United States are widely reported to be less adequately  prepared
than similar systems in the United States.

Any combination of the foregoing risks or other adverse Year 2000 related events
which would not in and of themselves constitute a material adverse event may, in
the  aggregate,  materially  and  adversely  affect  the  Company's  results  of
operations, liquidity and overall financial position.

All  statements  made herein  regarding the Company's Year 2000 efforts are Year
2000  Readiness  Disclosures  made  pursuant  to the Year 2000  Information  and
Readiness  Disclosure  Act and, to the extent  applicable,  are  entitled to the
protections of such act.

RISKS AND UNCERTAINTIES

INCREASED COSTS. As a part of the License  Agreements entered into in connection
with the  Company's  settlements  with  P&G and  K-C,  the  Company  will  incur
significant added costs in the form of running royalties payable to both parties
for sales of the licensed  diaper and training pant products.  While the Company
believes that the royalties being charged by P&G and K-C under their  respective
License Agreements are approximately the same royalties that will be paid by the
Company's major store brand competitors for similar patent rights, the royalties
will have a material adverse impact on the Company's future financial  condition
and  results  of  operations.  While  these  royalty  costs are  expected  to be
partially  offset  by  projected  raw  material  cost  savings  related  to  the
conversion to a dual cuff product,  the Company's overall raw material costs are
expected to increase.  These royalties are also expected to be partially  offset
by the  price  increases  discussed  below  to the  extent  such  increases  are
realized.

In addition,  as a part of the License Agreement entered into in connection with
the K-C  Settlement  Agreement,  the  Company had to change to a new SAP for its
diapers and training pants which exhibits certain  performance  characteristics.
The Company has experienced  product  performance  issues which it believes have
impacted volume for the first quarter of 1999. As a result,  the Company expects
that it will incur increased  marketing and SG&A expenditures in 1999 to address
product performance issues. These increased  expenditures are expected to have a
material  adverse  impact on the  Company's  financial  position  and results of
operations in 1999. The Company is encountering  increased  product costs due to
the  increased  price and usage of the new SAP.  While the  Company  is  working
diligently  with its SAP suppliers to develop a better  performing  alternative,
the Company cannot predict at this time whether or when such an alternative  SAP
will be available.  The Company expects that these increased  product costs will
have a  material  adverse  impact on its  financial  condition  and  results  of
operations for at least 1999 and potentially beyond.

                                    Page 30
<PAGE>

REORGANIZATION. The ability of the Company to effect a successful reorganization
will depend, in significant part, upon the Company's ability to formulate a plan
of  reorganization  that is approved by the Bankruptcy Court. The Company cannot
predict at this time the effect of the material  adverse  impact  related to the
increased costs described above on the Company's enterprise valuation and on the
Company's  ability to timely  formulate  a plan of  reorganization.  The Company
believes,  however,  that it may be  impossible  to  satisfy  in full all of the
claims against the Company. Investment in securities of, and claims against, the
Company, therefore, should be regarded as highly speculative. As a result of the
Chapter  11  filing,  the  Company  has  incurred  and  will  continue  to incur
significant costs for professional fees as the reorganization plan is developed.
The  Company  is  also  required  to pay  certain  expenses  of the  Committees,
including professional fees, to the extent allowed by the Bankruptcy Court.

The Company is unable to  predict at this time when it will emerge from  Chapter
11  protection.  See "ITEM 1: BUSINESS:  REORGANIZATION CASE."

TERMINATION OF LICENSE  AGREEMENTS.  The License Agreements with each of P&G and
K-C provide  that if the related  Settlement  Agreements  are not  approved,  as
specified  in each  respective  agreement,  by July 31, 1999 and August 1, 1999,
respectively,  the P&G License Agreements will become terminable at P&G's option
and the K-C License Agreement will terminate  automatically.  If the P&G and K-C
License Agreements are terminated because the respective  Settlement  Agreements
are not approved in a timely  manner,  the Company could be faced with having to
convert  to a diaper  design  other  than the dual cuff  design  covered  by the
licenses.  At this time, the Company's only viable alternative product design is
the  single  cuff  product  which is the  subject  of P&G's  Contempt  Motion in
Delaware.  While the  Company  intends to  vigorously  pursue  approval  of both
settlements,  it cannot predict when, or if, such approval will be granted.  See
"ITEM 3: LEGAL PROCEEDINGS."

PRICING.  The  Company  announced  in the  fourth  quarter of 1998 that it would
implement  a price  increase  of 5  percent.  A  significant  part of this price
increase is required to offset the  increased  costs of certain of the Company's
infant care product  designs.  Additional  price  increases  are needed to fully
offset the added royalty cost to be incurred by the Company  pursuant to the P&G
and K-C settlements  described above.  Should the Company not be able to realize
these price  increases,  its margins are  expected to continue to be  negatively
impacted.

REALIZATION  OF  INVESTMENT IN FEMININE  CARE AND ADULT  INCONTINENCE  BUSINESS.
Given the slow start up of the feminine  care and adult  incontinence  business,
which  was  exacerbated  by the  Company's  Chapter  11  filing,  and  given the
resulting feminine care and adult incontinence  losses, the Company's ability to
recover its  investment  in such  business is highly  uncertain.  The  Company's
ability to recover its  investment  is dependent  upon a prompt  emergence  from
Chapter 11 and the successful execution of the Company's feminine care and adult
incontinence business plan. The Company believes that the P&G and K-C Settlement
Agreements  will provide the  cornerstone for what it intends to be a consensual
plan of reorganization.  The Company cannot predict at this time, however,  when
it will emerge from Chapter 11  protection.  The Company  believes  that once it
emerges from Chapter 11 the feminine care and adult  incontinence  business will
see an increase in sales and  improved  results.  The  Company  cannot  predict,
however, whether or when such improved results will be realized.

MARKET FOR THE COMPANY'S COMMON STOCK.  During 1998, the Company was notified by
the New  York  Stock  Exchange  ("NYSE")  that as a result  of the $200  million
settlement  contingency  and the  Company's  net loss in 1997,  certain  minimum
listing  requirements had not been  maintained.  After a review of the Company's
business  and  prospects,  the NYSE agreed to  continue  the  Company's  listing
subject to future  developments.  There can be no assurances  that the NYSE will
continue to list the Company's stock.

BRANDED PRODUCT  INNOVATIONS.  Because of the emphasis on product innovations in
the disposable diaper, feminine care and adult incontinence markets, patents and
other  intellectual  property rights are an important  competitive  factor.  The
national branded  manufacturers  have sought to vigorously  enforce their patent
rights.  Patents held by the national branded manufacturers could severely limit
the Company's ability to keep up with branded product innovations by prohibiting
the Company from introducing products with comparable features. P&G and K-C have
also heavily  promoted diapers in the multi-pack  configuration.  These packages
offer a lower unit price to the retailer and  consumer.  It is possible that the
Company may continue to realize lower  selling  prices and/or lower volumes as a
result of these initiatives.

                                    Page 31
<PAGE>

FORWARD-LOOKING STATEMENTS

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

NEW ACCOUNTING STANDARDS

The  Financial   Accounting  Standards  Board  has  issued  Statement  No.  133,
Accounting  for Derivative  Instruments  and Hedging  Activities,  which must be
adopted by the Company's fiscal year 2000. This statement establishes accounting
and  reporting   standards  for  derivative   instruments  -  including  certain
derivative instruments embedded in other contracts - and for hedging activities.
Adoption of this  statement  is not  expected  to have a material  impact on the
Company's financial statements.

In March 1998, the American Institute of Certified Public Accountants  ("AICPA")
issued a new Statement of Position 98-1,  "Accounting  for the Costs of Computer
Software  Developed  or Obtained  for  Internal  Use." This  statement  requires
capitalization  of certain costs of internal-use  software.  The Company adopted
this  statement  in the  first  fiscal  quarter  of 1999,  and it did not have a
material impact on the financial statements.

In April 1998, the AICPA issued a new Statement of Position 98-5,  "Reporting on
the Costs of Start-up  Activities."  This  statement  requires that the costs of
start-up  activities and  organizational  costs be expensed as incurred.  Any of
these costs previously  capitalized by a company must be written off in the year
of adoption.  The Company  adopted this statement in the first fiscal quarter of
1999, and it did not have a material impact on the financial statements.

INFLATION

Inflation  has  not  been a  significant  factor  in the  Company's  results  of
operations  in recent  years due to the modest  rate of price  increases  in the
United States and Canada.


ITEM 7A:       QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company's market  risk-sensitive  instruments and foreign currency  exchange
rate risks do not subject the Company to material market risk exposures.




                                    Page 32
<PAGE>




ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
                  PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES:

                                                                            PAGE

Responsibility for Financial Reporting                                        34

Report of Independent Public Accountants                                      35

Consolidated Earnings (Loss) Statements for the three years in
        the period ended December 27, 1998                                    37

Consolidated Balance Sheets as of December 27,1998 and
        December 28, 1997                                                     38

Consolidated Statements of Cash Flows for the three years in
        the period ended December 27, 1998                                    39

Consolidated Statements of Comprehensive Income for the three years in
        the period ended December 27, 1998                                    40

Consolidated Statements of Changes in Shareholders' Equity
        for the three years in the period ended December 27, 1998             41

Notes to Financial Statements                                                 42

Financial Statement Schedule

        Schedule II - Valuation and Qualifying Accounts                       68






                                    Page 33
<PAGE>



                     RESPONSIBILITY FOR FINANCIAL REPORTING


Management is  responsible  for the  preparation  of the Company's  consolidated
financial  statements  appearing in this Annual Report. The financial statements
have been prepared in accordance with generally accepted  accounting  principles
and,  in the  opinion of  management,  present  fairly the  Company's  financial
position,  results  of  operations  and cash  flows.  The  financial  statements
necessarily  contain  amounts that are based on the best estimates and judgments
of management.

The Company maintains a system of internal controls which management believes is
adequate to provide reasonable  assurance as to the integrity and reliability of
the financial  statements,  the  protection of assets from  unauthorized  use or
disposition and the prevention and detection of fraudulent  financial reporting.
The  selection  and  training of  qualified  personnel,  the  establishment  and
communication of accounting and  administrative  policies and procedures,  and a
program of internal audit are important elements of these control systems.

The Company  maintains a strong  internal  auditing  program that  independently
assesses the  effectiveness  of the internal  controls and  recommends  possible
improvements   thereto.   Management  has  considered  the  internal   auditors'
recommendations  concerning  the Company's  system of internal  controls and has
taken actions that management  believes are  cost-effective in the circumstances
to respond appropriately to these recommendations.

The Audit  Committee of the Board of  Directors,  comprised  entirely of outside
directors,  oversees the fulfillment by management of its responsibilities  over
financial  controls and the preparation of financial  statements.  The Committee
meets  regularly  with  representatives  of management and internal and external
auditors to review accounting, auditing and financial reporting matters.

As part of  their  audit of the  Company's  consolidated  financial  statements,
Arthur Andersen LLP considered the Company's system of internal  controls to the
extent they deemed necessary to determine the nature, timing and extent of their
audit tests.



Alan J. Cyron
Executive Vice President & Chief Financial Officer




                                    Page 34
<PAGE>



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Shareholders of Paragon Trade Brands, Inc.:

We have audited the  accompanying  consolidated  balance sheets of Paragon Trade
Brands, Inc., a Delaware Corporation, and subsidiaries,  as of December 27, 1998
and December  28,  1997,  and the related  consolidated  statements  of earnings
(loss),  comprehensive income (loss),  changes in shareholders' equity (deficit)
and cash flows for each of the three  years in the  period  ended  December  27,
1998.  These  financial  statements  and the schedule  referred to below are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements and the schedule based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the financial position of Paragon Trade Brands, Inc. and
subsidiaries  as of December 27, 1998 and December 28, 1997,  and the results of
their  operations and their cash flows for each of the three years in the period
ended  December 27, 1998,  in  conformity  with  generally  accepted  accounting
principles.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company will continue as a going concern. As more fully described in Notes 1 and
15 to the accompanying financial statements,  on December 30, 1997, the District
Court for the District of Delaware  issued a judgment (the  "Judgment")  finding
that the Company's diaper products  infringe certain patents held by The Procter
& Gamble Company ("P&G"). Also, as more fully described in Notes 1 and 15 to the
accompanying  financial  statements,  on January 6, 1998,  the  Company  filed a
voluntary  petition for relief under Chapter 11 of the U.S.  Bankruptcy Code. On
February 2, 1999,  the Company  entered  into a  settlement  agreement  with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Judgment. In addition, as more fully described in Notes 1
and 15 to the  accompanying  financial  statements,  on October  26,  1995,  the
Kimberly-Clark  Corporation ("K-C") filed a lawsuit against the Company alleging
infringement by the Company's  products of certain patents held by K-C. On March
19, 1999, the Company  entered into a settlement  agreement  with K-C which,  if
approved by the  Bankruptcy  Court,  will fully and  finally  settle all matters
related  to  K-C's  lawsuit  against  the  Company.  The  Company  has  recorded
litigation  settlement losses related to the P&G and K-C matters discussed above
of  $278,500,000.  After giving effect to these losses,  the Company has a total
shareholders'  deficit of  $61,840,000  as of December 27, 1998.  These matters,
among others, raise substantial doubt about the Company's ability to continue as
a going concern.  Management's  plans in regard to these matters,  including its
intent  to  file a  plan  of  reorganization  that  will  be  acceptable  to the
Bankruptcy Court and to the Company's  creditors,  are also described in Notes 1
and  15 to  the  accompanying  financial  statements.  In the  event  a plan  of
reorganization is accepted, continuation of the business thereafter is dependent
upon  the  Company's  ability  to  achieve  successful  future  operations.  The
accompanying financial statements do not include any adjustments relating to the
recoverability  and  classification of recorded asset amounts or the amounts and
classification  of  liabilities  that might be  necessary  should the Company be
unable to continue as a going concern.

                                    Page 35
<PAGE>

Our audit was made for the purpose of forming an opinion on the basic  financial
statements  taken as a whole.  The financial  statement  schedule  listed in the
index to  financial  statements  and  schedules  is  presented  for  purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures  applied in the audit of the basic  financial  statements and, in our
opinion,  fairly states in all material  respects the financial data required to
be set forth therein in relation to the basic  financial  statements  taken as a
whole.

Arthur Andersen LLP



Atlanta, Georgia
April 9, 1999



                                    Page 36
<PAGE>

                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)
                     CONSOLIDATED EARNINGS (LOSS) STATEMENTS
              (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                     Year Ended
                                             --------------------------------------------------------------
                                             December 27, 1998    December 28, 1997       December 29, 1996
                                             -----------------    -----------------       -----------------
<S>                                              <C>                 <C>                   <C>
Sales, net of discounts and allowances           $  535,207          $   561,975           $   581,929
Cost of sales                                       428,572              454,911               449,885
                                                 ----------          -----------           -----------
Gross profit                                        106,635              107,064               132,044
Selling, general and administrative expense          78,447               76,347                92,212
Research and development expense                      4,248                5,063                 4,163
Asset impairments                                     3,416                9,442                     -
Settlement contingencies (Notes 1 and 15)            78,500              200,000                     -
                                                 ----------          -----------           -----------
Operating profit (loss)                             (57,976)            (183,788)               35,669
Equity in earnings of  unconsolidated
    subsidiaries                                      4,077                  953                   423
Dividend income from unconsolidated
    subsidiary                                          922                1,055                     -
Interest expense(1)                                     450                4,667                 2,864
Other income, net                                     2,437                1,664                   581
                                                 ----------          -----------           -----------
Earnings (loss) before income taxes and
    bankruptcy costs                                (50,990)            (184,783)               33,809
Bankruptcy costs                                      6,302                    -                     -
Provision for income taxes                            8,091               27,934                12,687
                                                 ----------          -----------           -----------
Net earnings (loss)                              $  (65,383)         $  (212,717)          $    21,122
                                                 ==========          ===========           ===========
Basic earnings (loss) per common share           $    (5.48)         $   (17.86)           $      1.76
                                                 ==========          ===========           ===========
Diluted earnings (loss) per common share         $    (5.48)         $   (17.86)           $      1.74
                                                 ==========          ===========           ===========
Dividends paid                                   $        -          $         -           $         -
                                                 ==========          ===========           ===========
---------------
<FN>
(1) Contractual interest                         $    5,836
                                                 ==========
</FN>
</TABLE>


SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.



                                    Page 37
<PAGE>

                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)
                           CONSOLIDATED BALANCE SHEETS
                          (DOLLAR AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                             December 27, 1998      December 28, 1997
                                                             -----------------      -----------------
<S>                                                               <C>                    <C>
ASSETS
Cash and short-term investments                                   $  22,625              $     991
Receivables                                                          79,156                 70,616
Inventories                                                          53,282                 48,257
Current portion of deferred income taxes                              4,260                  1,800
Prepaid expenses                                                      4,323                    697
                                                                  ---------              ---------
    Total current assets                                            163,646                122,361
Property and equipment, net                                         106,200                118,383
Construction in progress                                             19,626                 11,154
Assets held for sale                                                  4,691                 11,073
Investment in unconsolidated subsidiary at cost                      22,743                 19,964
Investment in and advances to unconsolidated
    subsidiaries, at equity                                          66,041                 53,844
Goodwill                                                             32,819                 34,739
Other assets, net                                                    13,521                  4,624
                                                                  ---------              ---------
    Total assets                                                  $ 429,287              $ 376,142
                                                                  =========              =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Short-term borrowings                                             $       -              $  14,185
Checks issued but not cleared                                        12,433                  9,375
Accounts payable                                                     32,416                 40,305
Accrued liabilities                                                  33,646                 32,392
Accrued settlement contingency (Notes 1, 15 and 16)                       -                200,000
                                                                  ---------              ---------
    Total current liabilities                                        78,495                296,257
Liabilities subject to compromise                                   406,859                      -
Long-term debt                                                            -                 70,000
Deferred compensation                                                     -                  1,275
Deferred income taxes                                                 5,773                  3,656
                                                                  ---------              ---------
    Total liabilities                                               491,127                371,188

Commitments and contingencies (Notes 1, 15 and 16)

Shareholders' equity (deficit):
Preferred stock:  authorized 10,000,000 shares,
    no shares issued, $.01 par value                                      -                      -
Common stock:  authorized 25,000,000 shares,
    issued 12,378,616 and 12,343,324, $.01 par value                    124                    123
Capital surplus                                                     143,918                144,368
Accumulated other comprehensive loss                                 (1,840)                (1,066)
Retained earnings (deficit)                                        (193,758)              (128,376)
Less:  treasury stock, 429,696 and 388,658 shares, at cost          (10,284)               (10,095)
                                                                  ---------              ---------
    Total shareholders' equity (deficit)                            (61,840)                 4,954
                                                                  ---------              ---------
        Total liabilities and shareholders' equity (deficit)      $ 429,287              $ 376,142
                                                                  =========              =========
</TABLE>

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.


