**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**














**FORM
      10-Q**














**QUARTERLY
      REPORT**


**PURSUANT
      TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**











**For
      the quarterly period ended May 31, 2007**


**Commission
      file number 0-5905**














**CHATTEM,
      INC.**


**A
      TENNESSEE CORPORATION**


**I.R.S.
      EMPLOYER IDENTIFICATION NO. 62-0156300**


**1715
      WEST 38TH STREET**


**CHATTANOOGA,
      TENNESSEE 37409**


**TELEPHONE:  423-821-4571**























**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**þ**NO**o





**Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.  (Check one):**





**Large
                accelerated filer**þ
            **Accelerated
                filer**o
            **Non-accelerated
                filer**o




**Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).**


******YES**o      **NO**þ








**As
      of July 2, 2007,19,139,504shares of the Company’s common stock, without
      par value, were
      outstanding.**
















**CHATTEM,
      INC.**





**INDEX**







PAGE
                NO.**PART
              I.  FINANCIAL INFORMATION**Item
                1.    Financial StatementsConsolidated
                  Balance Sheets as of May 31, 2007 and November 30,
                  2006
            3Consolidated
                  Statements of Income for the Three and Six Months Ended May
                  31, 2007 and May 31, 2006
            5Consolidated
                  Statements of Cash Flows for the Three and Six Months Ended
                  May 31, 2007 and May 31, 2006
            6Notes
                to Consolidated Financial Statements
            7Item
                  2.    Management's Discussion and Analysis of Financial
                  Conditionand Results of Operations
            28Item
                3.    Quantitative and Qualitative Disclosures About Market
                Risk
            38Item
                4.    Controls and Procedures
            39**PART
                II.  OTHER INFORMATION**Item
                1.    Legal Proceedings
            40Item
                1A. Risk Factors
            40Item
                2.    Unregistered Sales of Equity Securities and Use of
                Proceeds
            40Item
                3.    Defaults Upon Senior Securities
            40Item
                4.    Submission of Matters to a Vote of Security
                Holders
            40Item
                5.    Other Information
            41Item
                6.    Exhibits
            41**SIGNATURES**
            42










2


**PART
      1. FINANCIAL INFORMATION**








**Item
      1. Financial Statements**


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**


(In
      thousands)







ASSETS
            
            MAY
                31,
              2007
            
            
            NOVEMBER
                30,
              2006(Unaudited)CURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            12,657
            
            
            $
            90,527Accounts
                receivable, less allowances of $13,284 atMay
                31, 2007 and $10,907 at November 30, 2006
            
            
            51,828
            
            
            
            29,852Inventories
            
            
            34,225
            
            
            
            31,389Refundable
                income taxes
            
            
            1,491
            
            
            
            —Deferred
                income taxes
            
            
            3,711
            
            
            
            4,341Prepaid
                expenses and other current assets
            
            
            3,718
            
            
            
            5,857Total
                current assets
            
            
            107,630
            
            
            
            161,966PROPERTY,
                PLANT AND EQUIPMENT, NET
            
            
            30,197
            
            
            
            30,353OTHER
                NONCURRENT ASSETS:Patents,
                trademarks and other purchased product rights, net
            
            
            617,543
            
            
            
            206,149Debt
                issuance costs, net
            
            
            16,975
            
            
            
            11,399Other
            
            
            4,908
            
            
            
            5,446Total
                other noncurrent assets
            
            
            639,426
            
            
            
            222,994TOTAL
                ASSETS
            
            $
            777,253
            
            
            $
            415,313











The
      accompanying notes are an integral part of these consolidated financial
      statements.











3


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**


(In
      thousands)








LIABILITIES
                AND SHAREHOLDERS’ EQUITY
            
            MAY
                31,
              2007
            
            
            NOVEMBER
                30,
              2006(Unaudited)CURRENT
                LIABILITIES:Current
                maturities of long-term debt
            
            $
            3,000
            
            
            $
            —Accounts
                payable and other
            
            
            12,831
            
            
            
            9,948Bank
                overdraft
            
            
            4,432
            
            
            
            5,824Accrued
                liabilities
            
            
            28,812
            
            
            
            11,805Total
                current liabilities
            
            
            49,075
            
            
            
            27,577LONG-TERM
                DEBT, less current maturities
            
            
            533,500
            
            
            
            232,500DEFERRED
                INCOME TAXES
            
            
            14,100
            
            
            
            17,668OTHER
                NONCURRENT LIABILITIES
            
            
            1,464
            
            
            
            1,987COMMITMENTS
                AND CONTINGENCIES (Note 19)SHAREHOLDERS’
                EQUITY:Preferred
                shares, without par value, authorized 1,000,none
                issued
            
            
            —
            
            
            
            —Common
                shares, without par value, authorized 100,000,issued
                and outstanding 19,139 at May 31, 2007 and18,669
                at November 30, 2006
            
            
            44,134
            
            
            
            30,452Retained
                earnings
            
            
            134,523
            
            
            
            105,965178,657
            
            
            
            136,417Cumulative
                other comprehensive income, net of tax:Interest
                rate hedge adjustment
            
            
            485
            
            
            
            (597
            )Foreign
                currency translation adjustment
            
            
            (28
            )
            
            
            (239
            )Total
                shareholders’ equity
            
            
            179,114
            
            
            
            135,581TOTAL
                LIABILITIES AND SHAREHOLDERS’EQUITY
            
            $
            777,253
            
            
            $
            415,313














The
      accompanying notes are an integral part of these consolidated financial
      statements.









4





**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF INCOME**


(Unaudited
      and in thousands, except per share amounts)





FOR
                THE THREE MONTHS
              ENDED
                MAY 31,
            
            
            FOR
                THE SIX MONTHS
              ENDED
                MAY 31,2007
            
            
            2006
            
            
            2007
            
            
            2006REVENUES:Net
                sales
            
            $
            112,915
            
            
            $
            79,352
            
            
            $
            213,694
            
            
            $
            163,329Royalties
            
            
            49
            
            
            
            59
            
            
            
            101
            
            
            
            106Total
                revenues
            
            
            112,964
            
            
            
            79,411
            
            
            
            213,795
            
            
            
            163,435COSTS
                AND EXPENSES:Cost
                of sales
            
            
            35,095
            
            
            
            25,054
            
            
            
            66,075
            
            
            
            51,074Advertising
                and promotion
            
            
            29,664
            
            
            
            24,781
            
            
            
            58,451
            
            
            
            51,968Selling,
                general and administrative
            
            
            14,311
            
            
            
            11,528
            
            
            
            26,897
            
            
            
            23,119Acquisition
                expenses
            
            
            886
            
            
            
            —
            
            
            
            2,057
            
            
            
            —Litigation
                settlement
            
            
            —
            
            
            
            108
            
            
            
            —
            
            
            
            (8,505
            )Total
                costs and expenses
            
            
            79,956
            
            
            
            61,471
            
            
            
            153,480
            
            
            
            117,656INCOME
                FROM OPERATIONS
            
            
            33,008
            
            
            
            17,940
            
            
            
            60,315
            
            
            
            45,779OTHER
                INCOME (EXPENSE):Interest
                expense
            
            
            (8,319
            )
            