                                    Page 38
<PAGE>

                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                          (DOLLAR AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                     Year Ended
                                               -------------------------------------------------------
                                               December 27, 1998  December 28, 1997  December 29, 1996
                                               -----------------  -----------------  -----------------
<S>                                                 <C>                <C>                <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)                                 $  (65,383)        $ (212,717)        $   21,122
Non-cash charges to earnings:
    Depreciation and amortization                       34,459             35,514             38,828
    Deferred income taxes                                 (343)            36,464              1,656
    Equity in (earnings) loss of unconsolidated
        subsidiaries                                    (2,807)               615                (34)
    Write-down of assets                                 3,408              7,967                 69
Changes in working capital:
    Accounts receivable                                (16,010)            (5,430)           (12,300)
    Inventories and prepaid expenses                   (12,230)            (3,997)             8,117
    Accounts payable                                    34,529              3,238               (224)
    Accrued liabilities and loss contingency            85,255            192,615             11,777
    Prepetition reclamation payment
        authorized by court                             (1,034)                 -                  -
    Checks issued but not cleared                        3,058               (858)                 1
Other                                                   (1,598)               652               (723)
                                                    ----------         ----------         ----------
    Net cash provided by operating activities           61,304             54,063             68,289
                                                    ----------         ----------         ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property and equipment                (28,283)           (49,420)           (48,867)
Proceeds from sale of property and equipment             3,435             10,266              3,822
Proceeds from sale of Changing Paradigms,
    Inc.                                                 5,163                  -                  -
Acquisition of Pope & Talbot, Inc.'s disposable
    diaper business assets                                   -                  -            (56,963)
Investment in Grupo P.I. Mabe, S.A. de C.V.             (2,779)            (3,433)           (15,908)
Investment in and advances to
    unconsolidated subsidiaries, at equity              (5,375)           (24,102)           (11,033)
Other                                                   (9,043)            (9,104)            (1,731)
                                                    ----------         ----------         ----------
    Net cash used by investing activities              (36,882)           (75,793)          (130,680)
                                                    ----------         ----------         ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in short-term
    borrowings                                            (921)            14,185             (1,760)
Prepetition debt payment authorized by court            (1,867)                 -                  -
Proceeds from U.S. bank credit facility                      -             25,000             85,000
Repayments of U.S. bank credit facility                      -            (25,000)           (15,000)
Sale of common stock                                         -                239                641
Purchases of treasury stock                                  -                  -            (10,083)
                                                    ----------         ----------         ----------
    Net cash provided (used) by financing
        activities                                      (2,788)             4,424             58,798
                                                    ----------         ----------         ----------
NET INCREASE (DECREASE) IN CASH                         21,634             (7,306)            (3,593)
Cash at beginning of period                                991              8,297             11,890
                                                    ----------         ----------         ----------
Cash at end of period                               $   22,625         $      991         $    8,297
                                                    ==========         ==========         ==========
Cash paid (received) during the year for:
    Interest (net of amounts capitalized)           $    1,557         $    4,259         $    2,961
                                                    ==========         ==========         ==========
    Income taxes                                    $       78         $   (4,242)        $   15,189
                                                    ==========         ==========         ==========
    Bankruptcy costs                                $    2,461         $        -         $        -
                                                    ==========         ==========         ==========
</TABLE>


SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.



                                    Page 39
<PAGE>

                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)
                    STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
                          (DOLLAR AMOUNTS IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                     Year Ended
                                               -------------------------------------------------------
                                               December 27, 1998  December 28, 1997  December 29, 1996
                                               -----------------  -----------------  -----------------
<S>                                                <C>                <C>                  <C>
Net earnings (loss)                                $   (65,383)       $   (212,717)        $    21,122

Other comprehensive income (loss), net of tax
    Foreign currency translation adjustments(1)           (774)               (452)                 47
                                                   -----------        ------------        ------------
Comprehensive income (loss)                        $   (66,157)       $   (213,169)        $    21,169
                                                   ===========        ============        ============
<FN>
---------------
(1)     Tax expense (benefit)                      $      (485)       $       (283)       $         29
                                                   ===========        ============        ============
</FN>
</TABLE>

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.




                                    Page 40
<PAGE>




                             PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                                       (DEBTOR-IN-POSSESSION)
                     CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                                    (DOLLAR AMOUNTS IN THOUSANDS)


<TABLE>
<CAPTION>
                                                              Accumulated
                                                                 Other         Retained
                                    Common       Capital     Comprehensive     Earnings     Treasury
                                     Stock       Surplus     Income (Loss)      (Loss)        Stock
                                    -------      --------    --------------    --------     ---------
<S>                                  <C>         <C>            <C>           <C>            <C>
BALANCE, December 31, 1995           $   119     $132,722       $   (661)     $   63,219     $  (3,710)
    Net earnings                           -            -              -          21,122             -
    Issue common stock                     4       10,483              -               -         1,443
    Translation adjustment                 -            -             47               -             -
    Purchase of treasury stock             -            -              -               -       (10,083)
                                     -------     --------       --------      ----------     ---------
BALANCE, December 29, 1996               123      143,205          (614)          84,341       (12,350)
    Net loss                               -            -              -        (212,717)            -
    Issue common stock                     -        1,163              -               -         2,255
    Translation adjustment                 -            -           (452)              -             -
                                     -------     --------       --------      ----------     ---------
BALANCE, December 28, 1997               123      144,368         (1,066)       (128,376)      (10,095)
    Net loss                               -            -              -         (65,383)            -
    Issue common stock                     1          150              -               -             -
    Translation adjustment                 -            -           (774)              -             -
    Restricted stock forfeiture            -         (600)             -               -          (189)
                                     -------     --------       --------      ----------     ---------
BALANCE, December 27, 1998           $   124     $143,918       $ (1,840)     $ (193,758)    $ (10,284)
                                     =======     ========       ========      ==========     =========
</TABLE>


The following summarizes the changes in the number of shares of capital stock:

<TABLE>
<CAPTION>
                                                                Common Stock         Treasury Stock
                                                            --------------------   -------------------
<S>                                                              <C>                   <C> 
BALANCE, December 31, 1995                                       11,851,504             245,322
    Issue common stock - Pope & Talbot
        disposable diaper business                                  387,800                   -
    Issue common stock - 1995 Incentive Compensation Plan            26,157              (3,000)
    Issue common stock - 1996 Non-Officer Employee
        Incentive Compensation Plan                                       -             (30,000)
    Issue common stock - Profit Sharing and Savings Plan                  -             (54,372)
    Issue common stock - Exercise of stock options                   22,832             (10,500)
    Purchase of treasury stock                                            -             387,800
                                                                 ----------             -------
BALANCE, December 29, 1996                                       12,288,293             535,250
    Issue common stock - 1995 Incentive Compensation Plan            36,655                   -
    Issue common stock - 1996 Non-Officer Employee
        Incentive Compensation Plan                                  12,279                   -
    Issue common stock - Profit Sharing and Savings Plan              3,597            (135,845)
    Issue common stock - Exercise of stock options                    2,500             (10,747)
                                                                 ----------             -------
BALANCE, December 28, 1997                                       12,343,324             388,658
    Issue common stock - Profit Sharing and Savings Plan             35,292                   -
    Restricted stock forfeiture                                           -              41,038
                                                                 ----------             -------
BALANCE, December 27, 1998                                       12,378,616             429,696
                                                                 ==========             =======
</TABLE>

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.




                                    Page 41
<PAGE>




                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
                             (DEBTOR-IN-POSSESSION)
                          NOTES TO FINANCIAL STATEMENTS
              (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)


NOTE 1:    CHAPTER 11 PROCEEDINGS

On January 6, 1998,  Paragon Trade  Brands,  Inc.  ("Paragon" or the  "Company")
filed for relief  under  Chapter 11 of the United  States  Bankruptcy  Code (the
"Chapter 11 filing"),  in the United  States  Bankruptcy  Court for the Northern
District   of   Georgia.    The   Company   is   currently    operating   as   a
debtor-in-possession under the Bankruptcy Code.

The Procter & Gamble Company  ("P&G") had filed a lawsuit against the Company in
the United States District Court for the District of Delaware, alleging that the
Company's disposable baby diaper products infringe two of P&G's dual cuff diaper
patents.  The lawsuit sought injunctive relief, lost profit and royalty damages,
treble damages and attorneys' fees and costs. The Company denied liability under
the  patents  and  counterclaimed  for  patent  infringement  and  violation  of
antitrust laws by P&G.

On December 30, 1997, the District  Court issued a Judgment and Opinion  finding
that P&G's dual cuff diaper  patents were valid and  infringed by certain of the
Company's disposable diaper products,  while also rejecting the Company's patent
infringement  claims against P&G. The District  Court had earlier  dismissed the
Company's antitrust  counterclaim on summary judgment. The Judgment entitled P&G
to damages based on sales of the Company's  diapers  containing  the  "inner-leg
gather" feature.  While the final damages number of  approximately  $178,400 was
not entered by the  District  Court until June 2, 1998,  the Company  originally
estimated the  liability and  associated  litigation  costs to be  approximately
$200,000.  The amount of the award  resulted in violation  of certain  covenants
under the  Company's  then-existing  bank  loan  agreements.  As a  result,  the
issuance of the Judgment and the  uncertainty it created caused an immediate and
critical liquidity issue for the Company.  The Chapter 11 filing was designed to
prevent P&G from placing liens on Company property, permit the Company to appeal
the Delaware District Court's decision on the P&G case in an orderly fashion and
give the Company the opportunity to resolve  liquidated and unliquidated  claims
against the Company which arose prior to the Chapter 11 filing.

Substantially  all  liabilities  outstanding  as of the date of the  Chapter  11
filing are subject to resolution under a plan of reorganization to be voted upon
by  those of the  Company's  creditors  and  shareholders  entitled  to vote and
confirmed by the Bankruptcy Court.  Schedules were filed by the Company on March
3, 1998 with the  Bankruptcy  Court setting forth the assets and  liabilities of
the Company as of the date of the Chapter 11 filing,  as shown by the  Company's
accounting  records.  Amended  schedules  were filed by the Company on March 30,
1998 with the Bankruptcy  Court.  The Bankruptcy Court set a bar date of June 5,
1998 by which time  creditors  must have filed proofs of claim setting forth any
claims which arose prior to the Chapter 11 filing.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition claim of $158,500 and an allowed  administrative claim of
$5,000.  As a part of the  settlement,  the  Company has  entered  into  License
Agreements  for the U.S.  and  Canada,  which  are  exhibits  to the  Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for these  rights,  the Company has
agreed to pay P&G running  royalties on net sales of the licensed products equal
to 2 percent through October 2005, .75 percent  thereafter  through October 2006
and .375  percent  thereafter  through  March  2007 in the  U.S.;  and 2 percent
through  October  2008 and 1.25  percent  thereafter  through  December  2009 in
Canada.  The Settlement  Agreement also provides,  among other things,  that P&G
will grant the Company and/or its affiliates "most favored licensee" status with
respect to patents owned by P&G on the date of the  Settlement  Agreement or for
which an  application  was pending on that date.  In  addition,  the 


                                    Page 42
<PAGE>

Company has agreed with P&G that prior to litigating any future patent  dispute,
the parties will engage in good faith negotiations and will consider arbitrating
the dispute before resorting to litigation.

The Company believes that the royalty rates being charged by P&G,  together with
royalties to be paid to Kimberly-Clark Corporation ("K-C") described below, will
have a material adverse impact on the Company's  future financial  condition and
results of operations.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Official  Committee of Equity
Security  Holders  and K-C have  objected  to the P&G  settlement.  The  Company
intends to continue to pursue  approval of the P&G  Settlement by the Bankruptcy
Court.  Should the P&G Settlement  Agreement not be approved by a Final Order of
the Bankruptcy Court by July 31, 1999, however, the License Agreements described
above will become  terminable at P&G's option.  The Company cannot predict when,
or if, such approval will be granted.

On October 26, 1995,  K-C filed a lawsuit  against the Company in U.S.  District
Court in Dallas,  Texas,  alleging infringement by the Company's products of two
K-C patents  relating  to dual cuffs.  The  lawsuit  sought  injunctive  relief,
royalty  damages,  treble  damages and  attorneys'  fees and costs.  The Company
denied liability under the patents and  counterclaimed  for patent  infringement
and  violation  of antitrust  laws by K-C. In addition,  K-C sued the Company on
another patent issued to K-C which is based upon a further  continuation  of one
of the K-C dual cuff patents asserted in the case.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C  an  allowed  unsecured   prepetition  claim  of  $110,000  and  an  allowed
administrative  claim of $5,000.  As a part of the  settlement,  the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with respect to the patents  asserted by K-C in the
Texas action.  The patent rights licensed by the Company from K-C will allow the
Company to manufacture a dual cuff diaper  design.  In exchange for these patent
rights,  the Company has agreed to pay K-C annual running royalties on net sales
of the  licensed  products in the U.S.  and Canada  equal to: 2.5 percent of the
first  $200,000 of net sales of the covered  diaper  products and 1.5 percent of
such net sales in excess of $200,000 in each  calendar year  commencing  January
1999 through November 2004. In addition, the Company has agreed to pay a minimum
annual  royalty  for diaper  sales of $5,000,  but  amounts  due on the  running
royalties  will be offset  against this  minimum.  The Company will also pay K-C
running  royalties of 5 percent of net sales of covered  training  pant products
for the same period, but there is no minimum royalty for training pants. As part
of the  settlement,  the Company has granted a  royalty-free  license to K-C for
three patents which the Company in the Texas action claimed K-C infringed.

The Company  believes that these royalties  will,  together with royalties to be
paid to P&G described  above,  have a material  adverse  impact on the Company's
future financial condition and results of operations.

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of  super-absorbent  polymers ("SAP") in
diapers  and  training  pants,  so long as the Company  uses SAP which  exhibits
certain  performance  characteristics  (the "SAP Safe Harbor").  The Company has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased  marketing and selling,  general and administrative  expenses ("SG&A")
expenditures  in 1999 to address  product  performance  issues.  These increased
expenditures  are expected to have a material  adverse  impact on the  Company's
financial   position  and  results  of  operations  in  1999.   The  Company  is
encountering increased product costs due to the increased price and usage of the
new 


                                    Page 43
<PAGE>

SAP. While the Company is working diligently with its SAP suppliers to develop a
better  performing  alternative  which is still within the SAP Safe Harbor,  the
Company  cannot  predict at this time  whether or when such an  alternative  SAP
would be available.  The Company expects that these increased product costs will
have a  material  adverse  impact on its  financial  condition  and  results  of
operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.

The ability of the Company to effect a successful reorganization will depend, in
significant   part,   upon  the  Company's   ability  to  formulate  a  plan  of
reorganization  that is approved by the Bankruptcy Court and meets the standards
for plan  confirmation  under the Bankruptcy Code. The Company cannot predict at
this time the effect of the material  adverse  impact  related to the  increased
costs described above on the Company's enterprise valuation and on the Company's
ability to timely  formulate a plan of  reorganization.  The  Company  believes,
however,  that it may be impossible to satisfy in full all of the claims against
the Company.  As a result of the Chapter 11 filing, the Company has incurred and
will  continue  to  incur   significant  costs  for  professional  fees  as  the
reorganization  plan is  developed.  The Company is also required to pay certain
expenses of the Committees,  including  professional fees, to the extent allowed
by the Bankruptcy Court.

The  License  Agreements  with each of P&G and K-C  provide  that if the related
Settlement  Agreements  are  not  approved,  as  specified  in  each  respective
agreement,  by July 31, 1999 and August 1, 1999,  respectively,  the P&G License
Agreements will become  terminable at P&G's option and the K-C License Agreement
will  terminate  automatically.  If the  P&G  and  K-C  License  Agreements  are
terminated  because the respective  Settlement  Agreements are not approved in a
timely  manner,  the  Company  could be faced with having to convert to a diaper
design other than the dual cuff design  covered by the  licenses.  At this time,
the Company's only viable alternative  product design is the single cuff product
which is the subject of P&G's  Contempt  Motion in  Delaware.  While the Company
intends to vigorously  pursue  approval of both  settlements,  it cannot predict
when, or if, such approval will be granted.

The Chapter 11 filing did not include the  Company's  wholly owned  subsidiaries
including   Paragon   Trade  Brands   (Canada)   Inc.,   Paragon   Trade  Brands
International, Inc., Paragon Trade Brands FSC, Inc. and Changing Paradigms, Inc.
The following information  summarizes the combined results of operations for the
fiscal years ended  December 27, 1998,  December 28, 1997 and December 29, 1996,
as well as the combined  balance sheets as of December 27, 1998 and December 28,
1997 for these  subsidiaries.  This  information  has been  prepared on the same
basis as the consolidated financial statements.

<TABLE>
<CAPTION>
                                     DECEMBER 27, 1998      DECEMBER 28, 1997        DECEMBER 29, 1996
                                     -----------------      -----------------        -----------------
<S>                                 <C>                    <C>                       <C>
Sales, net of discounts and
  allowances                        $      55,338          $      53,523             $      60,948
Gross profit                        $      10,161          $       8,649             $      15,069
Earnings before income taxes        $      10,034          $       4,814             $      11,695
Net earnings                        $       7,277          $       4,121             $       7,982
</TABLE>


<TABLE>
<CAPTION>
                                     DECEMBER 27, 1998      DECEMBER 28, 1997
                                     -----------------      -----------------
<S>                                 <C>                    <C>          
Current assets                      $      17,863          $      14,782
Non-current assets                  $      54,734          $      48,840
Current liabilities                 $       5,700          $       8,424
Non-current liabilities             $       8,495          $       8,873
</TABLE>


                                    Page 44
<PAGE>

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

BASIS OF PRESENTATION AND RELATED INFORMATION

Paragon is the leading  manufacturer of store brand infant disposable diapers in
the United States and Canada. Paragon manufactures a line of premium and economy
diapers,  training  pants,  and feminine care and adult  incontinence  products,
which are distributed throughout the United States and Canada, primarily through
grocery and food stores,  mass  merchandisers,  warehouse  clubs, toy stores and
drug stores that market the products under their own store brand names.  Paragon
has also established international joint ventures in Mexico,  Argentina,  Brazil
and China for the  manufacture and sale of infant  disposable  diapers and other
absorbent personal care products.

The  consolidated  financial  statements  include the accounts of Paragon  Trade
Brands,  Inc. and its wholly owned  subsidiaries,  Paragon Trade Brands (Canada)
Inc. and Paragon Trade Brands  International,  Inc.  ("PTBI").  All  significant
intercompany transactions and accounts have been eliminated.

The consolidated financial statements were prepared in conformity with generally
accepted  accounting   principles  and  necessarily  include  amounts  based  on
management's  estimates  and  assumptions.  The  estimates  and  assumptions  of
management  affect the  reported  amounts of assets,  liabilities,  revenues and
expenses,  including  disclosures  regarding  contingent assets and liabilities.
Actual  results  may  differ  from those  reported  due to these  estimates  and
assumptions.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going  concern.  As more fully  described in
Notes 1 and 15, the  Company is unable to predict  when it will submit a plan of
reorganization  that will be acceptable to the Bankruptcy  Court. In the event a
plan  of  reorganization  is  confirmed  and  consummated,  continuation  of the
business  thereafter  is  dependent  on the  Company's  ability to  successfully
execute the underlying  business plan. The accompanying  consolidated  financial
statements do not include any  adjustments  relating to the  recoverability  and
classification  of recorded asset amounts or the amounts and  classification  of
liabilities  that might be necessary should the Company be unable to continue as
a going concern.

The Company uses a 52/53-week  year.  The fiscal years ended  December 27, 1998,
December 28, 1997 and December 29, 1996 include 52 weeks.

CASH AND SHORT-TERM INVESTMENTS

For purposes of cash flow and fair value reporting,  short-term investments with
original  maturities  of 90 days or less  are  considered  as cash  equivalents.
Short-term  investments are stated at cost, which  approximates  fair value. The
obligation  for  outstanding  checks  is  reflected  as checks  issued,  but not
cleared.

FINANCIAL INSTRUMENTS - FOREIGN CURRENCY FORWARD CONTRACTS

The Company  occasionally enters into forward contracts to hedge certain foreign
currency  denominated purchase commitments for periods consistent with the terms
of the underlying transactions. While the forward contracts affect the Company's
results  of  operations,  they do so  only in  connection  with  the  underlying
transactions.  Gains and  losses on these  contracts  are  deferred  and  offset
exchange gains and losses on the transactions  hedged.  At December 27, 1998 and
December 28, 1997, the Company did not have any forward  contracts  outstanding.
The Company's other off-balance sheet risks are not material.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The  Company  estimates  that  the  fair  value  of  its  financial  instruments
approximate their carrying values as of the balance sheet dates,  other than the
guarantees  of  PTB  International,   Inc.  discussed  below.  The  Company  has
determined  that it is not  practicable  to  determine  the  fair  value of such
guarantees. Accordingly, no separate disclosure of fair value is made.

                                    Page 45
<PAGE>

NONCASH TRANSACTIONS

During the fiscal years ended  December  27, 1998 and  December  28,  1997,  the
Company issued 35,292 and 188,376,  respectively,  shares of common stock to key
management and employees through the Company's Long-Term Incentive  Compensation
Plan and its Profit  Sharing  and Savings  Plan (see Note 7). The balance  sheet
effect of  issuing  these  shares of common  stock  was a  decrease  in  accrued
liabilities  of $150 and $3,354,  respectively,  and an increase in equity by an
equal amount without the use of cash.

INVENTORIES

Inventories  are stated at the lower of cost or  market.  Cost  includes  labor,
materials and production  overhead.  The last-in,  first-out  ("LIFO") method is
used to cost domestic pulp and diaper-related  finished goods  inventories.  The
first-in,  first-out ("FIFO") method is used to cost all other inventories.  Had
the  FIFO  method  been  used to cost  the  domestic  pulp  and  finished  goods
inventories,  the amounts at which they are stated would have been $346 and $509
greater at December 27, 1998 and December 28, 1997,  respectively.  During 1996,
the Company  liquidated  certain  LIFO  inventories  that were carried at higher
costs  prevailing in prior years. The effect of this liquidation was to decrease
earnings before taxes by approximately $1,100.

PROPERTY AND EQUIPMENT

Paragon's  property  accounts  are  maintained  on an  individual  asset  basis.
Betterments  and  replacements  of major  units  are  capitalized.  Maintenance,
repairs and minor  replacements  are expensed.  Depreciation  is provided on the
straight-line method at rates based upon estimated useful lives as follows:

     Buildings                                                  20 to 40 years
     Building improvements                                      10 years
     Machinery, equipment, furniture and fixtures               2 to 10 years

The cost and related  depreciation  of property  sold or retired is removed from
the property and  allowance  for  depreciation  accounts and the gain or loss is
recorded.

PATENTS AND TRADEMARKS

The Company  operates in a  commercial  field in which  patents  relating to the
products,  processes,  apparatus  and  materials  are more numerous than in many
other  fields.  The Company  takes  careful  steps in  designing,  producing and
selling its products to avoid  infringing any valid patents of its  competitors.
However,  there can be no assurance that the Company will not be challenged with
respect to patents in the future (see Notes 1 and 15).

Purchased  patents and trademarks are amortized on a straight-line  basis over a
five- to ten-year  life. In 1997, the Company  evaluated the remaining  value of
one  of  the  purchased  patents  and  wrote-off  the  entire  amount  of  $255.
Amortization  expense was $676 for the year ended  December 28, 1997,  including
the  write-off.  Amortization  expense was $501 for the year ended  December 29,
1996. Accumulated  amortization was $5,523 at December 27, 1998 and December 28,
1997,  respectively.  All purchased  patents were fully amortized as of December
28, 1997.

INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES

On January  26,  1996,  the  Company  through its wholly  owned  subsidiary  PTB
International,  Inc. ("PTBI") completed the purchase of a 15 percent interest in
Grupo P.I.  Mabe,  S.A. de C.V.  ("Mabesa"),  a diaper  manufacturer  located in
Mexico,  for  $15,300 in cash plus  additional  consideration  based on Mabesa's
future financial results through 2001. In 1998, based on Mabesa's 1997 financial
results, the Company paid additional  consideration of $2,800. In 1997, based on
Mabesa's 1996 financial  results,  the Company paid additional  consideration of
$3,400.  The Company  also  acquired  the option to purchase  an  additional  34
percent interest in Mabesa at a contractually  determined  price. The investment
is carried at cost in the accompanying consolidated balance sheets.

                                    Page 46
<PAGE>

The Company  also owns a 49 percent  interest in  Paragon-Mabesa  International,
S.A. de C.V. ("PMI"). The investment is accounted for using the equity method.

On August 26, 1997, PTBI purchased a 49 percent interest in Stronger Corporation
S.A.  ("Stronger"),   a  financial  investment  corporation  incorporated  under
Uruguayan  law. An affiliate of Mabesa owns the  remaining 51 percent.  Stronger
will be  used  to  establish  additional  Latin  American  joint  ventures.  The
investment is accounted for using the equity method.

On August 26, 1997, Stronger acquired 70 percent of Serenity S.A.  ("Serenity"),
a diaper  manufacturer  in  Argentina,  for  approximately  $11,600 in cash plus
earn-out  payments based on Serenity's  future  financial  results over the next
three  years.  Stronger  also  acquired an option to purchase  the  remaining 30
percent  interest  in Serenity by 2002 at a  contractually  determined  exercise
price.  Serenity  manufactures infant disposable  diapers,  sanitary napkins and
adult incontinence products in two facilities. PTBI advanced $5,700 to Stronger,
its pro-rata share of the purchase  price,  and made a $601 earn-out  payment in
1998.  PTBI has  guaranteed  earn-out  payments  estimated  not to exceed $2,300
through 2000.

On November  10, 1997,  Stronger  acquired 99 percent of the  disposable  diaper
business of MPC Productos para Higiene Ltda.("MPC") for approximately $10,500 in
cash from Cremer S.A., a Brazilian textile  manufacturer.  MPC is engaged in the
manufacture,  distribution,  and sale of  disposable  diapers,  skin lotions for
children and other personal care products. PTBI advanced $5,100 to Stronger, its
pro-rata share of the purchase price. In 1998, the Company  converted  $2,000 of
outstanding  notes receivable and accumulated  interest for equipment sales into
an additional capital contribution.

The  investment in Stronger  exceeds the  underlying  net assets by $6,392.  The
difference is being amortized over a 20 year life.

On December 31, 1997,  the Company  completed  the  acquisition  of its share of
Goodbaby Paragon Hygenic Products Ltd., a diaper  manufacturing joint venture in
China.  The joint  venture  partners  are  Goodbaby  Group  and  First  Shanghai
Investment of Hong Kong.  Paragon maintains a 40 percent  ownership  position in
the venture with  Goodbaby  Group and First  Shanghai  Investment  at 30 percent
each.  Initial  registered  capital of the venture  was  approved by the Chinese
government  at  $15,000,  to be funded over a two-year  period.  During the year
ended December 27, 1998, the Company contributed $4,000 of capital to Goodbaby.

There have been no dividend  distributions to the Company from PMI,  Stronger or
Goodbaby.  The Company has recorded a dividend of $922 declared by Mabesa in the
year ended December 27, 1998 to be paid in 1999. The Company received a dividend
distribution  of $1,055 from Mabesa in the year ended  December 28, 1997.  There
was no dividend distribution from Mabesa for the year ended December 29, 1996.

GOODWILL

On February 8, 1996, the Company  completed the purchase of substantially all of
the assets of Pope & Talbot, Inc.'s ("P&T") disposable diaper business. Goodwill
represents  the excess of the cost of these  assets  over their  estimated  fair
value at the date of acquisition and is amortized on a straight-line  basis over
20 years.  Management continually evaluates whether events or circumstances have
occurred  that  indicate  the  remaining  useful  life of  goodwill  may warrant
revision or that the remaining  balance of goodwill may not be realizable.  When
factors indicate that goodwill should be evaluated for possible impairment,  the
Company compares an estimate of the related business segment's  undiscounted net
cash flow over the remaining life of the related  goodwill to determine  whether
the goodwill is recoverable.

Amortization expense was $1,919,  $1,919 and $1,735 for the years ended December
27, 1998,  December 28, 1997 and  December 29, 1996,  respectively.  Accumulated
amortization  was $5,573 and $3,654 as of  December  27, 1998 and  December  28,
1997, respectively.

OTHER ASSETS - SOFTWARE

The primary  component of other assets is capitalized  software and  development
costs.  During  1998,  the Company  implemented  SAP-R3  software  at  corporate
headquarters and in its U.S. infant care plants.

                                    Page 47
<PAGE>

The SAP-R3 software and development costs are being amortized on a straight-line
basis over a 10-year life.  Other software and development  costs related to the
project are being primarily  amortized on a  straight-line  basis over a one- to
three-year life.  Amortization  expense was $442 for the year ended December 27,
1998. Accumulated amortization was $442 at December 27, 1998.

TREASURY STOCK

In July 1995,  the Board of Directors  authorized  the  repurchase  of up to 1.0
million shares of the Company's outstanding common stock.  Purchases may be made
periodically in the open market or in privately-negotiated  transactions over an
extended  period of time,  if and when  management  believes  market  conditions
warrant.  The Company  reissued  135,845 of these shares  through its  Long-Term
Incentive  and Profit  Sharing  Plans in the year ended  December 28, 1997.  The
Company also  reissued  10,747  shares for the exercise of stock  options in the
year ended December 28, 1997 (see Note 7). During the fiscal year ended December
27, 1998,  the Company  acquired  41,038 shares through  employee  forfeiture of
restricted stock.

SIGNIFICANT CUSTOMER

During the years ended  December  27,  1998,  December 28, 1997 and December 29,
1996,  the  percentages  of net  sales to an  individual  customer  whose  sales
represent  in excess of 10 percent of net sales were 19 percent,  15 percent and
13  percent,  respectively.  These  sales  consisted  entirely  of  infant  care
products.

INCOME TAXES

The  Company  accounts  for income  taxes  based on the  liability  method  and,
accordingly, deferred income taxes are provided to reflect temporary differences
between  financial and tax reporting.  Deferred tax assets and  liabilities  are
measured  based on enacted  tax laws and rates  without  anticipation  of future
changes. Effects on deferred taxes of enacted changes in tax laws are recognized
in income for financial statement purposes in the period of enactment.

As of  December  27,  1998,  there  were  approximately  $19,158  of  cumulative
undistributed  earnings of the Company's  foreign  subsidiaries  and investments
accounted  for by the equity  method.  U.S.  taxes have not been provided for on
these earnings.  Under existing law,  undistributed  earnings are not subject to
U.S. tax until distributed as dividends.  Any future earnings are intended to be
indefinitely  reinvested in these  operations.  Furthermore,  any taxes that are
paid to foreign  governments on such future earnings may be used, in whole or in
part, as credits against the U.S.
tax on any distributions from such earnings.

Income  taxes have been  provided  for all items  included  in the  consolidated
earnings  (loss)  statements,  regardless  of the period when such items will be
deductible  for  tax  purposes.  The  principal  temporary  differences  between
financial  and tax  reporting  arise from  tax-basis  goodwill  and reserves not
currently deductible.

FOREIGN CURRENCY

Non-U.S.   assets  and  liabilities  are  translated  into  U.S.  dollars  using
period-end exchange rates. Revenues and expenses are translated at average rates
during the period.

PROFIT SHARING AND 401(K) PLANS

Effective February 2, 1993, Paragon adopted both a defined  contribution  profit
sharing  plan and a 401(k)  savings  plan  covering  most of its  employees.  On
October 1, 1993, the two plans were merged,  amended and restated into one plan,
the Paragon Trade Brands,  Inc. Profit Sharing and Savings Plan. The name of the
plan was changed by  resolution  of the Board of Directors  in December  1995 to
Paragon  Retirement  Investment  Savings  Management  Plan  ("PRISM").  The plan
provides for both  employer-matching  contributions  based on  voluntary  salary
deferrals  of  employees  and   discretionary   employer   contributions.   Plan
participants are fully vested with respect to employer contributions after three
years of service. Employee contributions vest immediately.  Contributions to the
plan are based on various levels of employee participation. Plan expense for the
fiscal 


                                    Page 48
<PAGE>

years ended  December  27,  1998,  December  28, 1997 and  December 29, 1996 was
$2,589, $1,141 and $2,607, respectively.

NEW ACCOUNTING STANDARDS

The  Financial   Accounting  Standards  Board  has  issued  Statement  No.  133,
Accounting  for Derivative  Instruments  and Hedging  Activities,  which must be
adopted by the Company's fiscal year 2000. This statement establishes accounting
and  reporting   standards  for  derivative   instruments  -  including  certain
derivative instruments embedded in other contracts - and for hedging activities.
Adoption of this  statement  is not  expected  to have a material  impact on the
Company's financial statements.

In March 1998, the American Institute of Certified Public Accountants  ("AICPA")
issued a new Statement of Position 98-1,  "Accounting  for the Costs of Computer
Software  Developed  or Obtained  for  Internal  Use." This  statement  requires
capitalization  of certain costs of internal-use  software.  The Company adopted
this  statement  in the  first  fiscal  quarter  of 1999,  and it did not have a
material impact on the financial statements.

In April 1998, the AICPA issued a new Statement of Position 98-5,  "Reporting on
the Costs of Start-up  Activities."  This  statement  requires that the costs of
start-up  activities and  organizational  costs be expensed as incurred.  Any of
these costs previously  capitalized by a company must be written off in the year
of adoption.  The Company  adopted this statement in the first fiscal quarter of
1999, and it did not have a material impact on the financial statements.

RECLASSIFICATIONS

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


NOTE 3:    ASSET IMPAIRMENTS

Asset  impairments  were $3,416 and $9,442 for the years ended December 27, 1998
and December 28, 1997,  respectively.  There were no asset  impairments  for the
year ended December 29, 1996.

The asset  impairment for the year ended December 27, 1998 represented a further
write down of the  tampon-related  manufacturing  equipment that was shutdown in
early 1998.  The  equipment has been written down to estimated net selling price
and is  categorized  as assets  held for sale on the  accompanying  consolidated
balance sheet.

The asset  impairments  for the year ended  December  28, 1997  include a $5,000
write-off of software and associated  consulting  costs related to the Company's
enterprise-wide  information system  installation.  The write off was due to the
inability  of the  software  to  perform  as  represented  during  the  software
selection process. The asset impairments also include a write-down of $4,442 for
the shut-down of the tampon-related manufacturing equipment at the feminine care
products  operation.  Also  included in the  shut-down  of the tampon  producing
operation  were  write-offs  of  $900  for  raw  material,  finished  goods  and
spare-part  inventories  which were  charged to cost of sales for the year ended
December 28, 1997.

The  Company  experienced  operating  losses  in its  feminine  care  and  adult
incontinence  business in 1998 and 1997 and expects  these losses to continue in
the  near-term.  The Company has  developed a business  plan that  supports  the
realization  of its  investment  in its  feminine  care and  adult  incontinence
business.  Accordingly,  the Company has not  recorded  any  adjustments  in its
financial  statements  relating to the recoverability of the operating assets of
the feminine care and adult  incontinence  business.  The  Company's  ability to
recover its investment is dependent upon a prompt  emergence from Chapter 11 and
the successful  execution of the Company's  feminine care and adult incontinence
business  plan. The Company cannot predict at this time when it will emerge from
Chapter 11 protection. The Company believes that once it emerges from Chapter 11
the feminine care and adult incontinence  business will see an increase in sales
and improved results. The Company cannot predict,  however, whether or when such
improved results will be realized.

                                    Page 49
<PAGE>


NOTE 4:    OTHER INCOME, NET

Other income was $2,437, $1,664  and $581 in 1998, 1997 and 1996,  respectively,
and  consisted primarily of interest income from PMI.


NOTE 5:  BANKRUPTCY COSTS

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

<TABLE>
<CAPTION>
                                                       YEAR ENDED
                                                       ----------
                                                    DECEMBER 27, 1998
                                                    -----------------
<S>                                                    <C>
Professional fees                                      $     6,772
Amortization of DIP credit facility deferred
    financing costs                                            813
Other                                                          160
Interest Income                                             (1,443)
                                                       -----------
                                                       $     6,302
                                                       ===========
</TABLE>


NOTE 6:    INCOME TAXES

Taxes on income are based on earnings (losses) before taxes as follows:

<TABLE>
<CAPTION>
                                     December 27, 1998      December 28, 1997      December 29, 1996
                                     -------------------    -------------------    -------------------
<S>                                   <C>                   <C>                     <C>
Domestic                              $    (62,239)         $    (188,784)          $     22,035
Foreign                                      4,947                  4,001                 11,774
                                      ------------          -------------           ------------
                                      $    (57,292)         $    (184,783)          $     33,809
                                      ============          =============           ============
</TABLE>


Provisions for (benefits from) income taxes include the following:

<TABLE>
<CAPTION>
                                     December 27, 1998       December 28, 1997      December 29, 1996
                                     -----------------       -----------------      -----------------
<S>                                     <C>                    <C>                     <C>
Federal:
    Current                             $    4,647             $   (6,594)             $   8,651
    Deferred                                   967                 33,494                 (1,098
                                        ----------             ----------              ---------
                                             5,614                 26,900                  7,553
                                        ----------             ----------              ---------
State:
    Current                                    598                 (1,197)                 1,496
    Deferred                                   161                    833                   (200)
                                        ----------             ----------              ---------
                                               759                   (364)                 1,296
                                        ----------             ----------              ---------
Foreign:
    Current                                  2,096                  1,803                  1,578
    Deferred                                  (378)                  (405)                 2,260
                                        ----------             ----------              ---------
                                             1,718                  1,398                  3,838
                                        ----------             ----------              ---------
                                        $    8,091             $   27,934              $  12,687
                                        ==========             ==========              ========= 
</TABLE>


                                    Page 50
<PAGE>

A reconciliation  between the federal  statutory rate and the effective tax rate
follows:

<TABLE>
<CAPTION>
                                      December 27, 1998       December 28, 1997      December 29, 1996
                                      -----------------       -----------------      -----------------
<S>                                      <C>                    <C>                     <C>
Expected provision (benefit) at
    the statutory rate                  $  (20,052)             $  (64,674)             $   11,833
State income taxes, net of
    federal tax benefit                     (2,005)                 (6,640)                  1,319
Undistributed earnings of
    subsidiaries                              (983)                    215                     (12)
Change in valuation allowance               32,585                  99,052                     (78)
All other, net                              (1,454)                    (19)                   (375)
                                         ---------              ----------              ----------

                                         $   8,091              $   27,934              $   12,687
                                         =========              ==========              ==========
</TABLE>

Net  deferred  tax  liabilities  at December 27, 1998 and December 28, 1997 were
$1,513 and $1,856,  respectively.  The amounts  recorded  primarily  reflect the
following: (1) reserves not currently deductible and (2) deferred tax assets due
to the enactment of the Omnibus Budget  Reconciliation Act of 1993, which allows
amortization of intangibles,  including goodwill.  Net deferred income taxes are
attributable to the following temporary differences:

<TABLE>
<CAPTION>
                                                 December 27, 1998       December 28, 1997
                                                 -----------------       -----------------
<S>                                                 <C>                    <C>        
Intangible assets                                   $   (1,992)            $   (2,127)
                                                    ----------             ----------
    Deferred tax liabilities                            (1,992)                (2,127)
                                                    ----------             ----------
Depreciation/amortization                               (1,737)                   389
Goodwill                                                 7,168                  9,902
Reserves not currently deductible                      113,465                 85,814
Package design costs                                     2,045                  2,099
Land                                                       392                    393
Net operating loss carryforwards                         3,057                    648
Credit carryforwards                                     9,045                    344
All other, net                                          (1,038)                    15
                                                    ----------             ----------
    Deferred tax assets                                132,397                 99,604
                                                    ----------             ----------
Deferred tax assets valuation allowance               (131,918)               (99,333)
                                                    ----------             ----------
    Total deferred taxes, net                       $   (1,513)            $   (1,856)
                                                    ==========             ==========
</TABLE>

The Company has recorded a valuation  allowance with respect to its net deferred
tax assets as realization is dependent upon sufficient future taxable income.


NOTE 7:    LONG-TERM  INCENTIVE,  DEFERRED   COMPENSATION,  PROFIT  SHARING  AND
           PENSION PLANS, INCLUDING 401(K)

LONG-TERM INCENTIVE PLANS

The Company's Long-Term  Incentive  Compensation Plan ("LTIC Plan") and its 1995
Incentive  Compensation  Plan ("1995 Plan") are administered by the Compensation
Committee of the Board of Directors.  In February 1996, the Company  adopted its
1996 Non-Officer  Employee  Incentive  Compensation Plan ("1996 Plan"). The 1996
Plan is administered by an  Administrative  Committee  appointed by the Board of
Directors. The LTIC, 1995 and 1996 Plans are designed to link management rewards
with the long-term interests of Paragon's shareholders.  Given the uncertainties
related to the Company's  Chapter 11 filing,  the Compensation  Committee of the
Company's Board of Directors decided in early 1998 to suspend the grant of stock
option  awards  or  stock   appreciation   rights  ("SARs")  until  the  Company
successfully  emerges  from  Chapter  11. As a result,  no  options or SARs were
granted in 1998.