            
            (2,456
            )
            
            
            (15,555
            )
            
            
            (5,300
            )Investment
                and other income, net
            
            
            291
            
            
            
            234
            
            
            
            1,059
            
            
            
            428Loss
                on early extinguishment of debt
            
            
            (2,219
            )
            
            
            —
            
            
            
            (2,219
            )
            
            
            (2,805
            )Total
                other income (expense)
            
            
            (10,247
            )
            
            
            (2,222
            )
            
            
            (16,715
            )
            
            
            (7,677
            )INCOME
                BEFORE INCOME TAXES
            
            
            22,761
            
            
            
            15,718
            
            
            
            43,600
            
            
            
            38,102PROVISION
                FOR INCOME TAXES
            
            
            7,853
            
            
            
            5,518
            
            
            
            15,042
            
            
            
            13,129NET
                INCOME
            
            $
            14,908
            
            
            $
            10,200
            
            
            $
            28,558
            
            
            $
            24,973NUMBER
                OF COMMON SHARES:Weighted
                average outstanding-basic
            
            
            19,021
            
            
            
            19,290
            
            
            
            18,841
            
            
            
            19,420Weighted
                average and potential dilutive outstanding
            
            
            19,359
            
            
            
            19,529
            
            
            
            19,237
            
            
            
            19,705NET
                INCOME PER COMMON SHARE:Basic
            
            $
            .78
            
            
            $
            .53
            
            
            $
            1.52
            
            
            $
            1.29Diluted
            
            $
            .77
            
            
            $
            .52
            
            
            $
            1.48
            
            
            $
            1.27







The
      accompanying notes are an integral part of these consolidated financial
      statements.







5


**CHATTEM,
      INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Unaudited
      and in thousands, except per share amount)






FOR
                THE SIX MONTHS ENDEDMAY
                31, 2007
            
            
            MAY
                31, 2006OPERATING
                ACTIVITIES:Net
                income
            
            $
            28,558
            
            
            $
            24,973Adjustments
                to reconcile net income to net cash provided byoperating
                activities:Depreciation
                and amortization
            
            
            4,278
            
            
            
            2,891Deferred
                income taxes
            
            
            6,647
            
            
            
            2,172Tax
                benefit realized from stock options
            
            
            (3,966
            )
            
            
            (661
            )Stock-based
                compensation expense
            
            
            2,632
            
            
            
            2,192Loss
                on early extinguishment of debt
            
            
            2,219
            
            
            
            2,805Other,
                net
            
            
            117
            
            
            
            112Changes
                in operating assets and liabilities, net of effects from
                acquisitions:Accounts
                receivable and other
            
            
            (21,976
            )
            
            
            3,280Inventories
            
            
            3,255
            
            
            
            (4,900
            )Refundable
                income taxes
            
            
            2,475
            
            
            
            804Prepaid
                expenses and other current assets
            
            
            1,130
            
            
            
            1,936Accounts
                payable and accrued liabilities
            
            
            18,006
            
            
            
            (7,482
            )Net
                cash provided by operating activities
            
            
            43,375
            
            
            
            28,122INVESTING
                ACTIVITIES:Purchases
                of property, plant and equipment
            
            
            (1,580
            )
            
            
            (2,091
            )Acquisition
                of brands
            
            
            (415,980
            )
            
            
            —Increase
                in other assets, net
            
            
            2,458
            
            
            
            (1,430
            )Net
                cash used in investing activities
            
            
            (415,102
            )
            
            
            (3,521
            )FINANCING
                ACTIVITIES:Repayment
                of long-term debt
            
            
            (128,000
            )
            
            
            (75,000
            )Proceeds
                from long-term debt
            
            
            400,000
            
            
            
            —Proceeds
                from borrowings under revolving credit facility
            
            
            89,000
            
            
            
            38,000Repayments
                of revolving credit facility
            
            
            (57,000
            )
            
            
            —Proceeds
                from exercise of stock options
            
            
            8,434
            
            
            
            658Change
                in bank overdraft
            
            
            (1,392
            )
            
            
            3,701Repurchase
                of common shares
            
            
            —
            
            
            
            (21,332
            )Purchase
                of note hedge
            
            
            (29,500
            )
            
            
            —Proceeds
                from issuance of warrant
            
            
            17,430
            
            
            
            —Increase
                in debt issuance costs
            
            
            (9,110
            )
            
            
            (15
            )Debt
                retirement costs
            
            
            —
            
            
            
            (1,501
            )Tax
                benefit realized from stock options
            
            
            3,966
            
            
            
            661Net
                cash provided by (used in) financing activities
            
            
            293,828
            
            
            
            (54,828
            )EFFECT
                OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            29
            
            
            
            (47
            )CASH
                AND CASH EQUIVALENTS:Decrease
                for the period
            
            
            (77,870
            )
            
            
            (30,274
            )At
                beginning of period
            
            
            90,527
            
            
            
            47,327At
                end of period
            
            $
            12,657
            
            
            $
            17,053PAYMENTS
                FOR:Interest
            
            $
            13,025
            
            
            $
            5,933Taxes
            
            $
            6,434
            
            
            $
            9,439





The
      accompanying notes are an integral part of these consolidated financial
      statements.






6


**CHATTEM,
      INC.  AND SUBSIDIARIES**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Unaudited)**





All
      monetary and share amounts (other than per share amounts) in these Notes are
      expressed in thousands.





**1.**
            **BASIS
                OF PRESENTATION**





The
      accompanying unaudited consolidated financial statements have been prepared
      in
      accordance with generally accepted accounting principles for interim financial
      information and the instructions to Form 10-Q and Rule 10-01 of Regulation
      S-X.  Accordingly, they do not include all of the information and
      footnotes required by generally accepted accounting principles in the United
      States for complete financial statements.  These consolidated
      financial statements should be read in conjunction with the audited consolidated
      financial statements and related notes thereto included in our Annual Report
      on
      Form 10-K for the year ended November 30, 2006.  The accompanying
      unaudited consolidated financial statements, in the opinion of management,
      include all adjustments necessary for a fair presentation.  All such
      adjustments are of a normal recurring nature.





**2.**
            **CASH
                AND CASH EQUIVALENTS**





We
      consider all short-term deposits and investments with original maturities of
      three months or less to be cash equivalents.





**3.**
            **RECLASSIFICATIONS**





Certain
      prior year amounts have been reclassified to conform to the current period’s
      presentation.  The accrual for vendor allowances of $3,663 for the six
      months ended May 31, 2006, which was included as a component of accrued
      liabilities, has been reclassified as a reduction of accounts
      receivable.  The bank overdraft of $3,701 for the six months ended May
      31, 2006, which was included in cash and cash equivalents, has been reclassified
      as an increase to total current liabilities.




**4.**
              **RECENT
                    ACCOUNTING
                    PRONOUNCEMENTS**


In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
      123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of
      SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS 123R
      supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for
      Stock Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash
      Flows”.  SFAS 123R focuses primarily on accounting for transactions in
      which an entity obtains employee services in share-based payment transactions
      and requires all share-based payments to employees, including grants of employee
      stock options, to be recognized as additional compensation expense in the
      financial statements based on the calculated fair value of the
      awards.  SFAS 123R also requires the benefits of tax deductions in
      excess of recognized compensation costs to be reported as a financing cash
      flow.  This requirement will reduce net operating cash flows and
      increase net financing cash flows in periods after adoption.  We
      adopted SFAS 123R effective for our fiscal year beginning December 1,
      2005.