                                    Page 51
<PAGE>

RESTRICTED STOCK GRANTS

In 1997,  restricted shares of common stock were issued at a discounted value in
lieu of  some  or all of cash  bonuses  for  key  employees,  at the  employee's
discretion.  During the fiscal year ended  December 28, 1997,  there were 12,279
shares of common  stock  issued  under the 1996 Plan as  restricted  shares  and
36,655 shares of common stock issued under the 1995 Plan as restricted and bonus
shares.  The restricted shares are  non-transferable  for two years.  During the
year ended  December 27, 1998,  41,038  shares of  restricted  stock  previously
granted under the various plans were  forfeited by employees.  The 1995 and 1996
Plans provide that a maximum of 150,000 and 250,000  shares,  respectively,  are
available for grant thereunder as restricted shares or other stock based awards.
Compensation  expense  is  recorded  for the stock  grants  at their  discounted
amounts.  Compensation  expense  (income)  recorded  for the fiscal  years ended
December 27, 1998,  December 28, 1997 and December 29, 1996 was $(788), $856 and
$800,  respectively.  The weighted average fair value per share of stock granted
was $17.50 and $24.52 for the years ended  December  28, 1997 and  December  29,
1996,  respectively.  The  weighted  average fair value per share at the date of
grant of stock forfeited for the year ended December 27, 1998 was $19.20.

STOCK OPTIONS AND SARS

The LTIC,  1995 and 1996 Plans have a maximum of  800,000,  450,000  and 400,000
shares  available,  respectively,  for  grant as stock  options  or SARs.  Stock
options, when granted to key management, are granted at amounts that approximate
market value at the date of the grant.  Awards,  when made,  vest 25 percent per
year for four years and have a term of 10 years.  The Company also has a maximum
of  100,000  shares  available  for  grant  under  the  Stock  Option  Plan  for
Non-Employee Directors ("Director Plan"). Stock options are awarded to directors
at amounts that approximate  market value at the date of the grant.  Awards vest
100  percent  after  one year  and have a term of 10  years.  Awards  under  the
Director Plan were also suspended in 1998 until the Company successfully emerges
from Chapter 11.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company applies APB Opinion 25 in accounting for stock options granted under
the 1995, LTIC and Director Plans.  Accordingly,  no compensation  cost has been
recognized  for these plans in 1998,  1997 or 1996. Had  compensation  cost been
recognized  on the basis of fair value  pursuant to FASB  Statement No. 123, net
earnings  (loss) and  earnings  (loss) per share  would  have been  affected  as
follows:

<TABLE>
<CAPTION>
                                     December 27, 1998      December 28, 1997       December 29, 1996
                                     -----------------      -----------------       -----------------
<S>                                     <C>                    <C>                    <C>
NET EARNINGS (LOSS)
------------------
    As reported                         $   (65,383)           $  (212,717)           $    21,122
    Pro forma                           $   (65,646)           $  (213,265)           $    20,486

BASIC EARNINGS (LOSS) PER SHARE
-------------------------------
    As reported                         $     (5.48)           $    (17.86)           $      1.76
    Pro forma                           $     (5.50)           $    (17.90)           $      1.70

DILUTED  EARNINGS  (LOSS)  PER SHARE
------------------------------------
    As reported                         $     (5.48)           $    (17.86)           $      1.74
    Pro forma                           $     (5.50)           $    (17.90)           $      1.68
</TABLE>

The fair value of each option grant was estimated on the date of the grant using
the Black-Scholes  multiple option pricing model with the following  assumptions
for the  years  ended  December  28,  1997 and  December  29,  1996:  a range of
risk-free  interest  rates of 6.15 - 6.43  percent  was used for the years ended
December  28, 1997,  and December 29, 1996; a dividend  yield of 0.0 percent was
used for both years; and an estimated  volatility of 40 percent was used for the
year  ended  December  28,  1997,  and 44  percent  was used for the year  ended
December 29, 1996.

                                    Page 52
<PAGE>

Following is a summary of the status of the 1995, LTIC and Director Plans during
the years ended December 27, 1998, December 28, 1997 and December 29, 1996.

<TABLE>
<CAPTION>
                           December 27, 1998          December 28, 1997          December 29, 1996
                        -----------------------    -----------------------    -----------------------
                                      Weighted                   Weighted                   Weighted
                         Number        Average      Number       Average       Number       Average
                           of         Exercise        of         Exercise        of         Exercise
                         Shares         Price       Shares        Price         Shares        Price
                        ------------  ---------    ------------  ---------    ------------  ---------
<S>                       <C>            <C>         <C>            <C>         <C>            <C>
Outstanding,
    beginning of
    period                774,935        $20.46      735,932        $21.00      703,678        $20.40
Granted                         -             -       91,000        $16.42       89,000        $24.78
Exercised                       -             -       13,247        $18.03       33,332        $19.00
Forfeited                  75,444        $20.54       38,750        $22.10       23,414        $20.30
Expired                         -             -            -             -            -             -
                          -------        ------      -------        ------      -------        ------
Outstanding, end of
    period                699,491        $20.45      774,935        $20.46      735,932        $21.00
                          =======                    =======                    =======
Options exercisable
    end of period         569,407        $20.96      518,103        $21.18      368,361        $21.53
                          =======                    =======                    =======
Weighted average
    fair value of
    options granted
    during the period           -                  $    8.95                  $   14.05
                          =======                    =======                    =======
</TABLE>


Following is a summary of the status of options granted under the 1995, LTIC and
Director Plans at December 27, 1998:

<TABLE>
<CAPTION>
                                    Outstanding Options                         Exercisable Options
                    ----------------------------------------------------   ----------------------------
                                Weighted Average
                                    Remaining                                                Weighted
Exercise Price                     Contractual         Weighted Average                      Average
     Range           Number        Life (Years)         Exercise Price       Number      Exercise Price
--------------       ------        ------------         --------------       ------      --------------
<S>                  <C>                <C>                  <C>             <C>              <C>    
$12.69-$16.44        242,447            6.94                 $14.62          151,363          $14.15
$19.00-$22.13        245,500            4.10                 $19.80          245,500          $19.80
$22.25-$31.13        211,544            5.96                 $27.88          172,544          $28.57
                     -------                                                 -------
$12.69-$31.13        699,491            5.64                 $20.45          569,407          $20.96
                     =======                                                 =======
</TABLE>


                                    Page 53
<PAGE>

The following summarizes  transactions  involving SARs granted to key management
during the years ended:

<TABLE>
<CAPTION>
                              December 27, 1998           December 28, 1997         December 29, 1996
                           -------------------------    ----------------------    ----------------------
                            Number       Weighted        Number     Weighted       Number     Weighted
                              of          Average          of        Average         of        Average
                             SARs        Exercise         SARs      Exercise        SARs      Exercise
                                           Price                      Price                     Price
                           ----------   ------------    ---------   ----------    ---------   ----------
<S>                        <C>             <C>          <C>            <C>         <C>           <C>
Outstanding,
    beginning of
    period                 235,660         $20.35       121,330        $24.32
    Granted                      -              -       122,330        $16.64      121,330        $24.32
Forfeited                   84,920         $20.63         8,000        $23.82            -             -
                           -------                      -------                    -------
Outstanding, end of
    period                 150,740         $20.19       235,660        $20.35      121,330        $24.32
Exercisable, end of
    period                  61,917         $21.26        28,585        $24.28            -             -
</TABLE>

SARs, when granted,  are granted at amounts that approximate market value at the
date of the grant.  Awards,  when made,  vest 25 percent per year for four years
and have a term of 10 years.  Compensation expense (income) is recorded based on
the   period-ending   stock  price  in  relation  to  the  SAR  exercise  price.
Compensation  expense (income) recorded in 1998, 1997 and 1996 was $(184), $(34)
and $220, respectively. Redemption of the SARs, when exercised, will be in cash.

DEFERRED COMPENSATION PLAN

The Company  adopted a Paragon Trade Brands,  Inc.  Deferred  Compensation  Plan
("DCP")  in  April  1997.  The  DCP  was  an  unfunded,  non-qualified  deferred
compensation  plan under which eligible  employees of the Company and members of
the Board of Directors could elect, on a voluntary basis, to defer  compensation
until  retirement  or  termination  from  the  Company  or the  Board.  Eligible
participants   were  selected  for  participation  by  a  committee  (the  "Plan
Committee") which consisted of the Board or a committee  appointed by the Board.
As of December  31, 1997,  the DCP was  terminated  and no further  compensation
deferrals were permitted under the DCP.

Under the DCP,  eligible  participants  could elect to defer up to 50 percent of
their annual base salary, up to 100 percent of their annual bonus or, in case of
the directors,  up to 100 percent of their director fees. A participant would be
fully vested in their elective deferrals.  If a participant were employed at the
end of the calendar year, the Company would credit the participant's  account 50
percent  of  their   elective   deferrals  not  to  exceed  25  percent  of  the
participant's  combined  base  salary and annual  bonus for the  calendar  year.
Participants  would become fully vested in the Company  contribution  after five
years of service with the Company.

Participants,  at the discretion of the Plan Committee, could request that their
account be invested in one or more Measurement  Funds,  which were chosen by the
Plan  Committee and were based on one or more mutual  funds.  To the extent that
the  request  was  approved  by the Plan  Committee,  the  funds  credited  to a
participant's  account  would be  adjusted  to reflect  gain,  loss,  income and
expense as though the account had  actually  been  invested in such  Measurement
Funds. In this regard, the Company also adopted in April 1997 a so called "rabbi
trust" known as the Paragon Trade Brands, Inc. Deferred Compensation Plan Master
Trust  Agreement (the "Trust  Agreement")  with Wachovia  Bank,  N.A. as Trustee
which was  intended to serve as a funding  vehicle for the DCP.  However,  as of
December  28,  1997,  the Company had not  transferred  any funds to the Trustee
under the Trust Agreement.  The expense recorded for the DCP was $16 and $247 in
the years ended December 27, 1998 and December 28, 1997, respectively.

PROFIT SHARING AND 401(K) PLANS

To further encourage the ownership of common stock by all employees, the Company
maintains the PRISM Plan, formerly known as the Profit Sharing and Savings Plan,
that  offers  both  profit  sharing  and 401(k)  features.  There were no profit
sharing  contributions  made during the fiscal  year ended  December  27,  1998.
Profit sharing

                                    Page 54
<PAGE>

contributions  made during the fiscal years ended December 28, 1997 and December
29, 1996  consisted of 110,520 and 29,613 shares of common stock,  respectively.
For the years ended  December  27, 1998 and December  28,  1997,  the  Company's
401(k)  contributions  consisted  of 35,292 and 28,915  shares of common  stock,
respectively  and cash. The Company's 401(k)  contributions  consisted of 24,759
shares of common stock for the year ended December 29, 1996.


NOTE 8:    RECEIVABLES

Receivables consist of the following:

<TABLE>
<CAPTION>
                                                   December 27, 1998           December 28, 1997
                                                   -----------------           -----------------
<S>                                                 <C>                          <C>       
Accounts receivable - trade                         $   71,079                   $   52,583
Other receivables                                       16,777                       24,568
                                                    ----------                   ----------
                                                        87,856                       77,151
Less:  Allowance for doubtful accounts                  (8,700)                      (6,535)
                                                    ----------                   ----------
Net receivables                                     $   79,156                   $   70,616
                                                    ==========                   ==========
</TABLE>


NOTE 9:    INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>
                                                  December 27, 1998            December 28, 1997
                                                  -----------------            -----------------
<S>                                                 <C>                           <C>
LIFO:
      Raw materials - pulp                          $      232                    $      381
      Finished goods                                    31,417                        25,770
FIFO:                                             
      Raw materials - other                              7,346                         8,561
      Materials and supplies                            20,924                        20,942
                                                    ----------                    ----------
                                                        59,919                        55,654
      Reserve for excess and obsolete
         items                                          (6,637)                       (7,397)
                                                    ----------                    ----------
Net Inventories                                     $   53,282                    $   48,257
                                                    ==========                    ==========
</TABLE>


NOTE 10:   PROPERTY AND EQUIPMENT

Property and equipment, at cost, are as follows:

<TABLE>
<CAPTION>
                                                  December 27, 1998           December 28, 1997
                                                  -----------------           -----------------
<S>                                                <C>                           <C>       
Land                                               $     3,715                   $    3,741
Buildings and improvements                              40,150                       40,191
Machinery and equipment                                227,433                      226,951
                                                   -----------                   ----------
                                                       271,298                      270,883
Less:  Allowance for depreciation                     (165,098)                    (152,500)
                                                   -----------                   ----------
Net property and equipment                         $   106,200                   $  118,383
                                                   ===========                   ==========
</TABLE>


                                    Page 55
<PAGE>

NOTE 11:   ACCRUED LIABILITIES

Accrued liabilities are as follows:

<TABLE>
<CAPTION>
                                                  December 27, 1998           December 28, 1997
                                                  -----------------           -----------------
<S>                                                 <C>                          <C>
Payroll - wages and salaries,
    incentive awards, retirement,
    vacation and severance pay                      $   16,977                   $   10,375
Coupons and promotions                                   5,994                        7,826
Integration/relocation reserves                              -                        2,575
Income taxes payable - current                               -                          195
Other                                                   10,675                       11,421
                                                    ----------                   ----------
Total                                               $   33,646                   $   32,392
                                                    ==========                   ==========
</TABLE>


NOTE 12:   BANK CREDIT FACILITIES

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

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

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

At December 27, 1998, there were no outstanding  direct borrowings under the DIP
Credit  Facility.  The Company had an  aggregate  of $1,300 in letters of credit
issued  under the DIP Credit  Facility  at  December  27,  1998.  The DIP Credit
Facility contains customary covenants. The Company for a period of time has been
unable to fully comply with certain  reporting  requirements  of such covenants.
The Company has obtained  waivers with respect to these events of default  which
are  effective  through May 10, 1999.  The Company  believes  that it will be in
compliance with the reporting requirements of the DIP Credit Facility by May 10,
1999.

At  December  28,  1997,  the Company  maintained  a $150,000  revolving  credit
facility with a group of nine financial  institutions available through February
2001.  At December  28,  1997,  borrowings  under this credit


                                    Page 56
<PAGE>

facility totaled $70,000. Borrowings under this credit facility are reflected as
long-term debt in the accompanying  balance sheet at December 28, 1997. Interest
was at fixed or floating  rates  based on the  financial  institution's  cost of
funds. Paragon Trade Brands (Canada) Inc. has guaranteed  obligations under this
revolving  credit  facility.  The Company also had access to short-term lines of
credit on an uncommitted  basis with several major banks.  At December 28, 1997,
the Company had approximately $50,000 in uncommitted lines of credit. Borrowings
under these lines of credit  totaled  $12,800 at December 28,  1997.  Borrowings
under these lines of credit  were  reflected  as  short-term  borrowings  in the
accompanying  balance  sheet at December 28, 1997. As a result of the Chapter 11
filing,  the  Company is  prohibited  from  paying any  prepetition  liabilities
without  Bankruptcy Court approval.  The Chapter 11 filing resulted in a default
under the Company's  prepetition  revolving  credit  facility and its borrowings
under uncommitted lines of credit.

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

Paragon  Trade Brands  (Canada)  Inc.  entered  into a new $3,000 Cdn  operating
credit facility with a financial institution dated February 11, 1998. Borrowings
under the prior Canadian  revolving credit facility were repaid in full with the
proceeds  from  borrowings  under the new Canadian  operating  credit  facility.
Borrowings  under  this  Canadian  operating  credit  facility  are  secured  by
substantially  all of Paragon Trade Brands  (Canada) Inc.'s assets and will bear
interest at a rate of 1 percent over the financial institution's prime rate. The
Company  does not  guaranty  borrowings  under  the  Canadian  operating  credit
facility.  The maximum  borrowings under the Canadian  operating credit facility
are  limited to the lesser of $3,000 Cdn or 75 percent of Paragon  Trade  Brands
(Canada) Inc.'s trade accounts receivable.  There were no borrowings outstanding
under this operating credit facility on December 27, 1998.


NOTE 13:  LIABILITIES SUBJECT TO COMPROMISE

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

Liabilities subject to compromise are comprised of the following:

<TABLE>
<CAPTION>
                                                       December 27, 1998
                                                       -----------------
<S>                                                         <C> 
Accrued settlement contingencies                            $  278,500
Bank debt                                                       81,397
Accounts payable                                                39,752
Accrued liabilities                                              5,920
Deferred compensation                                            1,290
                                                            ----------
                                                            $  406,859
                                                            ==========
</TABLE>


NOTE 14:   RELATED PARTY TRANSACTIONS

The  Company has entered  into  various  agreements  with its  subsidiaries  and
affiliates to sell certain diaper making equipment and purchase a portion of its
diaper  needs.  Prices for the  various  transactions  are  established  through
negotiations  between  the  related  parties.  The  following  is a  summary  of
significant transactions and balances with its subsidiaries and affiliates as of
or for the years ended  December  27,  1998,  December 28, 1997 and December 29,
1996:

                                    Page 57
<PAGE>

PMI

Pursuant to the Joint  Venture  Agreement  dated  January  26, 1996  whereby the
Company acquired a 49 percent interest in PMI, the Company agreed to sell to PMI
certain diaper manufacturing  equipment,  finance the construction of a building
and purchase a portion of its diaper needs from PMI.

<TABLE>
<CAPTION>
                                    December 27, 1998      December 28, 1997         December 29, 1996
                                    -----------------      -----------------         -----------------
<S>                                 <C>                    <C>                       <C>          
Sale of equipment                   $           -          $         194             $      14,650
Purchase of diapers from PMI        $      67,346          $      40,823             $      11,860
Due from PMI                        $      43,381          $      39,725             $      27,857
Due to PMI                          $       7,340          $       5,313             $           -
</TABLE>

The amounts due from PMI are primarily for equipment purchased, the financing of
the building  construction and working capital funding. They are evidenced by an
interest-bearing  promissory note and  corresponding  Purchase Loan and Security
Agreements. The amounts due under these agreements are carried as investments in
and advances to  unconsolidated  subsidiaries,  at equity on the balance  sheet.
Amounts due to PMI are carried as accounts  payable and  liabilities  subject to
compromise  on  the  balance  sheets.  Loans  due  from  PMI  are  evidenced  by
interest-bearing promissory notes. The notes bore an interest rate of 10 percent
until  December  1,  1997.  The  notes   currently  bear  an  interest  rate  of
approximately 6 percent.

MABESA

The Company has purchased certain diaper product needs from Mabesa and also sold
excess diaper making equipment to Mabesa.

<TABLE>
<CAPTION>
                                                        December 27, 1998       December 28, 1997
                                                        -----------------       -----------------
<S>                                                           <C>                 <C>
Sale of equipment                                             $       -           $    4,843
Purchase of diapers from Mabesa                               $   1,733           $    2,196
Due from Mabesa                                               $   2,732           $    3,623
Due to Mabesa                                                 $     312           $      119
</TABLE>

The  amounts  due  from  Mabesa  for  equipment   purchased  are  classified  as
receivables on the balance  sheets.  The amounts due to Mabesa are classified as
accounts  payable and  liabilities  subject to compromise on the balance sheets.
Depending on the expected payment terms under the purchase  agreements,  certain
amounts due bear an interest rate of approximately 7 percent.

MPC

The Company has sold certain diaper making equipment to MPC.

<TABLE>
<CAPTION>
                                                        December 27, 1998    December 28, 1997
                                                        -----------------    -----------------
<S>                                                           <C>              <C>       
Sale of equipment and technology transfer                     $       -        $    2,400
Due from MPC                                                  $     287        $    2,000
</TABLE>

The amounts due from MPC for equipment  purchased are  classified as receivables
on the balance  sheets.  The loan to MPC,  which bore an interest  rate of LIBOR
plus 4 percent, was converted into an additional capital contribution in 1998.

                                    Page 58
<PAGE>

GOODBABY

The Company has sold certain diaper making equipment to Goodbaby.

<TABLE>
<CAPTION>
                                                         December 27, 1998    December 28, 1997
                                                         -----------------    -----------------
<S>                                                           <C>                 <C>       
Sale of equipment                                             $       -           $    2,415
Due from Goodbaby                                             $   1,182           $    2,710
</TABLE>

The amounts due from  Goodbaby  are  classified  as  receivables  on the balance
sheets.

At December 27, 1998 and December  28, 1997,  the Company had deferred  gains on
the sales of equipment of $3,927 and $4,583,  respectively.  These gains will be
amortized to income over the depreciable life of the equipment.