In
      July 2006, FASB issued Interpretation No. 48 (“FIN 48”), “Accounting
      for Uncertainty in Income Taxes”, which clarifies the accounting for uncertainty
      in income taxes recognized in the financial statements in accordance with FASB
      Statement No. 109, “Accounting for Income Taxes” (“SFAS 109”). FIN 48
      provides guidance on the financial statement recognition and measurement of
      a
      tax position taken or expected to be taken in a tax return. FIN 48 also provides
      guidance on de-recognition, classification, interest and penalties, accounting
      in interim periods, disclosures, and transition. FIN 48 is effective for fiscal
      years beginning after December 15, 2006, or our fiscal year beginning
      December 1, 2007.  We are evaluating the impact of adopting FIN 48 on
      our consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
      157”).  SFAS 157 provides guidance for using fair value to measure
      assets and liabilities and is intended to respond to investors’ requests for
      expanded information about the extent to which companies measure assets and
      liabilities at fair value, the information used to measure fair value, and
      the
      effect of fair value measurements on earnings.  SFAS 157 applies
      whenever other standards require (or permit) assets or liabilities to be
      measured at fair value but does not expand the use of fair value in any new
      circumstances.  SFAS 157 also requires expanded disclosure of the
      effect on earnings for items measured using unobservable data, establishes
      a
      fair value hierarchy that prioritizes the information used to develop those
      assumptions and requires separate disclosure by level within the fair value
      hierarchy.  The provisions of SFAS 157 are effective for interim
      financial statements issued for fiscal years beginning after November 15, 2007,
      or our fiscal 2008.





7


In
      September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined
      Benefit Pension and Other Postretirement Plans -- An Amendment of FASB
      Statements No. 87, 88, 106, and 132R” (“SFAS 158”).  SFAS 158 requires
      an employer to recognize in its balance sheet an asset or liability for a
      plan’s funded status, measure a plan’s assets and obligations as of the end of
      the employer’s fiscal year and recognize changes in the funded status in the
      year in which the changes occur.  SFAS 158 also enhances the current
      disclosure requirements for pension and other postretirement plans to include
      disclosure related to certain effects on net periodic benefit
      cost.  The requirement to recognize the funded status of a benefit
      plan and the disclosure requirements are effective as of the end of the fiscal
      year ending after December 15, 2006, or our fiscal 2007.  The
      requirement to measure plan assets and benefit obligations as of the employer’s
      fiscal year-end is effective for fiscal years ending after December 15, 2008,
      or
      our fiscal 2009.  We are evaluating the impact of adopting SFAS 158 on
      our consolidated financial statements.





In
        September 2006, the Securities and Exchange Commission released Staff Accounting
        Bulletin 108 (“SAB 108”).  SAB 108 provides interpretative guidance on how
        the effects of the carryover or reversal of prior year misstatements should
        be
        considered in quantifying a current year misstatement.  SAB 108 is
        effective for fiscal years ending after November 15, 2006.  SAB 108
        did not have an impact on the accompanying consolidated financial
        statement.





In
        February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
        Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
        permits entities to choose to measure certain financial assets and liabilities
        at fair value.  Unrealized gains and losses on items for which the
        fair value option has been elected are reported in earnings.  SFAS 159
        is effective for fiscal years beginning after November 15, 2007.  We
        are evaluating the impact of adopting SFAS 159 on our consolidated financial
        statements.





**5.**
            **STOCK-BASED
                COMPENSATION**





We
      currently provide stock-based compensation under five stock incentive plans
      that
      have been approved by our shareholders.  Our 1998 Non-Statutory Stock
      Option Plan provides for the issuance of up to 1,400 shares of common stock
      to
      key employees while the 1999 Non-Statutory Stock Option Plan for Non-Employee
      Directors allows for the issuance of up to 200 shares of common
      stock.  The 2000 Non-Statutory Stock Option Plan provides for the
      issuance of up to 1,500 shares of common stock.  The 2003 and 2005
      Stock Incentive Plans both provide for the issuance of up to 1,500 shares of
      common stock.  Stock options granted under all of these plans
      generally vest over four years from the date of grant as specified in the plans
      or by the compensation committee of our board of directors and are exercisable
      for a period of up to ten years from the date of grant.





Effective
      December 1, 2005, we adopted SFAS 123R, using the modified prospective
      method.  SFAS 123R requires the recognition of the cost of employee
      services received in exchange for an award of equity instruments in the
      financial statements and is measured based on the grant date fair value of
      the
      award.  SFAS 123R also requires the stock option compensation expense
      to be recognized over the period during which an employee is required to provide
      service in exchange for the award (the vesting period).   Prior
      to our adopting SFAS 123R, we accounted for our stock-based compensation plans
      under APB 25.





For
      the
      three and six months ended May 31, 2007, we recorded compensation expense
      related to stock options that reduced income from operations by $1,428 and
      $2,632, provision for income taxes by $493 and $908, net income by $935 and
      $1,724 and basic and diluted net income per share by $0.05 and $0.09,
      respectively.  The stock option compensation expense was included
      partly in cost of sales, advertising and promotion expenses and selling, general
      and administrative expenses in the accompanying consolidated statements of
      income.  We capitalized $217 of stock option compensation cost as a
      component of the carrying cost of inventory on-hand as of May 31,
      2007.





8


The
      weighted average grant-date fair value of stock options granted during the
      three
      months ended May 31, 2007 and 2006 was $24.50 and $16.56, respectively, and
      for
      the six months ended May 31, 2007 and 2006 was $24.50 and $16.83,
      respectively.  The fair value of each stock option grant was estimated
      on the date of grant using a Flex Lattice Model.  The following
      assumptions were used to determine the fair value of stock option grants during
      the six months ended May 31, 2007 and 2006:




Six
                Months Ended
              May
                31,2007
            
            2006Expected
                life
            6.0
                years
            
            6.0
                yearsVolatility
            34%
            
            43%Risk-free
                interest rate
            4.47%
            
            4.48%Dividend
                yield
            0%
            
            0%Forfeitures
            1.2%
            
            0.9%





The
      expected life of stock options represents the period of time that the stock
      options granted are expected to be outstanding based on historical exercise
      trends.  The expected volatility is based on consideration of the
      historical and implied price volatility of our common stock for fiscal 2007
      and
      historical price volatility of our common stock for fiscal 2006.  The
      risk-free interest rate represents the U.S. Treasury bill rate for the expected
      life of the related stock options.  The dividend yield represents our
      anticipated cash dividend over the expected life of the stock
      options.  In connection with using the Flex Lattice Model to determine
      the fair value of stock option grants, the forfeiture rate was determined by
      analyzing post vesting stock option activity for three separate groups
      (non-employee directors, officers and other employees).





A
      summary
      of stock option activity for the six months ended May 31, 2007 is presented
      below:





For
                the Six Months Ended May 31, 2007Shares
                Under Option
            
            
            Weighted
                Average
              Exercise Price
            
            Weighted
              Average
              Remaining
              Contractual
              Life
            
            Aggregate
              Intrinsic
                ValueOutstanding
                at December 1, 2006
            
            
            1,936
            
            
            $
            27.63Granted
            
            
            412
            
            
            
            59.74Exercised
            
            
            (469
            )
            
            
            17.97Cancelled
            
            
            (26
            )
            
            
            35.72Outstanding
                at May 31, 2007
            
            
            1,853
            
            
            $
            37.11
            
            5.5
                years
            
            $
            50,312Exercisable
                at May 31, 2007
            
            
            1,016
            
            
            $
            28.58
            
            5.4
                years
            
            $
            36,244





The
      total
      fair value of stock options that vested during the three months ended May 31,
      2007 and 2006 was $1,450 and $1,325, respectively, and during the six
      months ended May 31, 2007 and 2006 was $2,665 and $2,379,
      respectively.  The total intrinsic value of stock options exercised
      during the three months ended May 31, 2007 and 2006 was $6,434 and $976,
      respectively, and during the six months ended May 31, 2007 and 2006 was $17,906
      and $1,836, respectively.





As
      of May
      31, 2007, we had $15,513 of unrecognized compensation cost related to stock
      options that will be recorded over a weighted average period of approximately
      three years.





We
      are
      also authorized to grant restricted shares of common stock to employees under
      our stock incentive plans that have been approved by
      shareholders.  The restricted shares under these plans meet the
      definition of “nonvested shares” in SFAS 123R.  The restricted shares
      generally vest over a four year service period commencing upon the date of
      grant.  The total fair market value of restricted shares on the date
      of grant is amortized to expense on a straight line basis over the four-year
      vesting period.  The amortization expense related to restricted shares
      during the three months ended May 31, 2007 and 2006 was $175 and $184,
      respectively, and for the six months ended May 31, 2007 and 2006 was $358 and
      $367, respectively.





9


Restricted
      share activity under the
      plans is summarized as follows:





Number
              of
                 Shares
            
            
            Weighted
                Average Grant Date Fair ValueNonvested
                at December 1, 2006
            
            
            37
            
            
            $
            26.45Granted
            
            
            —
            
            
            
            —Vested
            
            
            (17
            )
            
            $
            20.93Forfeited
            
            
            (1
            )
            
            $
            35.37Nonvested
                at May 31, 2007
            
            
            19
            
            
            $
            30.69






**6.**
              **EARNINGS
                    PER SHARE**


The
      following table presents the computation of per share earnings for the three
      and
      six months ended May 31, 2007 and 2006, respectively:





For
                the Three Months
              Ended
                May 31,
            
            
            For
                the Six Months
              Ended
                May 31,2007
            
            
            2006
            
            
            2007
            
            
            2006NET
                INCOME
            
            $
            14,908
            
            
            $
            10,200
            
            
            $
            28,558
            
            
            $
            24,973NUMBER
                OF COMMON SHARES:Weighted
                average outstanding
            
            
            19,021
            
            
            
            19,290
            
            
            
            18,841
            
            
            
            19,420Issued
                upon assumed exercise of outstanding stock options
            
            
            328
            
            
            
            203
            
            
            
            385
            
            
            
            248Effect
                of issuance of restricted common shares
            
            
            10
            
            
            
            36
            
            
            
            11
            
            
            
            37Weighted
                average and potentialdilutive outstanding
                (1)
            
            
            19,359
            
            
            
            19,529
            
            
            
            19,237
            
            
            
            19,705NET
                INCOME PER COMMON   SHARE:Basic
            
            $
            .78
            
            
            $
            .53
            
            
            $
            1.52
            
            
            $
            1.29Diluted
            
            $
            .77
            
            
            $
            .52
            
            
            $
            1.48
            
            
            $
            1.27





(1)  Because
      their effects
      are anti-dilutive, excludes shares issuable under stock option plans and
      restricted stock issuance whose grant price was greater than the average market
      price of common shares outstanding as follows: 168 and 862 shares for the three
      months ended May 31, 2007 and 2006, respectively, and 85 and 787 shares for
      the
      six months ended May 31, 2007 and 2006, respectively.











10


**7.**
            **LONG-TERM
                DEBT**





Long-term
      debt consisted of the following as of May 31, 2007 and November 30,
      2006:





2007
            
            
            2006Revolving
                Credit Facility due 2010 at a variable rate of 6.82% and
                8.25% as of  May 31, 2007 and November
                30, 2006, respectively
            
            $
            32,000
            
            
            $
            —2.0%
                Convertible Senior Notes due 2013
            
            
            125,000
            
            
            
            125,0001.625%
                Convertible Senior Notes due 2014
            
            
            100,000
            
            
            
            —Term
                Loan due 2013 at a variable rate of  7.11% as of May 31,
                2007
            
            
            172,000
            
            
            
            —7.0%
                Senior Subordinated Notes due 2014
            
            
            107,500
            
            
            
            107,500Total
                long-term debt
            
            
            536,500
            
            
            
            232,500Less:  current
                maturities
            
            
            (3,000
            )
            
            
            —Total
                long-term debt, net of current maturities
            
            $
            533,500
            
            
            $
            232,500





In
      February 2004, we entered into a new Senior Secured Revolving Credit Facility
      with a maturity date of February 26, 2009 (the “Revolving Credit Facility”) with
      Bank of America, N.A. that provided an initial borrowing capacity of $25,000
      and
      an additional $25,000, subject to successful syndication.  In March
      2004, we entered into a new commitment agreement with a syndicate of commercial
      banks led by Bank of America, N.A., as agent, that enabled us to borrow up
      to a
      total of $50,000 under the Revolving Credit Facility and an additional $50,000,
      subject to successful syndication.  In November 2005, we entered into
      an amendment to our Revolving Credit Facility (the “Amended Revolving Credit
      Facility”) that, among other things, increased our borrowing capacity under the
      facility from $50,000 to $100,000, increased our flexibility to repurchase
      shares of our stock, improved our borrowing rate under the facility and extended
      the maturity date to November 15, 2010.  Upon successful syndication,
      we were able to increase the borrowing capacity under the Amended Revolving
      Credit Facility by $50,000 to an aggregate of $150,000.  In November
      2006, we entered into an amendment to our Amended Revolving Credit Facility
      that, among other things, permitted the sale of the 2.0% Convertible Senior
      Notes due 2013 (the “2.0% Convertible Notes”).  In January 2007, we
      completed an amended credit facility providing for up to a $100,000 revolving
      credit facility and a $300,000 term loan (the “Credit Facility”).  The
      proceeds from the term loan under the Credit Facility were used to finance
      in
      part the acquisition of the five consumer and over-the-counter (“OTC”) brands
      from Johnson & Johnson.  The Credit Facility includes an
“accordion” feature that permits us under certain circumstances to increase our
      borrowings under the revolving credit facility by $50,000 and to borrow an
      additional $50,000 as a term loan.  In April 2007, we entered into an
      amendment to our Credit Facility that, among other things, permitted the sale
      of
      the 1.625% Convertible Senior Notes due 2014  (the “1.625% Convertible
      Notes”) and reduced the applicable interest rates on the revolving credit
      facility portion of our Credit Facility.