NOTE 15:   LEGAL PROCEEDINGS

THE PROCTER & GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC. - P&G filed a lawsuit
in January 1994 in the District Court for the District of Delaware alleging that
the Company's "Ultra" infant  disposable diaper products  infringed two of P&G's
dual cuff diaper patents.  The lawsuit sought injunctive relief, lost profit and
royalty  damages,  treble  damages and  attorneys'  fees and costs.  The Company
denied liability under the patents and  counterclaimed  for patent  infringement
and  violation  of  antitrust  laws by P&G. In March 1996,  the  District  Court
granted  P&G's motion for summary  judgment to dismiss the  Company's  antitrust
counterclaim.  The trial was completed in February 1997,  the parties  submitted
post-trial  briefs and closing  arguments  were  conducted  on October 22, 1997.
Legal fees and costs for this litigation have been significant.

On December 30, 1997, the Delaware  District Court issued a Judgment and Opinion
finding that P&G's dual cuff patents were valid and infringed, while at the same
time finding the Company's patent to be invalid, unenforceable and not infringed
by P&G's  products.  Judgment  was  entered  on  January  6,  1998.  Damages  of
approximately  $178,400 were entered  against  Paragon by the District  Court on
June 2, 1998. At the same time,  the District  Court entered  injunctive  relief
agreed upon by P&G and the Company.

The Company had previously  filed with the District Court a motion under Rule 59
for a new trial or to alter or amend the  Judgment.  The  District  Court denied
Paragon's motion by order entered August 4, 1998. The District Court also denied
a motion by P&G seeking to recover  attorneys'  fees it  expended  in  defending
itself against Paragon's patent  infringement  counterclaim.  On August 4, 1998,
the Company filed with the Federal  Circuit Court of Appeals its amended  notice
of appeal.  The appeal was fully  briefed,  and oral  argument was scheduled for
February 5, 1999.

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

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

                                    Page 59
<PAGE>

P&G filed alleged claims in the Company's Chapter 11  reorganization  proceeding
ranging from  approximately  $2,300,000  (without  trebling) to $6,500,000 (with
trebling),  which  included a claim of $178,400 for the Delaware  judgment.  See
"--IN RE PARAGON TRADE BRANDS, INC.," below. The remaining claims include claims
for, among other things,  alleged patent  infringement by the Company in foreign
countries where it has operations.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition claim of $158,500 and an allowed  administrative claim of
$5,000.  As a part of the  settlement,  the  Company has  entered  into  License
Agreements  for the U.S.  and  Canada,  which  are  exhibits  to the  Settlement
Agreement,  with respect to certain of the patents  asserted by P&G in its proof
of claim, including those asserted in the Delaware Action. The U.S. and Canadian
patent  rights  licensed by the Company will allow the Company to  manufacture a
dual cuff baby diaper  design.  In exchange  for these  rights,  the Company has
agreed to pay P&G running  royalties on net sales of the licensed products equal
to 2 percent through October 2005, .75 percent  thereafter  through October 2006
and .375  percent  thereafter  through  March  2007 in the  U.S.;  and 2 percent
through  October  2008 and 1.25  percent  thereafter  through  December  2009 in
Canada.  The Settlement  Agreement also provides,  among other things,  that P&G
will grant the Company and/or its affiliates "most favored licensee" status with
respect to patents owned by P&G on the date of the  Settlement  Agreement or for
which an  application  was pending on that date.  In  addition,  the Company has
agreed with P&G that prior to litigating any future patent dispute,  the parties
will engage in good faith negotiations and will consider arbitrating the dispute
before resorting to litigation.

The Company believes that the royalty rates being charged by P&G,  together with
royalties to be paid to K-C described above, will have a material adverse impact
on the Company's future financial condition and results of operations.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have
objected  to the P&G  settlement.  The  Company  intends to  continue  to pursue
approval  of the  P&G  Settlement  by  the  Bankruptcy  Court.  Should  the  P&G
Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by
July 31,  1999,  however,  the License  Agreements  described  above will become
terminable  at P&G's  option.  The  Company  cannot  predict  when,  or if, such
approval will be granted.

KIMBERLY-CLARK CORPORATION V. PARAGON TRADE BRANDS, INC. -- On October 26, 1995,
K-C filed a lawsuit against the Company in U.S. District Court in Dallas, Texas,
alleging  infringement by the Company's  products of two K-C patents relating to
dual cuffs.  The lawsuit  sought  injunctive  relief,  royalty  damages,  treble
damages and attorneys'  fees and costs.  The Company denied  liability under the
patents and  counterclaimed  for patent  infringement and violation of antitrust
laws by K-C.  Several  pre-trial  motions were filed by each party,  including a
motion for summary judgment filed by K-C with respect to the Company's antitrust
counterclaim  and a motion for summary  judgment  filed by the Company on one of
the patents asserted by K-C. In addition, K-C sued the Company on another patent
issued to K-C which is based upon a further  continuation of one of the K-C dual
cuff patents asserted in the case. That action was consolidated with the pending
action.  The Court  appointed a special  master to rule on the  various  pending
motions.  Legal  fees and costs in  connection  with this  litigation  have been
significant.

As a result of the  Company's  Chapter 11  filing,  the  proceedings  in the K-C
litigation were stayed.  The Bankruptcy  Court issued an order on April 10, 1998
permitting,  among  other  things,  a partial  lifting  of the stay to allow the
issuance of the special  master's  report on the items under his  consideration.
K-C  filed  with  the


                                    Page 60
<PAGE>

Bankruptcy Court a motion for  reconsideration  of the Bankruptcy  Court's April
10, 1998 order,  which was denied on June 15, 1998. K-C has appealed this denial
of  reconsideration  to the District Court for the Northern District of Georgia.
The Company  objected to K-C's Appeal and sought to have it dismissed.  K-C also
filed a motion with the District Court in Atlanta to withdraw the reference with
respect to all matters pertaining to its proof of claim from the jurisdiction of
the Bankruptcy  Court.  By order executed  February 18, 1999, the appeal,  K-C's
motion for  withdrawal of the reference and the Company's  motion to dismiss the
appeal were  dismissed by the District  Court without  prejudice to the right of
either party  within  sixty days to re-open the actions if a settlement  was not
consummated. See "--IN RE PARAGON TRADE BRANDS, INC." below.

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

Effective September 1, 1998, the Texas action was reassigned to Judge Lindsey, a
newly-appointed  judge on the Dallas  District Court bench.  Judge Lindsey asked
the  parties  to  report  on the  status  of the  case  and  the  likelihood  of
settlement.  The parties  responded on November 6, 1998, that  negotiations were
underway and that they believed considerable progress was being made.

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

K-C filed alleged claims in the Company's Chapter 11  reorganization  proceeding
ranging from  approximately  $893,000  (without  trebling) to  $2,300,000  (with
trebling). See "--IN RE PARAGON TRADE BRANDS, INC.," below.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C  an  allowed  unsecured   prepetition  claim  of  $110,000  and  an  allowed
administrative  claim of $5,000.  As a part of the  settlement,  the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with  respect to the patents  asserted in the Texas
action.  In addition,  the patent  rights  licensed by the Company from K-C will
allow the Company to  manufacture  a dual cuff diaper  design.  In exchange  for
these patent rights,  the Company has agreed to pay K-C annual running royalties
on net sales of the  licensed  products  in the U.S.  and  Canada  equal to: 2.5
percent of the first $200,000of net sales of the covered diaper products and 1.5
percent of such net sales in excess of $200,000 in each calendar year commencing
January 1999 through November 2004. In addition, the Company has agreed to pay a
minimum  annual  royalty  for diaper  sales of $5,000,  but  amounts  due on the
running royalties will be offset against this minimum. The Company will also pay
K-C  running  royalties  of 5 percent  of net  sales of  covered  training  pant
products  for the same  period,  but there is no minimum  royalty  for  training
pants. As part of the settlement, the Company has granted a royalty-free license
to K-C for three  patents  which the  Company in the Texas  action  claimed  K-C
infringed.

The Company  believes that the overall  effective  royalty rate that the Company
will pay to K-C will, together with royalties to be paid to P&G described above,
have a material adverse impact on the Company's  future financial  condition and
results of operations

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of  super-absorbent  polymers ("SAP") in
diapers  and  training  pants,  so long as the Company  uses SAP which  exhibits
certain  performance  characteristics  (the "SAP Safe Harbor").  The Company has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased  marketing and selling,  general and administrative  expenses


                                    Page 61
<PAGE>

("SG&A")  expenditures  in 1999 to address  product  performance  issues.  These
increased  expenditures  are expected to have a material  adverse  impact on the
Company's  financial  position and results of operations in 1999. The Company is
encountering increased product costs due to the increased price and usage of the
new SAP.  While the  Company  is working  diligently  with its SAP  supplier  to
develop  a better  performing  alternative  which is still  within  the SAP Safe
Harbor,  the  Company  cannot  predict  at this  time  whether  or when  such an
alternative  SAP would be available.  The Company  expects that these  increased
product costs will have a material adverse impact on its financial condition and
results of operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted.

IN RE PARAGON TRADE BRANDS,  INC. -- As described  above,  on December 30, 1997,
the  Delaware  District  Court  issued a Judgment  and Opinion in the  Company's
lawsuit with P&G which  found,  in essence,  two of P&G's  diaper  patents to be
valid and infringed by the Company's "Ultra" disposable baby diapers, while also
rejecting  the Company's  patent  infringement  claim against P&G.  Judgment was
entered on January 6, 1998.  While a final damages number was not entered by the
District  Court  until  June 2,  1998,  the  Company  originally  estimated  the
liability and associated  litigation  costs to be  approximately  $200,000.  The
amount of the  award  resulted  in  violation  of  certain  covenants  under the
Company's bank loan  agreements.  As a result,  the issuance of the Judgment and
the uncertainty it created caused an immediate and critical  liquidity issue for
the Company which necessitated the Chapter 11 filing.

Subsequently,  damages of approximately $178,400 were entered against Paragon by
the District Court on June 2, 1998. At the same time, the District Court entered
injunctive  relief  agreed  upon by P&G and the  Company.  See "--THE  PROCTER &
GAMBLE COMPANY V. PARAGON TRADE BRANDS, INC.," above.

The Chapter 11 filing prevented P&G from placing liens on the Company's  assets,
permitted  the  Company to appeal the  District  Court's  decision in an orderly
fashion  and  affords the Company  the  opportunity  to resolve  liquidated  and
unliquidated  claims  against the  Company,  which arose prior to the Chapter 11
filing. The Company is currently operating as a  debtor-in-possession  under the
Bankruptcy  Code.  The bar date for the  filing of  proofs  of claim  (excluding
administrative  claims) by creditors was June 5, 1998.  P&G filed alleged claims
ranging from  approximately  $2,300,000  (without  trebling) to $6,500,000 (with
trebling),  which  included a claim of $178,400 for the Delaware  judgment.  See
"--THE  PROCTER & GAMBLE  COMPANY V. PARAGON  TRADE BRANDS,  INC.,"  above.  The
remaining  claims  include  claims  for,  among  other  things,  alleged  patent
infringement by the Company in foreign countries where it has operations.

On February 2, 1999,  the Company  entered into a Settlement  Agreement with P&G
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Delaware  Judgment,  the Company's appeal of the Delaware
Judgment,  P&G's motion to find the Company in contempt of the Delaware Judgment
and  P&G's  proof of claim  filed in the  Company's  Chapter  11  reorganization
proceeding.  As a part of the P&G  settlement,  Paragon  grants  P&G an  allowed
unsecured  prepetition claim of $158,500 and an allowed  administrative claim of
$5,000.  As a part of the  settlement,  the  Company has  entered  into  License
Agreements  for the U.S.  and  Canada,  which  are  exhibits  to the  Settlement
Agreement,  with  respect to the patents  asserted by P&G in its proof of claim,
including  those asserted in the Delaware  Action.  The U.S. and Canadian patent
rights licensed by the Company will allow the Company to manufacture a dual cuff
baby diaper design. In exchange for these rights,  the Company has agreed to pay
P&G running  royalties on net sales of the licensed  products equal to 2 percent
through  October  2005,  .75 percent  thereafter  through  October 2006 and .375
percent thereafter through March 2007 in the U.S.; and 2 percent through October
2008 and 1.25 percent thereafter through December 2009 in Canada. The Settlement
Agreement  also  provides,  among other things,  that P&G will grant the Company
and/or its  affiliates  "most favored  licensee"  status with respect to patents
owned by P&G on the date of the Settlement Agreement or for which an application
was  pending on that date.  In  addition,  the  Company has agreed with P&G


                                    Page 62
<PAGE>

that prior to litigating any future patent  dispute,  the parties will engage in
good  faith  negotiations  and will  consider  arbitrating  the  dispute  before
resorting to litigation.

The Company believes that the royalty rates being charged by P&G,  together with
royalties to be paid to Kimberly-Clark Corporation ("K-C") described below, will
have a material adverse impact on the Company's  future financial  condition and
results of operations.

Under the terms of the P&G  Settlement  Agreement,  the  Company and P&G jointly
requested  modification of the injunction  entered in Delaware District Court so
as to allow the Company to begin  converting  to a dual cuff design  pursuant to
the License Agreements described above. The injunction was modified as requested
on February 22, 1999 and the product  conversion is substantially  complete.  As
also  provided  under the terms of the P&G  Settlement  Agreement,  once a Final
Order, as defined  therein,  has been entered by the Bankruptcy  Court approving
the  settlement,  the Company will  withdraw  with  prejudice  its appeal of the
Delaware  Judgment to the Federal Circuit,  and P&G will withdraw with prejudice
its motion in  Delaware  District  Court to find the  Company in contempt of the
Delaware  Judgment.  A hearing on the Company's motion to seek approval from the
Bankruptcy  Court of this  settlement was commenced on March 22 and 23, 1999 and
is scheduled to resume on April 13, 1999. Both the Equity Committee and K-C have
objected  to the P&G  settlement.  The  Company  intends to  continue  to pursue
approval  of the  P&G  Settlement  by  the  Bankruptcy  Court.  Should  the  P&G
Settlement Agreement not be approved by a Final Order of the Bankruptcy Court by
July 31,  1999,  however,  the License  Agreements  described  above will become
terminable  at P&G's  option.  The  Company  cannot  predict  when,  or if, such
approval will be granted.

K-C filed alleged claims ranging from approximately  $893,000 (without trebling)
to $2,300,000 (with trebling), including claims related to the litigation in the
Dallas  District Court described  above.  See  "--KIMBERLY-CLARK  CORPORATION V.
PARAGON TRADE BRANDS,  INC.," above. K-C's claims in the Bankruptcy case include
an attempt to recover  alleged  lost  profits  for  infringement  of the patents
asserted in the Dallas  District  Court,  despite  the fact that a lost  profits
theory of damages was not pursued by K-C in the Dallas District Court.

On March 19, 1999,  the Company  entered into a  Settlement  Agreement  with K-C
which,  if approved by the Bankruptcy  Court,  will fully and finally settle all
matters related to the Texas action, including the Company's counterclaims,  and
K-C's  proof  of  claim  filed  in  the  Company's   Chapter  11  reorganization
proceeding.  Under the terms of the K-C Settlement Agreement, the Company grants
K-C  an  allowed  unsecured   prepetition  claim  of  $110,000  and  an  allowed
administrative  claim of $5,000.  As a part of the  settlement,  the Company has
entered into License  Agreements for the U.S. and Canada,  which are exhibits to
the  Settlement  Agreement,  with  respect to the patents  asserted in the Texas
action.  In addition,  the patent  rights  licensed by the Company from K-C will
allow the Company to  manufacture  a dual cuff diaper  design.  In exchange  for
these patent rights,  the Company has agreed to pay K-C annual running royalties
on net sales of the  licensed  products  in the U.S.  and  Canada  equal to: 2.5
percent of the first  $200,000 of net sales of the covered  diaper  products and
1.5  percent  of such net sales in  excess of  $200,000  in each  calendar  year
commencing  January 1999 through  November  2004.  In addition,  the Company has
agreed to pay a minimum annual  royalty for diaper sales of $5,000,  but amounts
due on the running  royalties will be offset  against this minimum.  The Company
will  also pay K-C  running  royalties  of 5  percent  of net  sales of  covered
training pant products for the same period,  but there is no minimum royalty for
training  pants.  As  part  of  the  settlement,   the  Company  has  granted  a
royalty-free  license to K-C for three  patents  which the  Company in the Texas
action claimed K-C infringed.

The Company believes that the overall  effective  royalty rates that the Company
will pay to K-C will, together with royalties to be paid to P&G described above,
have a material adverse impact on the Company's  future financial  condition and
results of operations.

As a part of the K-C License Agreement, K-C has agreed not to sue the Company on
two of K-C's patents related to the use of SAP in diapers and training pants, so
long  as the  Company  stays  within  the  SAP  Safe  Harbor.  The  Company  has
experienced  certain  product  performance  issues the Company  believes  may be
related  to such SAP.  As a  result,  the  Company  expects  that it will  incur
increased marketing and SG&A expenditures in 1999 to address product performance
issues.  These increased  expenditures  are expected to have a material  adverse
impact on the  Company's  financial  position and results of operations in 1999.
The Company is encountering  increased  product costs due to the increased price
and usage of the new SAP. While the Company is working  diligently  with its SAP
suppliers to develop a better  performing  alternative which is still within the
SAP Safe


                                    Page 63
<PAGE>

Harbor,  the  Company  cannot  predict  at this  time  whether  or when  such an
alternative  SAP would be available.  The Company  expects that these  increased
product costs will have a material adverse impact on its financial condition and
results of operations for at least 1999 and potentially beyond.

Upon the Effective  Date, as defined in the K-C Settlement  Agreement,  K-C will
dismiss with prejudice its complaint in the Texas action, as well as its related
filings in the District  Court in Georgia,  and the Company will  simultaneously
dismiss  with  prejudice  its  counterclaims  in the Texas  action.  The Company
intends to file shortly a motion with the  Bankruptcy  Court to seek approval of
the settlement.  If the K-C Settlement  Agreement is not approved by an order of
the Bankruptcy  Court entered  before August 1, 1999, the K-C License  Agreement
described above will terminate automatically.  The Company intends to vigorously
pursue  approval of the settlement but cannot predict when, or if, such approval
will be granted.

On  February  17,  1999,  the  Company,  P&G,  K-C,  the  Creditors'  and Equity
Committees  stipulated  to an extension of the Company's  exclusivity  period to
April  19,  1999  during  which  time  only the  Company  can  propose a plan of
reorganization.  On March 29, 1999, the Company filed a motion seeking to extend
this period,  initially, to May 19, 1999 and, subsequently,  to June 19, 1999. A
hearing on this motion is scheduled to occur on April 16, 1999.

On January 30, 1998, the Company received Bankruptcy Court approval of a $75,000
financing  facility  with a bank  group led by The Chase  Manhattan  Bank.  This
facility is designed to supplement the Company's cash on hand and operating cash
flow and to permit  the  Company to  continue  to operate  its  business  in the
ordinary  course.  As of December 27,  1998,  there were no  outstanding  direct
borrowings  under this  facility.  The  Company  had an  aggregate  of $1,300 in
letters of credit issued under the DIP Credit Facility at December 27, 1998. The
DIP Credit Facility contains  customary  covenants.  The Company for a period of
time has been unable to fully comply with certain reporting requirements of such
covenants.  The Company has  obtained  waivers  with  respect to these events of
default which are effective  through May 10, 1999. The Company  believes that it
will be in compliance with the reporting requirements of the DIP Credit Facility
by May 10,  1999.  See Note 12.  Legal  fees and  costs in  connection  with the
Chapter 11 case have been and will  continue to be  significant.  The Company is
unable to predict at this time when it will emerge from Chapter 11 protection.

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


NOTE 16:   COMMITMENTS

Paragon has operating lease agreements for certain facilities that expire during
the years 1999 through 2001.  Future minimum lease payments required under these
noncancelable  operating leases are: $391 in 1999, $134 in 2000 and $46 in 2001.
Rental expense for  facilities  and equipment was $2,676,  $3,015 and $2,967 for
the years ended  December  27,  1998,  December  28, 1997 and December 29, 1996,
respectively.

Commitments for capital expenditures as of December 27, 1998 are $13,780.  Other
Company commitments include purchase commitments for raw materials at prevailing
market rates. In early 1996, the Company entered into an agreement with Clariant
International  Ltd.  (subsequently  purchased  by BASF  Corporation)  whereby it
agreed,  subject  to  certain  limitations,  to  purchase  100  percent  of  its
requirements of SAP through  December 31, 2001.  Fluff pulp, a product made from
wood fibers,  is another  primary raw  material.  The Company's  agreement  with
Weyerhaeuser  whereby it purchased 100 percent of its  requirements  of bleached
chemical fluff pulp expired August 31, 1998. The Company  believes that at least
two other sources of supply exist for fluff pulp.

As a result of the Chapter 11 filing,  the Company is prohibited from paying any
prepetition  liabilities.  Pursuant to the Bankruptcy Code, the Company can seek
Bankruptcy Court approval for the rejection of executory  contracts or unexpired
leases,  including real property  leases.  Any such rejection may give rise to a
prepetition unsecured claim for damages arising therefrom.

                                    Page 64
<PAGE>


NOTE 17:   NET EARNINGS PER COMMON SHARE

Following is a  reconciliation  of the numerators and  denominators of the basic
and diluted earnings (loss) per common share:

<TABLE>
<CAPTION>
                                                                    Year Ended
                                             --------------------------------------------------------
                                             December 27, 1998   December 28, 1997  December 29, 1996
                                             -----------------   -----------------  -----------------
<S>                                             <C>                 <C>                <C>        
Net earnings (loss)                             $  (65,838)         $ (212,717)        $    21,122
                                                ==========          ==========         ===========
Weighted average number of common
    shares used in basic EPS (000's)               11,9387              11,913              12,022
Effect of dilutive securities:
    Stock options (000's)                                -                   -                 139
                                                ----------          ----------         -----------

Weighted average number of common
    shares and potentially dilutive
    common shares in diluted EPS (000's)            11,937              11,913              12,161
                                                ==========          ==========         ===========
Basic earnings (loss) per common share          $    (5.48)         $   (17.86)        $      1.76
Diluted earnings (loss) per common share        $    (5.48)         $   (17.86)        $      1.74
</TABLE>

Options  to  purchase  699,491,  313,612  and  223,987  shares of  common  stock
outstanding  during the years ended  December  27,  1998,  December 28, 1997 and
December 29, 1996,  respectively,  were not included in the calculation  because
the options'  exercise  price was greater  than the average  market price of the
common shares.

Diluted and basic  earnings per share are the same for the years ended  December
27, 1998 and December 28, 1997 because the  computation of diluted  earnings per
share was anti-dilutive.


NOTE 18:   SEGMENT REPORTING

Basis of Presentation. The Company operates principally in two segments that are
organized  based on the nature of the  products  sold:  (i) infant care and (ii)
feminine care and adult  incontinence.  Each operating  segment contains closely
related  products  that are unique to that  particular  segment.  The results of
Changing  Paradigms,  Inc. and the Company's  international  investment in joint
ventures in Mexico,  Argentina,  Brazil and China are reported in the  corporate
and other  segment.  Identifiable  assets  included in the  corporate  and other
segment include deferred tax assets, international investments in joint ventures
and cash and other  financial  instruments  managed  by the  corporate  treasury
department.  Inter-segment  net sales are not  significant.  Segment  accounting
policies are the same as those described in Note 2.

Management  evaluates the  performance of its operating  segments  separately to
individually  monitor the different  factors  impacting  financial  performance.
Segment  operating  profit  is  comprised  of net  sales  less cost of sales and
selling,  general  and  administrative  expense.  Loss  contingencies  and asset
impairments are recorded in the appropriate operating segment.

Certain  administrative  expenses common to all operating segments are currently
allocated  to the infant  care  operating  segment.  International  investments,
financial  costs,  such as interest  income and  expense,  and income  taxes are
managed by, and recorded in, the corporate and other operating segment.

                                    Page 65
<PAGE>

Corporate  and  other  capital  expenditures  include  substantially  all of the
Company's   spending  for  Year  2000  and   information   technology.   Related
depreciation and amortization is allocated to each operating segment.


<TABLE>
<CAPTION>
                                                                   Feminine
                                                                   Adult/Care    Corporate/
1998                                               Infant Care   Incontinence       Other         Total
----                                               -----------   ------------       -----      ----------
<S>                                                 <C>            <C>           <C>           <C>      
  Net sales                                         $ 512,759      $   6,608     $  15,840     $ 535,207
  Operating profit (loss)                             (42,209)(1)    (16,916)(2)     1,149       (57,976)
  Equity in earnings of unconsolidated                      -              -         4,077         4,077
  subsidiaries
  Dividend income from unconsolidated subsidiary            -              -           922           922
  Interest expense                                          -              -           450           450
  Other income                                              -              -         2,437         2,437
  Earnings (loss)before income taxes and
  bankruptcy costs                                    (42,209)       (16,916)        8,135       (50,990)
  Identifiable assets                                 245,772         39,614        55,118       340,503
  Investments                                               -              -        88,783        88,784
  Capital expenditures                                 24,410          1,256        11,655        36,453
  Depreciation and amortization                        29,536          4,742           181        34,459


                                                                    Feminine
                                                                   Adult/Care    Corporate/
1997                                               Infant Care   Incontinence       Other         Total
----                                               -----------   ------------       -----      ----------  
  Net sales                                         $ 545,225      $   4,264     $  12,486     $ 561,975
  Operating profit (loss)                            (154,989)(3)    (23,721)(4)    (5,078)(5)  (183,788)
  Equity in earnings of unconsolidated                      -              -           953           953
  subsidiaries
  Dividend income from unconsolidated subsidiary            -              -         1,055         1,055
  Interest expense                                          -              -         4,667         4,667
  Other income                                              -              -         1,664         1,664
  Earnings (loss) before income taxes                (154,989)       (23,721)       (6,073)     (184,783)
  Identifiable assets                                 234,707         45,540        22,087       302,334
  Investments                                               -              -        73,808        73,808
  Capital expenditures                                 31,607         12,415        11,013        55,035
  Depreciation and amortization                        33,127          2,294            93        35,514


                                                                   Feminine
                                                                   Adult/Care    Corporate/
1996                                               Infant Care   Incontinence       Other         Total
----                                               -----------   ------------       -----      ----------
  Net sales                                         $ 574,297      $     470     $   7,162      $ 581,929
  Operating profit (loss)                              52,852(6)      (7,999)       (9,184)(7)     35,669
  Equity in earnings of unconsolidated                      -              -           423            423
  subsidiaries
  Interest expense                                          -              -         2,864          2,864
  Other income, net                                         -              -           581            581
  Earnings (loss) before income taxes                  52,852         (7,999)      (11,044)        33,809
  Identifiable assets                                 231,926         36,825        58,324        327,075
  Investments                                               -              -        46,015         46,015
  Capital expenditures                                 15,160         24,223         9,484(8)      48,867
  Depreciation and amortization                        38,187            587            54         38,828

---------------
<FN>
(1)     Includes $78,500 accrued settlement contingency for estimated settlement costs.
(2)     Includes asset impairment of $3,408 related to tampon-related machinery.
(3)     Includes $200,000 accrued settlement contingency for P&G patent litigation.


                                    Page 66
<PAGE>

(4)     Includes asset impairment of $4,442 related to tampon-related machinery.
(5)     Includes $5,000 write-off of software and associated consulting.
(6)     Includes $8,032 in cost for the integration of the Pope & Talbot acquisition.
(7)     Includes $9,005 in costs related to the corporate headquarters relocation to Atlanta.
(8)     Includes $6,844 for purchase of the corporate headquarters in Atlanta.
</FN>
</TABLE>

The  following  table  presents  net sales by  country  based on the  country of
origin, including exports from such countries:

<TABLE>
<CAPTION>
                               1998          1997          1996
                               ----          ----          ----
<S>                           <C>          <C>           <C>      
United States                 $ 497,919    $ 521,487     $ 528,143
Canada                           37,288       40,488        53,786
                              ---------    ---------     ---------
Consolidated                    535,207      561,975       581,929
                              =========    =========     =========
</TABLE>


The following table presents net property, plant and equipment, including assets
held for sale, based on location of the asset:

<TABLE>
<CAPTION>
                               1998          1997          1996
                               ----          ----          ----
<S>                           <C>          <C>           <C>      
United States                 $ 106,705    $ 123,313     $ 122,140
Canada                            4,186        6,143         8,619
                              ---------    ---------     ---------
Consolidated                    110,891      129,456       130,759
                              =========    =========     =========
</TABLE>


NOTE 19:   QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

FISCAL YEAR ENDED DECEMBER 27, 1998

<TABLE>
<CAPTION>
                                                       First        Second        Third         Fourth
                                                       -----        ------        -----         ------
<S>                                                 <C>           <C>          <C>           <C>        
    Net sales                                       $   138,297   $   126,991   $  136,993   $  132,926
    Gross profit                                         27,498        24,647       27,912       26,578
    Net earnings (loss)                                   6,006         3,369        4,024      (78,782)
    Basic earnings (loss) per share of
        common stock                                $       .50   $       .28   $      .34   $    (6.59)
    Diluted earnings (loss) per share of
        common stock                                $       .50   $       .28   $      .34   $    (6.59)
    Price Range of the Company's common stock:
        High                                        $     20.25   $      6.81   $      4.63  $     3.63
        Low                                         $      4.19   $      2.63   $      2.63  $     1.75
</TABLE>


FISCAL YEAR ENDED DECEMBER 28, 1997

<TABLE>
<CAPTION>
                                                       First        Second        Third         Fourth
                                                       -----        ------        -----         ------
<S>                                                 <C>           <C>          <C>           <C>        
    Net sales                                       $   135,685   $   135,819   $  154,066   $   136,405
    Gross profit                                         27,838        23,929       28,601        26,696
    Net earnings (loss)                                   3,802         2,652        5,761      (224,932)
    Basic earnings (loss) per share of
        common stock                                $       .32   $       .22   $      .48   $    (18.82)
    Diluted earnings (loss) per share of
        common stock                                $       .32   $       .22   $      .48   $    (18.82)
    Price Range of the Company's common stock:
        High                                        $     30.00   $     18.00   $     19.13  $     23.50
        Low                                         $     14.88   $     15.25   $     15.38  $     17.50
</TABLE>


                                    Page 67
<PAGE>

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                   PARAGON TRADE BRANDS, INC. AND SUBSIDIARIES
            FOR THE THREE YEARS IN THE PERIOD ENDED DECEMBER 27, 1998
                          (DOLLAR AMOUNTS IN THOUSANDS)


<TABLE>
<CAPTION>
                                                 Balance at    Charged     Deductions      Balance at
                                                  Beginning       to          From          End of
Description                                       of Period    Earnings      Reserve        Period
---------------------------------------------     ---------    --------      --------       ------
<S>                                                <C>          <C>         <C>            <C>
Reserve deducted from related assets:
    Doubtful accounts - accounts receivable

        1998...............................        $  6,535     $  3,787    $  (1,622)     $   8,700
                                                   ========     ========    =========      =========
        1997...............................        $  7,637     $   (587)   $    (515)     $   6,535
                                                   ========     ========    =========      =========
        1996...............................        $  5,866     $  2,965    $  (1,194)     $   7,637
                                                   ========     ========    =========      =========

    Excess and obsolete items - inventories

        1998...............................        $  7,397     $  3,000    $  (3,760)     $   6,637
                                                   ========     ========    =========      =========
        1997...............................        $  7,803     $  6,140    $  (6,546)     $   7,397
                                                   ========     ========    =========      =========
        1996...............................        $  5,051     $  6,841    $  (4,089)     $   7,803
                                                   ========     ========    =========      =========
</TABLE>

                                    Page 68
<PAGE>


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

None.


                                              PART III

ITEM 10:   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS

The following table sets forth certain information regarding the Company's Board
of Directors:

<TABLE>
<CAPTION>
             Name               Age                          Principal Occupation
   -------------------------   -----   ---------------------------------------------------------------
<S>                              <C>     <C>
    Bobby V. Abraham             57      Chief Executive Officer and Chairman of the Board,
                                          Paragon Trade Brands, Inc.
    Adrian D.P. Bellamy          57      Nonexecutive Director of Companies
    Thomas B. Boklund            59      Chief Executive Officer, Oregon Steel Mills
    Robert L. Schuyler           63      Retired
</TABLE>


BOBBY V.  ABRAHAM  has been a director  and the Chief  Executive  Officer of the
Company since its initial public offering in February 1993, has been Chairman of
the  Company's  Board of Directors  since August 1993 and served as President of
the Company from its  inception  until  November  1993.  Prior to the  Company's
initial  public  offering,  Mr.  Abraham had been President of the Personal Care
Products Division of Weyerhaeuser since February 1988.

ADRIAN D.P.  BELLAMY has been a director of the Company since  February 1996 and
has served as a member of the  Compensation  Committee of the Company's Board of
Directors  since  February 1996 and as its Chairman  since  November  1996.  Mr.
Bellamy has also served as a member of the Governance Committee of the Company's
Board of  Directors  and as a member  of the  Company's  Audit  Committee  since
November  1996.  Mr.  Bellamy  formerly  served as Chairman and Chief  Executive
Officer of DFS Group Limited, an international  specialty retailer, from 1983 to
1995. Mr. Bellamy  currently  serves on the Boards of Directors of Airport Group
International  Holdings LLC, an airport  management  company;  The Gap,  Inc., a
clothing  retailer;  Gucci Group NV, a manufacturer and retailer;  The Body Shop
International PLC and its USA subsidiary, Buth-Na-Bodhaige Inc., a skin and hair
care products  manufacturer and retailer;  Williams-Sonoma Inc., a home products
retailer;   Shaman  Pharmaceuticals,   Inc.,  a  pharmaceutical  developer,  and
Benckiser N.V., a home products  company.  Mr. Bellamy has served as Chairman of
Gucci Group NV since January 1996, and Airport Group International  Holdings LLC
since July 1995.

THOMAS B. BOKLUND has been a director of the Company since April 1993 and served
as Chairman of the  Compensation  Committee of the Company's  Board of Directors
from May 1993 until  November  1996.  Mr.  Boklund has served as a member of the
Company's  Audit Committee since November 1996 and as its Chairman from November
1996 to February 1999. Mr. Boklund has also served as a member of the Governance
Committee of the  Company's  Board of Directors  since  November  1996,  and was
appointed its Chairman in February of 1999. Mr. Boklund  continues to serve as a
member of  Compensation  Committee.  Mr.  Boklund  has been the Chief  Executive
Officer of Oregon Steel Mills, an industrial steel manufacturer, since 1985, and
also serves as its Chairman of the Board.

ROBERT L.  SCHUYLER  has been a director  of the  Company  since  April 1993 and
served as Chairman of the Audit  Committee of the  Company's  Board of Directors
from May 1993 until November  1996. Mr.  Schuyler has also served as a member of
the  Compensation  Committee of the Company's  Board of Directors since February
1995,  and as Chairman of the  Governance  Committee of the  Company's  Board of
Directors from November 1996 to February 1999. Mr.  Schuyler  continues to serve
as a member of the Governance Committee,  and was 


                                    Page 69
<PAGE>

reappointed as Chairman of the Audit  Committee in February  1999. Mr.  Schuyler
formerly served as the President of Nisqually  Partners,  an investment company,
from 1991 through 1997. Mr. Schuyler currently serves on the Boards of Montrail,
a manufacturer and wholesaler of outdoor  footwear;  and Grande Alberta Paper, a
Canadian pulp and paper development company.

EXECUTIVE OFFICERS

The  following  table sets forth  certain  information  regarding  the Company's
executive officers:

<TABLE>
<CAPTION>
             Name               Age                                Position
   -------------------------   -----   ---------------------------------------------------------------
<S>                             <C>     <C>
   Bobby V. Abraham             57      Chief Executive Officer and Chairman of the Board
   David W. Cole                51      President, Sales and Marketing
   Alan J. Cyron                46      Executive Vice President and Chief Financial Officer
   Catherine O. Hasbrouck       34      Vice President, General Counsel and Secretary
   Robert E. McClain            49      Executive Vice President - Sales and Marketing
</TABLE>


BOBBY V.  ABRAHAM  has been a director  and the Chief  Executive  Officer of the
Company  since its initial  public  offering  in February  1993 and has been the
Chairman of the Company's Board of Directors since August 1993.

DAVID W. COLE has served the Company as  President,  Sales and  Marketing  since
March 1998. Prior to assuming his current responsibilities,  Mr. Cole had served
the Company as President and Chief Operating Officer from November 1993 to March
1998, and as Executive Vice President and Chief Operating  Officer from February
1993 to November 1993.

ALAN J. CYRON has been the Executive Vice President, Chief Financial Officer and
Assistant  Secretary of the Company since February  1997.  Prior to assuming his
current  responsibilities,  Mr. Cyron had served as Vice  President  since April
1995 and as Treasurer from May through July 1995.  Prior to joining the Company,
Mr. Cyron served as Managing Director of Chemical Securities, Inc., a subsidiary
of Chemical Banking Corp., from January 1992 through March 1995.

CATHERINE  O.  HASBROUCK  has been  the  Vice  President,  General  Counsel  and
Secretary  of the Company  since June 1996.  Prior to joining the  Company,  Ms.
Hasbrouck  practiced law as an associate  with the law firm of Troutman  Sanders
LLP from January 1992 to June 1996.

ROBERT E. MCCLAIN has served the Company as Executive Vice President - Sales and
Marketing since March 1997.  Prior to March 1997, Mr. McClain served the Company
as Vice  President - Business  Development  from  September  1996 to March 1997.
Before joining the Company, Mr. McClain was the Senior Vice President, Sales and
Marketing for Nice Pak Products from 1992 to 1996.


ITEM 11:   EXECUTIVE COMPENSATION

The following table discloses  information  concerning the compensation of those
persons who were,  at December  27,  1998,  the last day of the  Company's  1998
fiscal year, the Company's  Chief  Executive  Officer and four other most highly
compensated executive officers on that date (the "named executive officers").

                                    Page 70
<PAGE>

                                     SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>

                                                                          LONG-TERM
                                       ANNUAL COMPENSATION          COMPENSATION AWARDS
                                       -------------------          -------------------
                                                        OTHER      RESTRICTED  SECURITIES
                                                       ANNUAL         STOCK    UNDERLYING
      NAME AND        FISCAL               BONUS    COMPENSATION    AWARD(S)    OPTIONS/     ALL OTHER
 PRINCIPAL POSITION    YEAR    SALARY($) ($)(1)(2)    ($)(3)        ($)(4)      SARS(#)     COMPENSATION
 ------------------    ----    --------- ---------  ------------    --------    -------     ------------
<S>                    <C>      <C>        <C>         <C>           <C>          <C>         <C>    
Bobby V. Abraham...    1998     519,237    561,004           0             0           0      234,191
  Chief Executive      1997     500,006          0           0             0      30,000      104,885
  Officer and          1996     472,151    525,000     186,590       186,562      30,000      215,382
  Chairman of the 
  Board

David W. Cole......    1998     269,537    224,400       9,230             0           0       18,143
  President            1997     304,954          0      13,985             0      20,000        3,146
                       1996     290,658    221,265      97,244       124,375      20,000       14,459

Alan J. Cyron......    1998     228,422    210,375           0             0           0       16,318
  Executive Vice       1997     206,612          0       4,615             0      15,000        3,158
  President and        1996     193,865    156,450     212,626        49,750      15,000       12,614
  Chief Financial
  Officer

Arrigo D. Jezzi(6).    1998     224,423    210,375           0             0           0       18,289
  Executive Vice       1997     173,679          0      32,179             0      10,000        4,250
  President,
  Operations,
  Technology and
  International

Robert E. McClain .    1998     177,355    196,350           0             0           0       12,974
  Executive Vice
  President, Sales
  and Marketing

------------------
<FN>
(1) As a result of the  Company's  performance  in fiscal 1997,  no annual bonus
payment was made to any of the named executive officers for 1997.

(2) In addition to amounts earned under the Company's Annual Bonus program,  Mr.
McClain earned a sales bonus in the amount of $71,210.