Borrowings
      under the revolving credit facility portion of our Credit Facility bear interest
      at LIBOR plus applicable percentages of 0.875% to 1.500% or the higher of the
      federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The
      applicable percentages are calculated based on our leverage ratio.  As
      of May 31, 2007 and November 30, 2006, we had $32,000 and $0, respectively,
      of
      borrowings outstanding under the revolving credit facility portion of our Credit
      Facility.  As of July 2, 2007, we had $29,000 of borrowings
      outstanding under the revolving credit facility portion of our Credit Facility
      and our borrowing capacity was $71,000.





The
      term
      loan under the Credit Facility bears interest at either LIBOR plus 1.75% or the
      Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
      increments of $750 each calendar quarter, with the first principal payment
      paid
      on June 30, 2007.  The principal outstanding after scheduled repayment
      and any unscheduled prepayments is due January 2, 2013.  On April 16,
      2007, we utilized the net proceeds from the 1.625% Convertible Notes and
      borrowings under the revolving credit facility portion of our Credit Facility
      to
      repay $128,000 of the term loan under the Credit Facility.  In
      connection with this repayment, we retired a proportional share of the term
      loan
      debt issuance costs, which resulted in a loss on early extinguishment of debt
      of
      $2,219 during the second quarter of fiscal 2007.





Borrowings
      under the Credit Facility are secured by substantially all of our assets, except
      real property, and shares of capital stock of our domestic subsidiaries held
      by
      us and by the assets of the guarantors (our domestic
      subsidiaries).  The Credit Facility contains covenants,
      representations, warranties and other agreements by us that are customary in
      credit agreements and security instruments relating to financings of this
      type.  The significant financial covenants include fixed charge
      coverage ratio, leverage ratio, senior secured leverage ratio and brand value
      calculations.





11


In
      February 2004, we issued and sold $75,000 of Floating Rate Senior Notes due
      March 1, 2010 (the “Floating Rate Senior Notes”) and $125,000 of 7.0% Senior
      Subordinated Notes due 2014 (the “7.0% Subordinated Notes”).  In
      November 2005, we called our $75,000 of Floating Rate Senior Notes for full
      redemption on December 30, 2005 at a price of 102% of par plus accrued interest
      to December 30, 2005.  We utilized borrowings of $38,000 under our
      Amended Revolving Credit Facility and $38,948 of our cash on hand to fund the
      redemption of the Floating Rate Senior Notes.  As a result of the
      redemption, we retired associated debt issuance costs of $1,303 and incurred
      other related call fees, which resulted in a loss on early extinguishment of
      debt of $2,805 during the first quarter of fiscal 2006.





Interest
      payments on the 7.0% Subordinated Notes are due semi-annually in arrears on
      March 1 and September 1.  Our domestic subsidiaries are guarantors of
      the 7.0% Subordinated Notes.  The guarantees of the 7.0% Subordinated
      Notes are unsecured senior subordinated obligations of the
      guarantors.  At any time after March 1, 2009, we may redeem any of the
      7.0% Subordinated Notes upon not less than 30 nor more than 60 days’ notice at
      redemption prices (expressed in percentages of principal amount), plus accrued
      and unpaid interest, if any, and liquidation damages, if any, to the applicable
      redemption rate, if redeemed during the twelve-month periods beginning March
      1,
      2009 at 103.500%, March 1, 2010 at 102.333%, March 1, 2011 at 101.167% and
      March
      1, 2012 and thereafter at 100.000%.





The
      indenture governing the 7.0% Subordinated Notes, among other things, limits
      our
      ability and the ability of our restricted subsidiaries to: (i) borrow money
      or
      sell preferred stock, (ii) create liens, (iii) pay dividends on or redeem or
      repurchase stock, (iv) make certain types of investments, (v) sell stock in
      our
      restricted subsidiaries, (vi) restrict dividends or other payments from
      restricted subsidiaries, (vii) enter into transactions with affiliates, (viii)
      issue guarantees of debt and (ix) sell assets or merge with other
      companies.  In addition, if we experience specific kinds of changes in
      control, we must offer to purchase the 7.0% Subordinated Notes at 101.0% of
      their principal amount plus accrued and unpaid interest.





In
      March
      2004, we entered into an interest rate cap agreement effective June 1, 2004
      with
      decreasing annual notional principal amounts of $15,000 beginning March 1,
      2006
      and cap rates ranging from 4.0% to 5.0% over the life of the
      agreement.  We paid a $1,375 premium to enter into the interest rate
      cap agreement.  During the second quarter of fiscal 2007, the interest
      rate cap was sold for $353.  As a result, $49 was recorded as
      additional interest expense in the accompanying consolidated statement of income
      for the second quarter of fiscal 2007.





In
      July
      2006, we successfully completed a consent solicitation from the holders of
      the
      7.0% Subordinated Notes to an amendment to the indenture to increase our
      capacity to make restricted payments by an additional $85,000, including
      payments for the repurchase of our common stock, and adjust the fixed charge
      coverage ratio (as defined in the indenture).





In
      November 2006, we completed a private offering of $125,000 of the 2.0%
      Convertible Notes to qualified institutional purchasers pursuant to Section
      4(2)
      of the Securities Act of 1933.  The 2.0% Convertible Notes bear
      interest at an annual rate of 2.0%, payable semi-annually on May 15 and November
      15 of each year.  The 2.0% Convertible Notes are convertible into our
      common stock at an initial conversion price of $58.92 per share, upon the
      occurrence of certain events, including the closing price of our common stock
      exceeding 130% of the conversion price per share for 20 of the last 30 trading
      days of the conversion reference period.  The stock price at which the
      notes would be convertible is $76.59 and as of May 31, 2007 our closing stock
      price was $63.67. Upon conversion, a holder will receive, in lieu of common
      stock, an amount of cash equal to the lesser of (i) the principal amount of
      the 2.0% Convertible Notes, or (ii) the conversion value, determined in the
      manner set forth in the indenture governing the 2.0% Convertible Notes, of
      a
      number of shares equal to the conversion rate. If the conversion value exceeds
      the principal amount of the 2.0% Convertible Note on the conversion date, we
      will also deliver, at our election, cash or common stock or a combination of
      cash and common stock with respect to the conversion value upon conversion.
      If
      conversion occurs in connection with a change of control, we may be required
      to
      deliver additional shares of our common stock by increasing the conversion
      rate
      with respect to such notes. The maximum aggregate number of shares that we
      would
      be obligated to issue upon conversion of the 2.0% Convertible Notes is
      2,673.





Concurrently
      with the sale of the 2.0% Convertible Notes, we purchased a note hedge from
      an
      affiliate of Merrill Lynch (the “Counterparty”), which is designed to mitigate
      potential dilution from the conversion of the 2.0% Convertible Notes. Under
      the
      note hedge, the Counterparty is required to deliver to us the number of shares
      of our common stock that we are obligated to deliver to the holders of the
      2.0%
      Convertible Notes with respect to the conversion, calculated exclusive of shares
      deliverable by us by reason of any additional premium relating to the 2.0%
      Convertible Notes or by reason of any election by us to unilaterally increase
      the conversion rate pursuant to the indenture governing the 2.0% Convertible
      Notes. The note hedge expires at the close of trading on November 15, 2013,
      which is the maturity date of the 2.0% Convertible Notes, although the
      Counterparty will have ongoing obligations with respect to 2.0% Convertible
      Notes properly converted on or prior to that date of which the Counterparty
      has
      been timely notified.





In
      addition, we issued warrants to the Counterparty that could require us to issue
      up to approximately 2,122 shares of our common stock on November 15, 2013
      upon notice of exercise by the Counterparty. The exercise price is $74.82 per
      share, which represented a 60.0% premium over the closing price of our shares
      of
      common stock on November 16, 2006. If the Counterparty exercises the
      warrant, we will have the option to settle in cash or shares the excess of
      the
      price of our shares on that date over the initially established exercise
      price.





12


The
      note
      hedge and warrant are separate and legally distinct instruments that bind us
      and
      the Counterparty and have no binding effect on the holders of the 2.0%
      Convertible Notes.





In
      November 2006, we entered into a forward starting interest rate swap agreement
      effective January 15, 2007.  The forward starting swap has decreasing
      notional principal amounts beginning October 15, 2007 and a swap rate of 4.98%
      over the life of the agreement.  As of May 31, 2007, we had $175,500
      of LIBOR based borrowings hedged under the provisions of the
      swap.  During the three months ended May 31, 2007, the increase in
      fair value of the forward starting swap of $669, net of tax, was recorded to
      other comprehensive income.  The current portion of the fair value of
      the forward starting swap of $313 is included in prepaid expenses and other
      current assets, and the long-term portion of $548 is included in other
      non-current assets.  As of May 31, 2007, the forward starting swap was
      deemed to be an effective cash flow hedge.  The fair value of the
      forward starting swap agreement is valued by a third party.  The
      forward starting swap agreement terminates on January 15, 2010.





In
      November 2006, we entered into a forward starting interest rate cap agreement
      effective January 15, 2007.  The forward starting cap had decreasing
      notional principal amounts beginning October 15, 2007 and a cap rate of 5.0%
      over the life of the agreement.  We paid a $687 premium to enter into
      the forward starting cap agreement.  During the second fiscal quarter
      of 2007, the interest rate cap was sold for $555.  As a result, $50
      was recorded as additional interest expense in the accompanying consolidated
      statement of income.





In
      April
      2007, we entered into an interest rate cap agreement.  The cap has
      decreasing notional principal amounts beginning May 15, 2007 and a cap rate
      of
      5.0% over the life of the agreement.  We paid a $114 premium to enter
      into the cap agreement, which will be amortized over the life of the
      agreement.  As of May 31, 2007, we had $28,500 of LIBOR based
      borrowings hedged under the provisions of the cap.  During the three
      months ended May 31, 2007, the value of the premium on the cap was compared
      to
      the fair value of the cap and the increase in the market value of the premium
      of
      $8, net of tax, was recorded to other comprehensive income.  The
      current portion of the premium on the cap agreement of $80 is included in
      prepaid expenses and other current assets, and the long-term portion of $23
      is
      included in other non-current assets.   As of May 31, 2007, a
      portion of the interest rate cap was deemed an ineffective cash flow hedge
      due
      to the reduction of variable rate debt resulting in an insignificant charge
      recorded as additional interest expense in the accompanying consolidated
      statement of income for the second quarter of fiscal 2007.  The
      balance of the cash flow hedge was deemed to be effective.  The fair
      value of the cap agreement is valued by a third party.  The cap
      agreement terminates on September 15, 2008.





In
      April
      2007, we completed a private offering of $100,000 of the 1.625% Convertible
      Notes to qualified institutional investors pursuant to Section 144A of the
      Securities Act of 1933.  The 1.625% Convertible Notes bear interest at
      an annual rate of 1.625%, payable semi-annually on May 1 and November 1 of
      each
      year, with the first interest payment due on November 1, 2007.  The
      1.625% Convertible Notes are convertible into our common stock at an initial
      conversion price of $73.20 per share, upon the occurrence of certain events,
      including the closing price of our common stock exceeding 130% of the conversion
      price per share for 20 of the last 30 trading days of the conversion reference
      period.  The stock price at which the notes would be convertible is
      $95.16. Upon conversion, a holder will receive, in lieu of common stock, an
      amount of cash equal to the lesser of (i) the principal amount of the
      1.625% Convertible Notes, or (ii) the conversion value, determined in the
      manner set forth in the indenture governing the 1.625%  Convertible
      Notes, of a number of shares equal to the conversion rate. If the conversion
      value exceeds the principal amount of the 1.625% Convertible Note on the
      conversion date, we will also deliver, at our election, cash or common stock
      or
      a combination of cash and common stock with respect to the conversion value
      upon
      conversion. If conversion occurs in connection with a change of control, we
      may
      be required to deliver additional shares of our common stock by increasing
      the
      conversion rate with respect to such notes. The maximum aggregate number of
      shares that we would be obligated to issue upon conversion of the 1.625%
      Convertible Notes is 1,694.





Concurrently
      with the sale of the 1.625% Convertible Notes, we purchased a note hedge from
      the Counterparty, which is designed to mitigate potential dilution from the
      conversion of the 1.625% Convertible Notes. Under the note hedge, the
      Counterparty is required to deliver to us the number of shares of our common
      stock that we are obligated to deliver to the holders of the 1.625% Convertible
      Notes with respect to the conversion, calculated exclusive of shares deliverable
      by us by reason of any additional premium relating to the 1.625% Convertible
      Notes or by reason of any election by us to unilaterally increase the conversion
      rate pursuant to the indenture governing the 1.625% Convertible Notes. The
      note
      hedge expires at the close of trading on May 1, 2014, which is the maturity
      date
      of the 1.625% Convertible Notes, although the Counterparty will have ongoing
      obligations with respect to 1.625% Convertible Notes properly converted on
      or
      prior to that date of which the Counterparty has been timely
      notified.





In
      addition, we issued warrants to the Counterparty that could require us to issue
      up to approximately 1,366 shares of our common stock on May 1, 2014 upon notice
      of exercise by the Counterparty. The exercise price is $94.45 per share, which
      represented a 60% premium over the closing price of our shares of common stock
      on April 4, 2007. If the Counterparty exercises the warrant, we will have the
      option to settle in cash or shares the excess of the price of our shares on
      that
      date over the initially established exercise price.





13


Proceeds
      from the 1.625% Convertible Notes were used to repay a portion of the amount
      outstanding under the Credit Facility term loan, pay for a note hedge and pay
      approximately $2,500 in debt issuance costs.  The note hedge and
      warrant are separate and legally distinct instruments that bind us and the
      Counterparty and have no binding effect on the holders of the 1.625% Convertible
      Notes.