(3)  Messrs.  Cole  and  Cyron  received  tax  gross-up  payments  in  1997  for
reimbursements  by the  Company  of  taxable  relocation  expenses  incurred  in
connection  with their  relocation in 1996 from  Washington to Georgia.  Amounts
paid to Mr.  Jezzi  include  $14,365  for  reimbursement  of taxable  relocation
expenses, $6,904 for reimbursement of nontaxable relocation expenses and $10,190
for tax gross-up  payments,  each made in connection with his relocation in 1997
from Pennsylvania to Georgia. Included in such taxable and nontaxable relocation
expenses  reported above for Mr. Jezzi were $6,583 in payment of moving expenses
and $9,873  reimbursement  for loss on the sale of his  Pennsylvania  residence.
Messrs.  Abraham,  Cole and Cyron  recognized  income in 1997 in the  amounts of
$84,721, $13,748 and $24,825,  respectively, on the difference between the price
paid for shares of the  Company's  common  stock  purchased  in lieu of the 1996
bonus  and the  fair  market  value  of those  shares  on the date of  purchase.
Additional  amounts  paid in 1996  to Mr.  Abraham  were  $64,359,  $12,725  and
$24,786;  to Mr. Cole were $37,035,  $20,733 and $25,728;  and to Mr. Cyron were
$118,250,  $5,579 and $63,971;  in each case, for  reimbursement  of taxable and
nontaxable  relocation  expenses,  and  tax  gross-up  payments,   respectively.
Payments  to  Messrs.  Abraham  and Cole  were made in 1996 in  connection  with
relocation of the Company's  corporate  headquarters from Washington to Georgia.
Payments to Mr. Cyron were made in 1996 in connection  with his relocation  from
New York to Washington as a result of joining the Company in 1995,  and with his
subsequent  relocation from Washington to Georgia.  Included in such taxable and
nontaxable  relocation  expenses  reported above for Mr. Abraham were $29,000 in
payment  of a home sale bonus and  $57,101  in closing  costs on the sale of his
Washington residence; for Mr. Cole were $21,498 in payment of a home sale bonus,
$42,726 in closing costs on the sale of his Washington  residence and


                                    Page 71
<PAGE>

$20,231 in moving  expenses;  and for Mr. Cyron were $41,662 in payment for loss
on the sale of his Washington residence and $40,707 in closing costs on the sale
of his Washington residence.

(4)  Restricted  stock is valued at the  closing  price of the  Common  Stock as
reported on the New York Stock Exchange, Inc. (the "NYSE") on the date of grant.
Restricted  stock awards are forfeitable and vest,  generally,  in either two or
three equal annual installments from the date of grant,  subject to acceleration
in the event of certain mergers or consolidations involving the Company, a sale,
lease,  exchange or other transfer of all or substantially  all of the Company's
assets,  or a  liquidation  or  dissolution  of the Company.  Such awards may be
granted at up to a 20%  discount to the market  price of the Common stock on the
date of award.  A  restricted  stock award in the amount of $186,562 was made in
1996  in  recognition  of  Mr.  Abraham's  efforts  relating  to  the  Company's
acquisition of the Pope & Talbot  disposable  diaper business and the investment
in Mabesa..  A restricted  stock award in the amount of $49,750 was made in 1996
in  recognition  of Mr.  Cyron's  efforts in connection  with the  investment in
Mabesa,  and such award vested 33.4% on February 19, 1997, 33.3% on February 19,
1998 and 33.3% on February 19,  1999. A restricted  stock award in the amount of
$124,375 was made in 1996 in  recognition  of Mr.  Cole's  efforts in connection
with the integration of the Pope & Talbot disposable diaper business.

     Under ordinary  circumstances,  recipients of restricted  stock are able to
pay the tax  liability  arising  upon vesting out of the proceeds of the sale of
Company stock. Since the filing of the Company's Chapter 11 proceeding, however,
certain corporate  insiders have been unable to trade in the Company's stock. As
a result, on January 31, 1999 and February 18, 1999, in order to avoid incurring
a tax  liability  in  connection  with the vesting of certain  restricted  stock
awards,  Mr.  Abraham  forfeited  4,887  shares  awarded  February  1,  1994 and
scheduled  to vest on February 1, 1999,  and 2,500 shares  awarded  February 19,
1996 and scheduled to vest on February 19, 1999;  and on February 18, 1999,  Mr.
Cole forfeited  1,666 shares awarded  February 19, 1996 and scheduled to vest on
February 19, 1999. In addition,  on February 13, 1998, Messrs.  Abraham and Cole
forfeited 22,505 and 13,506 shares of restricted  stock,  respectively,  awarded
February 14, 1995 and  February  19, 1996 and  scheduled to vest on February 16,
1998 and February 19, 1998, respectively.

     On December 27, 1998,  Messrs.  Abraham,  Cole and Cyron held 7,387 shares,
1,666 shares and 666 shares,  respectively,  of restricted  Common  Stock,  with
market values, based on the closing price of the Common Stock as reported on the
NYSE on such date, of $17,544,  $3,957 and $1,582,  respectively.  Dividends are
payable on restricted stock at the same rate payable to all stockholders.

(5)  The  amounts  shown  for  fiscal  1998   represent:   (i)  matching  401(k)
contributions under the Paragon Retirement Savings Investment Management Program
(the "PRISM Plan") in the amounts of $4,250, $4,250, $4,276, $4,396 and $932 for
Messrs.  Abraham,  Cole,  Cyron,  Jezzi and McClain,  respectively;  (ii) profit
sharing  contributions under the PRISM Plan in the amounts of $13,893,  $13,893,
$12,042,  $13,893  and  $12,042  for Messrs.  Abraham,  Cole,  Cyron,  Jezzi and
McClain; and (iii) a $216,048 deferred  compensation award for Mr. Abraham under
the  terms  of his  employment  agreement  and  as  approved  by the  Creditors'
Committee and the Bankruptcy Court.

(6) Mr. Jezzi resigned effective as of April 15, 1999.
</FN>
</TABLE>

1998 OPTION GRANTS AND EXERCISES

There were no option  grants under any of the Company's  incentive  compensation
plans  in  1998.  SEE  "BOARD   COMPENSATION   COMMITTEE   REPORT  ON  EXECUTIVE
COMPENSATION: LONG-TERM INCENTIVES," BELOW.

                                    Page 72
<PAGE>

The following table provides information on the aggregated  option/SAR exercises
by named  executive  officers  in 1998  and the  value  of the  named  executive
officers' unexercised options/SARs at December 27, 1998.

               AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
                                       AND
                          FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                 NUMBER OF SECURITIES
                                                  UNDERLYING UNEXERCISED         NUMBER OF SECURITIES
                         OPTION/SAR                    OPTIONS AT           UNDERLYING UNEXERCISED SARS
                         EXERCISES                  FISCAL YEAR-END(#)          AT FISCAL YEAR END(#)
                         ---------                  ------------------          ---------------------
                           SHARES
                          ACQUIRED
                             ON       VALUE
         NAME             EXERCISE   REALIZED  EXERCISABLE   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
         ----             --------   --------  -----------   -------------   -----------   -------------
<S>                             <C>     <C>      <C>            <C>            <C>            <C>
Bobby V. Abraham......          0       0        170,411        81,249              0              0
David W. Cole.........          0       0         93,750        53,750              0              0
Alan J. Cyron.........          0       0         13,750        36,250              0              0
Arrigo D. Jezzi.......          0       0         20,000             0          7,500         12,500
Robert E. McClain.....          0       0              0             0         22,500         17,500
</TABLE>

<TABLE>
<CAPTION>
                             VALUE OF UNEXERCISED
                          IN-THE -MONEY OPTIONS/SARS
                                      AT
                            FISCAL YEAR-END($)(1)
                            ---------------------
         NAME            EXERCISABLE   UNEXERCISABLE
         ----            -----------   -------------
<S>                           <C>            <C>
Bobby V. Abraham......        0              0
David W. Cole.........        0              0
Alan J. Cyron.........        0              0
Arrigo D. Jezzi.......        0              0
Robert E. McClain.....        0              0

---------------
<FN>

(1) The value of the  options/SARs  on December 27, 1998 is based on the average
of the high and low sales  prices per share of the Common  Stock as  reported on
the NYSE on December 24, 1998 ($2.375).  None of the outstanding options or SARs
were in the money at December 27, 1998.
</FN>
</TABLE>


COMPENSATION OF DIRECTORS

FEES.  Directors  who are  employees  of the Company do not receive any fees for
their services as directors.  Directors who are not employees of the Company are
paid an annual  retainer of $13,000 for  serving on the Board of  Directors  and
$2,500 for serving on a committee of the Board of  Directors.  Each  nonemployee
director receives an additional fee of $1,000 per day for attending each meeting
of the Board of Directors and $750 for attending  each meeting of a committee of
the Board of Directors.  A nonemployee  director serving as a committee chairman
receives an additional $1,000 per annum.

OPTIONS.  Directors who are not employees of the Company are eligible to receive
grants of options to purchase Common Stock under the Company's Stock Option Plan
for Non-Employee  Directors (the "Director Plan"). Under the Director Plan, each
nonemployee director is eligible to automatically  receive an option to purchase
5,000 shares of Common  Stock on the first  business  day  following  his or her
initial  election as a director of the  Company  and  thereafter  is eligible to
receive  annually,  on the first  business day following the date of each annual
meeting of  stockholders  of the Company,  an option to purchase 2,000 shares of
Common Stock, at an


                                    Page 73
<PAGE>

exercise price for all grants equal to the fair market value of the Common Stock
on the date of grant.  The Board  has  suspended  the  Director  Plan  until the
Company emerges from Chapter 11 protection and, as such, no options were granted
to Directors in 1998.

EMPLOYMENT  CONTRACTS,  TERMINATION  OF  EMPLOYMENT   AND  CHANGE - IN - CONTROL
ARRANGEMENTS

CONFIRMATION  RETENTION  PLAN FOR TOP  EIGHT  EXECUTIVES.  In August  1998,  the
Company received  Bankruptcy  Court approval of its Confirmation  Retention Plan
for  Top  Eight  Executives  (the  "Confirmation  Retention  Plan"),  which  had
previously been adopted by the Compensation  Committee of the Company's Board of
Directors  (the  "Committee").  The  Confirmation  Retention Plan is designed to
provide  additional  incentive for the Company's top eight  executives to remain
with  the  Company   through  the   conclusion  of  the  Company's   Chapter  11
reorganization  proceeding and to ensure their continued  dedication and efforts
without undue concern for their personal  financial and  employment  security in
order to expedite the Company's  emergence from Chapter 11. In  particular,  the
Confirmation Retention Plan includes a bonus payable to the top eight executives
upon emergence from Chapter 11 (the "Confirmation Bonus") and enhanced severance
protection, as described below.

In  conjunction  with the  Confirmation  Retention  Plan,  each of the top eight
executives of the Company,  including Mr. Abraham and the other named  executive
officers,  entered into  Employment  Agreements  with the Company which provide,
among other  things,  that the  executives  are eligible to  participate  in the
Confirmation  Retention Plan.  These Employment  Agreements  supersede any prior
employment agreement that any of the top eight executives had with the Company.

Under the Confirmation Retention Plan, the Company shall be obligated to pay the
Confirmation  Bonus to the eligible  executives  upon  confirmation of a plan of
reorganization  by the  Bankruptcy  Court.  In order to  receive a  Confirmation
Bonus, an executive must (i) be an active employee of the Company on the date of
confirmation  of a plan by the  Bankruptcy  Court,  and (ii)  must not have been
terminated for Cause,  as defined in the  Confirmation  Retention  Plan, or have
voluntarily  resigned from  employment  on or before the date such  Confirmation
Bonus is paid.  Notwithstanding the foregoing, if an executive's employment with
the Company is terminated by reason of death,  retirement or  disability,  or if
the executive is terminated  for any reason other than Cause,  as defined in the
Confirmation  Retention Plan, the Executive shall receive the Confirmation Bonus
if such  termination  occurs  no  earlier  than  three  (3)  months  before  the
confirmation of a plan of  reorganization.  If such termination occurs more than
three (3) moths before the confirmation of a plan of reorganization,  the Board,
as defined in the  Confirmation  Retention  Plan,  shall have the  discretion to
award the executive a pro-rata portion of his or her Confirmation Bonus.

The  Confirmation  Bonus  for  each  eligible  executive  shall  be equal to the
executive's then base salary plus any amounts for which the executive  qualified
under the Company's 1998 Bonus Plan , subject to  enhancement  based on the date
the  Bankruptcy  Court  confirms  a  plan  of  reorganization.   If  a  plan  of
reorganization  is confirmed on or before May 15, 1999, the  Confirmation  Bonus
shall be  multiplied  by a factor of 1.25.  For each full month prior to May 15,
1999 that a plan of  reorganization  is confirmed by the Bankruptcy  Court, this
enhancement  shall be  increased  by 10 percent.  Likewise,  for each full month
after  May  15,  1999  during  which  a plan  of  reorganization  is  confirmed,
enhancement  shall be  decreased  by 10  percent  to a floor of 1.00  times  the
Confirmation  Bonus  should a plan be  confirmed  on or after July 16,  1999.  A
minimum aggregate  Confirmation Bonus of $2 million shall be immediately paid in
cash upon  consummation of the plan of  reorganization.  If the aggregate of all
the executives' Confirmation Bonuses exceeds $2 million, the Board shall pay any
or all of the excess in common stock of the Company unless the Board determines,
in its complete  discretion,  to pay such amount in cash.  Any stock received as
part of the  Confirmation  Bonus shall be fully  vested,  and the Company  shall
provide a loan program,  secured solely by the shares of stock issued, to assist
recipients of the stock with any tax liabilities arising from the receipt of the
stock.

The  Confirmation  Retention Plan also contains a severance  program pursuant to
which an eligible executive shall be entitled to receive severance benefits from
the Company equal to two times base salary,  plus a continuation of benefits for
two years, upon a Board Requested  Termination,  Resignation for Good Reason, or
upon a termination based on Permanent Disability or death (each such capitalized
term as defined in the  Confirmation  Retention  Plan).  In  general,  severance
benefits shall be paid in a lump sum on the last day of employment. No severance
benefits  shall  be  paid  upon  a  termination  for  Cause  or  upon  voluntary
termination of employment  for any reason other than very limited  circumstances
specified in the Confirmation Retention Plan

                                    Page 74
<PAGE>

Under the Confirmation  Retention Plan, an executive may voluntarily  resign and
still  receive  severance  benefits if (i) the Company does not make an offer to
the executive of continued employment of at least one additional year during the
tenth month after  confirmation  of a plan of  reorganization;  (ii) the Company
does make such an offer,  but such offer  contains  terms that would provide the
executive  with the option to Resign  for Good  Reason;  or (iii) the  executive
Resigns for Good Reason.  Should the Company  make an offer to the  executive of
continued  employment  of at least one  additional  year  during the tenth month
after  confirmation  of a plan,  which offer does not  contain  terms that would
provide  the  executive  with the  option to  Resign  for Good  Reason,  and the
executive  resigns anyway,  then the executive shall receive a lump sum equal to
only one times the executive's base salary upon  termination of employment.  The
remainder of the severance benefits shall be paid in 12 monthly installments and
shall be reduced in an amount equal to the salary  compensation  received by the
executive due to other employment, including fees from consulting services.

In addition to the above, the terms of the individual employment agreements with
the top eight executives also require that each executive diligently perform all
acts and duties and furnish such services as are customary for the position that
such executive  holds.  Each of the top eight executives must also comply with a
noncompete provision contained in their respective  employment  agreements which
runs  during the tenure of the  executive's  employment  and for a period of two
years thereafter. Each of the top eight executives was also required, as part of
their  respective  employment  agreements,   to  enter  into  a  confidentiality
agreement with the Company.  A breach by the executive of his or her obligations
under either the  employment  agreement or the  confidentiality  agreement  will
result  in a  forfeiture  of  the  executive's  rights  under  their  employment
agreement  and  will  make  the  executive  ineligible  to  participate  in  the
Confirmation Retention Plan.

1993 LONG-TERM PLAN. In the event of a merger,  consolidation  or acquisition of
the Company,  a sale or transfer of all or  substantially  all of the  Company's
assets, a tender or exchange offer for shares of Common Stock (other than offers
by the Company) or other reorganization, as a result of which the Company is not
likely to continue  as an  independent,  publicly  owned  corporation,  the 1993
Long-Term Plan provides that the Committee may take such action as it determines
necessary or advisable, and fair and equitable to participants,  with respect to
stock options, SARs and other awards under the 1993 Long-Term Plan. In addition,
shares of restricted  stock awarded for 1995 in lieu of cash bonuses will become
fully  exercisable,  subject  to  certain  exceptions,  in the event of  certain
mergers or  consolidations  involving the Company,  a sale,  lease,  exchange or
other  transfer  of  all or  substantially  all of  the  Company's  assets  or a
liquidation or dissolution of the Company.

1995 INCENTIVE PLAN. In the event of certain mergers or consolidations involving
the Company,  a sale, lease,  exchange or other transfer of all or substantially
all of the Company's  assets or a  liquidation  or  dissolution  of the Company,
outstanding  options,  SARs and  restricted  stock under the 1995 Incentive Plan
will become fully exercisable,  subject to certain exceptions.  In addition, the
Committee may take such further action as it deems  necessary or advisable,  and
fair to  participants,  with  respect  to  outstanding  awards  under  the  1995
Incentive Plan.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

During the fiscal year ended  December 27, 1998,  members of the Committee  were
Adrian D.P.  Bellamy  (Chairman),  Thomas B. Boklund and Robert L. Schuyler.  No
executive  officers  or  employees  of the  Company  served on the  Compensation
Committee.

BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

The Committee,  as noted above, is composed  entirely of nonemployee  directors.
The Committee is responsible for  establishing and  administering  the Company's
executive compensation programs.

COMPENSATION POLICIES

The  Committee  establishes  compensation  according  to the  following  guiding
principles:

(a)  Compensation  should be  directly  linked to the  Company's  operating  and
financial performance.

                                    Page 75
<PAGE>

(b) Total  compensation  should be  competitive  when  compared to  compensation
levels of  executives  of  companies  against  which the  Company  competes  for
management.

(c)   Performance-related  pay  should  be  a  significant  component  of  total
compensation,  placing a substantial  portion of an executive's  compensation at
risk.

COMPENSATION PRACTICES

Compensation for executives  includes base salary,  annual bonuses and long-term
incentive  awards,  including stock options,  SARs and restricted  stock awards.
Consistent  with the above  principles,  a  substantial  proportion of executive
compensation depends on Company performance and on enhancing stockholder value.

BASE  SALARY.  The Company  uses  externally-developed  compensation  surveys to
assign a competitive salary range to each salaried position, including executive
positions.  The  companies  included in the survey are selected by the Company's
outside  compensation  consultants and include  companies  engaged in nondurable
manufacturing with annual revenues of between $400 million and $1 billion.

The Committee sets actual base salary levels for the Company's  executives based
on  recommendations  by  management.  The  Committee  bases its decisions on the
executive's  performance,  the  executive's  position in the salary  range,  the
executive's experience and the Company's salary budget.

ANNUAL BONUS. The Company employs a formal system for developing measures of and
evaluating  executive  performance.  Bonuses are  determined  with  reference to
quantitative  measures  established by the Committee each year. At the beginning
of each year, the Committee also approves  performance  targets  relating to the
quantitative  measures  that, if achieved,  will establish a bonus pool equal to
the sum of the individual target bonuses for all executives.  The Committee also
establishes  performance  targets that could result in a range of bonus  payouts
from a minimum of zero to a maximum bonus payout of 200 percent of target bonus.
At the end of the year,  Company  performance,  as compared to the  quantitative
measures  described  above,  determines the bonus pool for the executive  group.
Target  bonuses for  individual  executives are in the range of 25 percent to 60
percent of base  salary.  The  Committee  retains the  discretion  to adjust any
individual bonus if deemed appropriate.

In the event Company performance exceeds the performance targets established for
the maximum 200 percent bonus payout, the bonus pool is funded in excess of such
200 percent payout. Such excess bonus funding is retained by the Company and may
be paid out, at the  Committee's  discretion,  in any year in which  performance
targets  are not  achieved,  if the  Committee  determines  such event to be the
result of factors unrelated to management performance.

In 1998,  the  quantitative  measure  for bonus  payments  was  earnings  before
interest, taxes, depreciation and amortization ("EBITDA").  The maximum possible
bonus  payout was 200 percent of target.  The  Company's  performance  in fiscal
1998, with EBITDA of $58.4 million, satisfied the quantitative measures designed
to fund  bonuses  at 187.3  percent  of target,  and the  Committee  accordingly
awarded such bonuses.

As a result of the Chapter 11 filing,  and in  recognition  of the need to drive
the operating  performance of the Company and to incent employees to remain with
the Company  throughout the course of the Chapter 11  proceeding,  the Committee
altered the Company's existing incentive  compensation  plans. The revised plans
include (i) a retention  incentive for employees of the Company,  other than the
top eight executives,  following the Chapter 11 filing and (ii) the Confirmation
Retention  Plan  described  above.  These  revised  plans were  approved  by the
Bankruptcy Court in August 1998.

For 1999, the Committee has determined that the  quantitative  measure for bonus
payments will again be EBITDA.  The plan will provide  minimum and target payout
levels. There is no upward limit on the maximum payout level.

LONG-TERM  INCENTIVES.  Long-term  incentives  are  designed to link  management
reward with the long-term interests of the Company's stockholders. Through 1997,
the Committee  granted stock options,  stock  appreciation  rights  ("SARs") and
restricted  stock as long-term  incentives.  Individual  stock option awards and

                                    Page 76
<PAGE>

SARs  were  based on level of  responsibility,  the  Company's  stock  ownership
objectives  for  management  and  upon  the  Company's  performance  versus  the
financial  performance  objectives  set each  year  for the  annual  bonus  plan
described above. The Company's long-term  performance  ultimately determines the
level of compensation  resulting from stock options and SARs, since stock option
and SAR value is entirely  dependent on the long-term growth of the Common Stock
price.

In 1998, the Committee determined, in connection with the Confirmation Retention
Plan described  above,  that in light of the  uncertainties  associated with the
Chapter 11 process,  the Company  should  discontinue  future stock option,  SAR
grants and  restricted  stock awards until its emergence from Chapter 11 and, as
such, no options,  SARs or restricted stock awards were granted to employees for
1998.

Section  162(m) of the Internal  Revenue Code of 1986,  as amended (the "Code"),
limits the Company's ability to deduct compensation in excess of $1 million paid
during a tax year to the Chief Executive Officer and the four other highest paid
executive officers of the Company. Certain performance-based compensation is not
subject  to such  deduction  limit.  Total  1998  compensation  for Mr.  Abraham
exceeded $1 million.  The Company intends,  at the appropriate  time, to qualify
stock  option  and SAR awards for the  "performance-based"  exception  to the $1
million  limitation on deductibility and otherwise to maximize the deductibility
of executive compensation while retaining the discretion necessary to compensate
executive officers in a manner commensurate with performance and the competitive
market of executive talent.

CHIEF EXECUTIVE OFFICER COMPENSATION

Mr.  Abraham  has served as the  Company's  Chief  Executive  Officer  since its
initial public offering in February 1993. Prior to such time, Mr. Abraham was in
charge of the Company's operations as a division of Weyerhaeuser.  Mr. Abraham's
base salary was  realigned in 1996 from prior year levels to $500,000.  Pursuant
to Mr. Abraham's previous  employment  agreement entered into at the time of the
Company's initial public offering, as amended and restated in 1997, and pursuant
to the discretion afforded the Board and the Committee pursuant to Mr. Abraham's
current Employment Agreement described above (SEE "--CONFIRMATION RETENTION PLAN
FOR TOP EIGHT  EXECUTIVES"),  Mr.  Abraham is  entitled  to  receive  additional
deferred  compensation  for the first seven years of service as Chief  Executive
Officer equal to 20 percent of his base salary and incentive  awards. As such, a
reserve of $216,048  was taken by the Company  which  represents  Mr.  Abraham's
deferred compensation award for 1998.

Given the challenges presented by the Company's Chapter 11 filing, the Committee
determined  to pay all 1998 bonuses based on the  corporate  EBITDA  performance
factor, with no adjustment for personal performance.  Mr. Abraham's target bonus
was $300,000. Based on the Company's EBITDA performance,  Mr. Abraham received a
1998  bonus  payout  of  $561,690.  Mr.  Abraham  will also  participate  in any
Confirmation  Bonus  payable under the  Confirmation  Retention  Plan  described
above. SEE "--CONFIRMATION RETENTION PLAN FOR TOP EIGHT EXECUTIVES."

The Committee has discontinued  the use of annual grants of stock options,  SARs
and restricted stock as incentive compensation for Mr. Abraham until the Company
emerges from Chapter 11 protection. In the past, annual stock option grants were
determined  by  reference  to the external  compensation  survey data  discussed
above,  as well as the Company's  performance  versus the financial  performance
objectives set each year for the annual bonus plan described above.

COMPENSATION COMMITTEE


Adrian D.P. Bellamy, Chairman
Thomas B. Boklund
Robert L. Schuyler




                                    Page 77
<PAGE>

STOCK PRICE PERFORMANCE GRAPH

Set forth below is a line graph  comparing  the  cumulative  total return on the
Common  Stock  during the period  beginning  on December  26, 1993 and ending on
December  27, 1998,  the last day of the  Company's  1998 fiscal year,  with the
cumulative  total  return on the  Standard & Poor's  500 Index and the  combined
Value  Line  Household  Products  and  Toiletries/Cosmetics   Indices  (weighted
equally).  The comparison  assumes $100 was invested on December 26, 1993 in the
Common  Stock,  the  Standard  & Poor's  500 Index and the  combined  Value Line
Household Products and Toiletries/Cosmetics  Indices and assumes reinvestment of
dividends.  The stock price  performance  shown on the graph is not  necessarily
indicative of future price performance.

[OBJECT OMITTED]
                                PERFORMANCE GRAPH DATA POINTS

<TABLE>
<CAPTION>
                                             CUMULATIVE TOTAL RETURN AS OF:
                                             ------------------------------
NAME                             26-DEC-93 25-DEC-94 31-DEC-95 29-DEC-96  28-DEC-97 27-DEC-98
----                             --------- --------- --------- ---------  --------- ---------

<S>                                 <C>      <C>       <C>        <C>       <C>       <C> 
PARAGON TRADE BRANDS, INC.          100.00    44.92     79.24     101.70     43.64      7.20
Standard & Poor's 500               100.00   101.60    139.71     172.18    229.65    294.87
Combined Value Line                 100.00   109.45    147.08     196.16    269.10(1) 305.20
  Household Products and
  Toiletries/Cosmetics Indices

----------
<FN>

(1)  Tambrands,  Inc.  ("Tambrands")  was a member of the  Combined  Value  Line
Household Products and Toiletries/Cosmetics Indices ("Peer Group") for the years
1993-1996.  Tambrands  was acquired by P&G during 1997 and total return data for
1997 is not  available.  Tambrands  was  removed  from the Value Line  Household
Products and Toiletries/Cosmetics Indices as of 1997.
</FN>
</TABLE>


                                    Page 78
<PAGE>

ITEM 12:   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following  table sets forth the beneficial  ownership of the Common Stock as
of March  31,  1999,  by (a) each  stockholder  known by the  Company  to be the
beneficial  owner of more than 5 percent of the Common Stock,  (b) the Company's
directors,  (c) the Company's named executive  officers,  as defined herein, and
(d) all the Company's directors and executive officers,  as a group. Each of the
named persons and members of the group has sole voting and investment power with
respect to the shares shown, except as otherwise stated.


<TABLE>
<CAPTION>
                                                                BENEFICIAL OWNERSHIP
                                                                --------------------
                                                 AMOUNT AND NATURE OF              PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER             BENEFICIAL OWNERSHIP             OUTSTANDING
------------------------------------             --------------------             -----------

<S>                                                    <C>                           <C>   
Wellington Management Company, LLP........             1,637,800 (1)                 13.71%
  75 State Street
  Boston, MA  02109

Vanguard Specialized Funds ...............
  Vanguard Health Care Fund                            1,124,100 (2)                  9.41%
  P.O. Box 2600
  Valley Forge, PA  19482-2600

Capital Guardian Trust Company............             1,042,700 (3)                  8.73%
  333 South Hope Street, 55th Floor
  Los Angeles, CA  90071

Appaloosa Management L.P..................               965,200 (4)                  8.08%
  26 Main Street, 1st Floor
  Chatam, NJ  07928

Bobby V. Abraham..........................               282,563 (5)                  2.32%
Adrian D.P. Bellamy.......................                12,000 (6)                   *
Thomas B. Boklund.........................                14,000 (7)                   *
Robert L. Schuyler........................                13,100 (7)                   *
David W. Cole.............................               149,505 (8)                  1.24%
Alan J. Cyron.............................                62,241 (9)                   *
Arrigo D. Jezzi...........................                35,198 (10)                  *
Robert E. McClain.........................                 5,017 (11)                  *
All directors and executive officers as a
group (10 persons) .......................               602,985 (12)                 4.84%

---------------
<FN>

*   Represents holdings of less than 1%.

(1) Wellington  Management Company,  LLP has shared power to vote 513,700 shares
and shared  power to dispose of  1,637,800  shares of Common  Stock,  based on a
Schedule 13G filed with the SEC and dated January 29, 1999.

(2)  Vanguard  Specialized  Funds - Vanguard  Health Care Fund has sole power to
vote 1,124,100  shares and shared power to dispose of 1,124,100 shares of Common
Stock, based on a Schedule 13G filed with the SEC and dated February 10, 1999.

(3) Capital  Guardian Trust Company has sole power to vote 1,042,700  shares and
sole power to dispose of 1,042,700  shares of Common Stock,  based on a Schedule
13G filed with the SEC and dated February 8, 1999.

                                    Page 79
<PAGE>

(4) Appaloosa Management L.P. ("AMLP") has sole power to vote 965,200 shares and
sole power to dispose of 965,200 shares of Common Stock, based on a Schedule 13G
filed with the SEC and dated  February 5, 1999.  AMLP is the general  partner of
Appaloosa  Investment Limited  Partnership I, the investment advisor to Palomino
Fund Ltd., and the managing member of Tersk LLC, which are the holders of record
of the reported securities (419,947,  491,765 and 53,488 shares,  respectively).
David A. Tepper is the sole stockholder and president of Appaloosa Partners Inc.
("API").  API is the general  partner of AMLP, and Mr. Tepper owns a majority of
the limited partnership interests of AMLP.

(5) Includes  options to purchase  229,160  shares of Common Stock,  exercisable
within 60 days of the date hereof.

(6)  Includes  options to purchase  9,000  shares of Common  Stock,  exercisable
within 60 days of the date hereof.

(7) Includes  options to purchase  13,000  shares of Common  Stock,  exercisable
within 60 days of the date hereof.

(8) Includes  options to purchase  132,500  shares of Common Stock,  exercisable
within 60 days of
the date hereof.

(9) Includes  options to purchase  38,750  shares of Common  Stock,  exercisable
within 60 days of the date hereof.

(10) Includes  options to purchase  20,000  shares of Common Stock,  exercisable
within  60 days of the date  hereof,  and  stock  appreciation  rights on 12,500
shares of Common Stock, exercisable within 60 days of the date hereof.

(11)  Includes  stock  appreciation  rights  on 10,000  shares  of Common  Stock
exercisable within 60 days of the date hereof.

(12) Includes  options to purchase  476,820 shares of Common Stock,  exercisable
within  60 days of the date  hereof,  and  stock  appreciation  rights on 22,500
shares of Common Stock exercisable within 60 days of the date of this document.
</FN>
</TABLE>


ITEM 13:   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.


                                               PART IV

ITEM 14:   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)     FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

         Report of Independent Public Accountants

         Consolidated Earnings (Loss) Statements  for the  three  years  in  the
         period ended December 27, 1998

         Consolidated  Balance  Sheets as of  December 27, 1998 and December 28,
         1997

         Consolidated Statements of Cash Flows for the three years in the period
         ended December 27, 1998

                                    Page 80
<PAGE>

         Consolidated Statements of Comprehensive  Income for the three years in
         the period ended December 27, 1998

         Consolidated  Statements  of  Changes in  Shareholders'  Equity for the
         three years in the period ended December 27, 1998

         Notes to Financial Statements

         FINANCIAL STATEMENT SCHEDULE:
         Schedule II:  Valuation and Qualifying Accounts

(b)     The registrant  filed no Reports on Form 8-K during  the fiscal  quarter
ended December 27, 1998.

(c)     EXHIBITS

<TABLE>
<CAPTION>
        EXHIBIT             DESCRIPTION
        -------             -----------
        <S>                 <C>
        Exhibit 3.1         Certificate of Incorporation of Paragon Trade Brands, Inc. 4

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

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

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

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

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

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

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

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

        Exhibit 10.7*       Stock Option Plan for Non-Employee Director 1

        Exhibit 10.8*       Annual Incentive Compensation Plan 1

        Exhibit 10.9*       1993 Long-Term Incentive Compensation Plan 1

        Exhibit 10.10*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Bobby V. Abraham 12

        Exhibit 10.11*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            David W. Cole 12

        Exhibit 10.12*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Alan J. Cyron 12

        Exhibit 10.13*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Arrigo D. (Rick) Jezzi 12

                                    Page 81
<PAGE>


        Exhibit 10.14*      Employment agreement, dated as of August 11, 1998, between Paragon and
                            Robert E. McClain 12

        Exhibit 10.15*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Catherine O. Hasbrouck 12

        Exhibit 10.16*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Kevin P. Higgins 12

        Exhibit 10.17*      1995 Incentive Compensation Plan5

        Exhibit 10.18*      Paragon Trade Brands, Inc. Confirmation Retention Plan for Top Eight
                            Executives and Summary Plan Description 12

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

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

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

        Exhibit 10.20.1     Fourth Amendment to Revolving Credit and Guaranty Agreement dated as of
                            September 28, 1998

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

        Exhibit 10.22       Revolving Canadian Credit Facility and Parent Guarantee 2

        Exhibit 10.23       Indemnification Agreements, dated as of February 2, 1993, between
                            Weyerhaeuser and Bobby V. Abraham and Gary M. Arnts1


        Exhibit 10.24       Rights Agreement dated December 14, 1994 between Paragon Trade Brands,
                            Inc. and Chemical Bank, as Rights Agent3

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

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

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

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

                                    Page 82
<PAGE>

        Exhibit 10.28       Settlement Agreement, dated as of February 2, 1999 between Paragon Trade
                            Brands, Inc. and The Procter & Gamble Company.

        Exhibit 10.29       U.S. License Agreement, dated as of February 2, 1999 between The Procter &
                            Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.30       Canadian  License  Agreement,   dated  as  of February  2,  1999  between  
                            The  Procter  &  Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.31       U.S. License Agreement, dated as of February 2, 1999 between The Procter &
                            Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.32       Canadian  License  Agreement, dated  as  of  February  2,  1999  between  
                            The  Procter  &  Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.33       Settlement  Agreement,  dated as of March 19, 1999 between Kimberly-Clark  Corporation and Paragon
                            Trade Brands, Inc.

        Exhibit 10.34       License Agreement Between Kimberly-Clark Corporation and Paragon Trade
                            Brands, Inc., dated as of March 15, 1999

        Exhibit 10.35       License Agreement Between Kimberly-Clark Corporation and Paragon Trade
                            Brands, Inc., dated as of March 15, 1999

        Exhibit 11          Computation of Per Share Earnings (See Note 17 to Financial Statements)

        Exhibit 21.1        Subsidiaries of the Company

        Exhibit 23.1        Consent of Independent Public Accountants

        Exhibit 27          Financial Data Schedule (for SEC use only)

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

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

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

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

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

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

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

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

                                    Page 83
<PAGE>

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

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

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

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

(12)  Incorporated  by reference  from Paragon  Trade Brands,  Inc.'s  Quarterly
Report on Form 10-Q for the quarter ended September 27, 1998.
</FN>
</TABLE>




                                    Page 84
<PAGE>


                                   SIGNATURES


Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this report to be signed on its
behalf by the undersigned,  thereunto duly authorized on this 12th day of April,
1999.

                                                   PARAGON TRADE BRANDS, INC.


                                                   By:    /S/  BOBBY V. ABRAHAM
                                                       -------------------------
                                                       Bobby V. Abraham
                                                       Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on this 12th day of April, 1999.



             /S/  BOBBY V. ABRAHAM                 
          ----------------------------
        Bobby V. Abraham
        Chairman and Chief Executive Officer


             /S/  ALAN J. CYRON                           
          ----------------------------
        Alan J. Cyron
        Executive Vice President and Chief Financial Officer
          (Principal Financial Officer)


             /S/  GARY M. ARNTS                    
          ----------------------------
        Gary M. Arnts
        Vice President and Controller
          (Principal Accounting Officer)


             /S/  ADRIAN D.P. BELLAMY                     
          ----------------------------
        Adrian D.P. Bellamy
        Director


             /S/  THOMAS B. BOKLUND                
          ----------------------------
        Thomas B. Boklund
        Director


             /S/  ROBERT L. SCHUYLER               
          ----------------------------
        Robert L. Schuyler
        Director




                                    Page 85
<PAGE>

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
       EXHIBIT             DESCRIPTION
       -------             -----------
        <S>                 <C>                                                                    <C>
        Exhibit 3.1         Certificate of Incorporation of Paragon Trade Brands, Inc. 4

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

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

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

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

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

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

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

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

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

        Exhibit 10.8*       Annual Incentive Compensation Plan 1

        Exhibit 10.9*       1993 Long-Term Incentive Compensation Plan 1

        Exhibit 10.10*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Bobby V. Abraham 12

        Exhibit 10.11*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            David W. Cole 12

        Exhibit 10.12*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Alan J. Cyron 12

        Exhibit 10.13*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Arrigo D. (Rick) Jezzi 12

        Exhibit 10.14*      Employment agreement, dated as of August 11, 1998, between Paragon and
                            Robert E. McClain 12

        Exhibit 10.15*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Catherine O. Hasbrouck 12

        Exhibit 10.16*      Employment Agreement, dated as of August 11, 1998, between Paragon and
                            Kevin P. Higgins 12

        Exhibit 10.17*      1995 Incentive Compensation Plan 5

                                    Page 86
<PAGE>


        Exhibit 10.18*      Paragon Trade Brands, Inc. Confirmation Retention Plan for Top Eight
                            Executives and Summary Plan Description 12

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

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

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

        Exhibit 10.20.1     Fourth Amendment to Revolving Credit and Guaranty Agreement dated as of
                            September 28, 1998

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

        Exhibit 10.22       Revolving Canadian Credit Facility and Parent Guarantee 2

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

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

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

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

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

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

        Exhibit 10.28       Settlement Agreement, dated as of February 2, 1999 between Paragon Trade
                            Brands, Inc. and The Procter & Gamble Company.

        Exhibit 10.29       U.S. License Agreement, dated as of February 2, 1999 between The Procter &
                            Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.30       Canadian  License  Agreement,   dated  as  of February  2,  1999  between 
                            The  Procter  &  Gamble Company and Paragon Trade Brands, Inc. 

        Exhibit 10.31       U.S. License Agreement, dated as of February 2, 1999 between The Procter &
                            Gamble Company and Paragon Trade Brands, Inc.

        Exhibit 10.32       Canadian  License  Agreement,   dated  as  of February  2,  1999  between  
                            The  Procter  &  Gamble  Company and Paragon Trade Brands, Inc.

                                    Page 87
<PAGE>

        Exhibit 10.33       Settlement  Agreement,  dated as of March 19, 1999 between Kimberly-Clark
                            Corporation and Paragon Trade Brands, Inc.

        Exhibit 10.34       License Agreement Between Kimberly-Clark Corporation and Paragon Trade
                            Brands, Inc., dated as of March 15, 1999

        Exhibit 10.35       License Agreement Between Kimberly-Clark Corporation and Paragon Trade
                            Brands, Inc., dated as of March 15, 1999

        Exhibit 11          Computation of Per Share Earnings (See Note 17 to Financial Statements)

        Exhibit 21.1        Subsidiaries of the Company

        Exhibit 23.1        Consent of Independent Public Accountants

        Exhibit 27          Financial Data Schedule (for SEC use only)

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

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

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

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

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

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

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

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

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

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

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

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

(12)  Incorporated  by reference  from Paragon  Trade Brands,  Inc.'s  Quarterly
Report on Form 10-Q for the quarter ended September 27, 1998.
</FN>
</TABLE>

                                    Page 88