Pursuant
      to EITF 90-19,*“*Convertible Bonds with Issuer Option to Settle for Cash
      upon Conversion”, (“EITF 90-19”), “Accounting for Derivative Financial
      Instruments Indexed to, and Potentially Settled in, a Company’s Own
      Stock”  (“EITF 00-19”), and EITF 01-6, “The Meaning of Indexed to
      a Company’s Own Stock”  (“EITF 01-6”), the 2.0% Convertible Notes and
      the 1.625% Convertible Notes are accounted for as convertible debt in the
      accompanying consolidated balance sheet and the embedded conversion option
      in
      the 2.0% Convertible Notes and the 1.625% Convertible Notes has not been
      accounted for as a separate derivative. Additionally, pursuant to EITF 00-19
      and
      EITF 01-6, the note hedges and warrants are accounted for as equity
      transactions, and therefore, the payments associated with the issuance of the
      note hedges and the proceeds received from the issuance of the warrants were
      recorded as a charge and an increase, respectively, in common shares in
      shareholders’ equity as separate equity transactions.





For
      income tax reporting purposes, we have elected to integrate the 2.0% Convertible
      Notes and the 1.625% Convertible Notes and the respective note hedge
      transaction. Integration of the respective note hedge with the 2.0% Convertible
      Notes and the 1.625% Convertible Notes creates an in-substance original issue
      debt discount for income tax reporting purposes and therefore, the cost of
      the
      note hedge transactions will be accounted for as interest expense over the
      term
      of the 2.0% Convertible Notes and the 1.625% Convertible Notes, respectively,
      for income tax reporting purposes. The income tax benefit related to each
      respective convertible note issuance was recognized as a deferred tax
      asset.





The
      future maturities of long-term debt to be funded for the next five successive
      fiscal years and those thereafter as of May 31, 2007 are as
      follows:





2007
            
            $
            1,5002008
            
            
            3,0002009
            
            
            3,0002010
            
            
            35,0002011
            
            
            3,000Thereafter
            
            
            491,000$
            536,500








**8.**
            **ACQUISITION
                AND SALES OF BRANDS**





On
      January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC
      brands from Johnson & Johnson (“J&J Acquisition”).  The
      acquired brands are: *ACT*, an anti-cavity mouthwash/mouth rinse;
*Unisom*, an OTC sleep-aid; *Cortizone*, a hydrocortisone
      anti-itch product; *Kaopectate*, an anti-diarrhea product; and
*Balmex*, a diaper rash product.  The J&J Acquisition was
      funded with the proceeds from the new $300,000 term loan provided under our
      Credit Facility, borrowings under the revolving credit facility of the Credit
      Facility and through the use of a portion of the proceeds derived from the
      2.0%
      Convertible Notes.  The purchase price of the J&J Acquisition was
      $410,000 plus $2,262 of costs directly related to the acquisition, of which
      $469
      was incurred and funded during our fiscal year ended November 30,
      2006.  The purchase price relates to $5,916 of inventory, $1,884 of
      assumed liabilities, $463 of equipment, $403,853 of trademarks which were
      assigned an indefinite life and $3,914 of distribution rights which was assigned
      a useful life of five years.  This is a preliminary assignment of
      values that will be completed during fiscal 2007.  Johnson &
Johnson will continue to manufacture and supply certain of the products for
      a
      period of up to 18 months from acquisition close, or such earlier date as we
      are
      able to move production to our facilities.  The price we pay Johnson
& Johnson for these products is equivalent to the manufacturing cost, which
      includes all costs associated with the manufacturing and delivery of the
      product.  For a period of up to six months from acquisition close,
      Johnson & Johnson was to provide transition services consisting of consumer
      affairs, distribution and collection services (including related financial,
      accounting and reporting services).  We terminated the distribution
      and collections services effective April 2, 2007 and the consumer affairs
      services effective June 21, 2007.  The costs charged for these
      transition services approximates the actual costs incurred by Johnson &
Johnson.  During the three and six months ended May 31, 2007, we
      incurred $886 and $2,057, respectively, of expenses related to these transition
      services.







14


The
      following unaudited consolidated pro forma information assumes the J&J
      Acquisition had occurred at the beginning of the periods presented:





PRO
      FORMA
      CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)





Three
                Months Ended May 31,
            
            
            Six
                Months Ended May 31,2007
            
            
            2006
            
            
            2007
            
            
            2006Total
                revenue
            
            $
            112,964
            
            
            $
            111,734
            
            
            $
            222,976
            
            
            $
            225,428Net
                income
            
            
            14,908
            
            
            
            14,493
            
            
            
            29,341
            
            
            
            32,137Earnings
                per share – basic:
            
            
            0.78
            
            
            
            0.75
            
            
            
            1.56
            
            
            
            1.65Earnings
                per share – diluted:
            
            
            0.77
            
            
            
            0.74
            
            
            
            1.53
            
            
            
            1.63





The
      pro
      forma consolidated results of operations include adjustments to give effect
      to
      interest expense on debt to finance the J&J Acquisition, increase
      advertising expense to raise brand awareness, incremental selling, general
      and
      administrative expenses, amortization of certain intangible assets and decrease
      in interest income on cash used in the J&J Acquisition, together with
      related income tax effects. The pro forma information is for comparative
      purposes only and does not purport to be indicative of the results that would
      have occurred had the J&J Acquisition and borrowings occurred at the
      beginning of the periods presented, or indicative of the results that may occur
      in the future.





On
      May
      25, 2007, we acquired the worldwide trademark and rights to sell and market
      *ACT* in Western Europe from Johnson & Johnson (“*ACT*Acquisition”) for $4,100 in cash plus certain assumed
      liabilities.  The *ACT* Acquisition was funded with existing
      cash.





**9.**
            **ADVERTISING
                EXPENSES**





We
      incur
      significant expenditures on television, radio and print advertising to support
      our nationally branded OTC health care products and
      toiletries.  Customers purchase products from us with the
      understanding that the brands will be supported by our extensive media
      advertising.  This advertising supports the retailers’ sales effort
      and maintains the important brand franchise with the consuming
      public.  Accordingly, we consider our advertising program to be
      clearly implicit in our sales arrangements with our
      customers.  Therefore, we believe it is appropriate to allocate a
      percentage of the necessary supporting advertising expenses to each dollar
      of
      sales by charging a percentage of sales on an interim basis based upon
      anticipated annual sales and advertising expenditures (in accordance with APB
      Opinion No. 28, “Interim Financial Reporting”) and adjusting that accrual to the
      actual expenses incurred at the end of the year.


**10.**
              **SHIPPING
                    AND
                    HANDLING**





Shipping
      and handling costs of $3,163 and $2,321 are included in selling expenses for
      the
      three months ended May 31, 2007 and 2006, respectively, and $5,565 and $4,585
      for the six months ended May 31, 2007 and 2006, respectively.


**11.**
                **PATENT,
                      TRADEMARKS AND OTHER PURCHASED PRODUCT
                      RIGHTS**


The
      carrying value of trademarks, which are not subject to amortization under the
      provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
      was $613,875 and $205,983 as of May 31, 2007 and November 30, 2006,
      respectively.  The gross carrying amount of intangible assets subject
      to amortization at May 31, 2007 and November 30, 2006, which consist primarily
      of non-compete agreements and distribution rights, was $6,053 and $2,139,
      respectively.  The related accumulated amortization of intangible
      assets at May 31, 2007 and November 30, 2006 was $2,385 and $1,973,
      respectively.  Amortization of our intangible assets subject to
      amortization under the provisions of SFAS 142 for the three months ended May
      31,
      2007 and 2006 was $222 and $59, respectively, and for the six months ended
      May
      31, 2007 and 2006 was $412 and $119, respectively.   Estimated
      annual amortization expense for these assets for the years ended November 30,
      2008, 2009, 2010, 2011 and 2012 is $823, $803, $783, $783 and $65,
      respectively.








15


**12.**
            **INVENTORIES**





Inventories
      consisted of the following as of May 31, 2007 and November 30,
      2006:




2007
            
            
            2006Raw
                materials and work in process
            
            $
            10,033
            
            
            $
            15,495Finished
                goods
            
            
            24,192
            
            
            
            15,894Total
                inventories
            
            $
            34,225
            
            
            $
            31,389





**13.**
            **ACCRUED
                LIABILITIES**





Accrued
      liabilities consisted of the following as of May 31, 2007 and November 30,
      2006:





2007
            
            
            2006Interest
            
            $
            3,957
            
            
            $
            2,599Salaries,
                wages and commissions
            
            
            4,129
            
            
            
            3,878Product
                advertising and promotion
            
            
            9,294
            
            
            
            1,936Litigation
                settlement and legal fees
            
            
            1,404
            
            
            
            1,162Income
                taxes payable
            
            
            —
            
            
            
            635Transition
              services and acquisition costs
            
            
            8,209
            
            
            
            —Other
            
            
            1,819
            
            
            
            1,595Total
                accrued liabilities
            
            $
            28,812
            
            
            $
            11,805








**14.**
            **COMPREHENSIVE
                INCOME**





Comprehensive
      income consisted of the following components for the three and six months ended
      May 31, 2007 and 2006, respectively:





For
                the Three Months Ended
              May
                31,
            
            
            For
                the Six Months Ended
              May
                31,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                income
            
            $
            14,908
            
            
            $
            10,200
            
            
            $
            28,558
            
            
            $
            24,973Other
                – interest rate hedge adjustment
            
            
            748
            
            
            
            134
            
            
            
            1,082
            
            
            
            187Other
                – foreign currency translation adjustment
            
            
            282
            
            
            
            (231
            )
            
            
            211
            
            
            
            11Total
            
            $
            15,938
            
            
            $
            10,103
            
            
            $
            29,851
            
            
            $
            25,171





**15.**
            **STOCK
                REPURCHASE**





On
      July
      25, 2006, our Board of Directors authorized the repurchase of up to an
      additional $100,000 of our common stock under the terms of our existing stock
      repurchase program.  On January 2, 2007, in connection with the
      completion of the Credit Facility, the ability to make restricted payments
      under
      the Credit Facility, including payments for the repurchase of our common stock,
      was increased to $93,110.  As of July 2, 2007, the current amount
      available under the authorization from the Board of Directors was
      $88,147.  No share repurchases have occurred in fiscal
      2007.








**16.**
            **RETIREMENT
                PLANS AND POSTRETIREMENT HEALTH CARE
                BENEFITS**





RETIREMENT
      PLANS





We
      have a
      noncontributory defined benefit pension plan (the “Plan”), which covers
      substantially all employees as of December 31, 2000.  The Plan
      provides benefits based upon years of service and the employee's
      compensation.  Our contributions are based on computations by
      independent actuaries.  Plan assets at May 31, 2007 and November 30,
      2006 were invested primarily in United States government and agency securities
      and corporate debt and equity securities.  Effective December 31,
      2000, participation and benefits under the Plan were frozen.





16


Net
      periodic pension cost for the three and six months ended May 31, 2007 and 2006
      included the following components:





For
                the Three Months
              Ended
                May 31,
            
            
            For
                the Six Months
              Ended
                May 31,2007
            
            
            2006
            
            
            2007
            
            
            2006Service
                cost
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Interest
                cost on projected benefit obligation
            
            
            153
            
            
            
            156
            
            
            
            306
            
            
            
            311Actual
                return on plan assets
            
            
            (220
            )
            
            
            (226
            )
            
            
            (440
            )
            
            
            (451
            )Net
                amortization and deferral
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Net
                pension cost (benefit)
            
            $
            (67
            )
            
            $
            (70
            )
            
            $
            (134
            )
            
            $
            (140
            )





No
      employer contributions were made for the three and six months ended May 31,
      2007
      and 2006, and no employer contributions are expected to be made in fiscal
      2007.





POSTRETIREMENT
      HEALTH CARE BENEFITS





We
      maintain certain postretirement health care benefits for eligible
      employees.  Employees become eligible for these benefits if they meet
      certain age and service requirements.  We pay a portion of the cost of
      medical benefits for certain retired employees over the age of
      65.  Effective May 31, 2006, we adopted an amendment to change the
      eligibility requirements for employee participation and limit the annual benefit
      to be paid.  This action resulted in a curtailment gain of $496 in the
      three months ended May 31, 2006 and is included as a component of selling,
      general and administrative expenses in the accompanying consolidated statements
      of income.   Employer contributions expected for fiscal 2007 are
      approximately $78.





Net
      periodic postretirement health care benefits cost for the three and six months
      ended May 31, 2007 and 2006 included the following components:





For
                the Three Months
              Ended
                May 31,
            
            
            For
                the Six Months
              Ended
                May 31,2007
            
            
            2006
            
            
            2007
            
            
            2006Service
                cost
            
            $
            14
            
            
            $
            20
            
            
            $
            28
            
            
            $
            40Interest
                cost on accumulated postretirement benefit obligation
            
            
            18
            
            
            
            22
            
            
            
            36
            
            
            
            44Amortization
                of prior service cost
            
            
            4
            
            
            
            4
            
            
            
            8
            
            
            
            8Amortization
                of net gain
            
            
            (4
            )
            
            
            (4
            )
            
            
            (8
            )
            
            
            (8
            )Curtailment
                gain
            
            
            —
            
            
            
            (496
            )
            
            
            —
            
            
            
            (496
            )Net
                periodic postretirement benefits cost (benefit)
            
            $
            32
            
            
            $
            (454
            )
            
            $
            64
            
            
            $
            (412
            )








**17.**
            **INCOME
                TAXES**





We
      account for income taxes using the asset and liability approach as prescribed
      by
      SFAS No. 109 and applicable FASB Staff Positions and
      Interpretations.  This approach requires recognition of deferred tax
      assets and liabilities for the expected future tax consequences of events that
      have been included in the consolidated financial statements or tax
      returns.  Using the enacted tax rates in effect for the year in which
      the differences are expected to reverse, deferred tax assets and liabilities
      are
      determined based on the differences between the financial reporting and the
      tax
      basis of an asset or liability.  We record income tax expense in our
      consolidated financial statements based on an estimated annual effective income
      tax rate.  Our effective tax rate was 34.5% for each of the six months
      ended May 31, 2007 and 2006.





Undistributed
      earnings of Chattem Canada amounted to approximately $708 and $807 for the
      three
      and six months ended May 31, 2007, respectively.  These earnings are
      considered to be reinvested indefinitely and, accordingly, no provision for
      U.S.
      federal and state income taxes has been provided thereon.  Upon
      distribution of those earnings in the form of dividends or otherwise, those
      earnings would be subject to U.S. income taxes (subject to an adjustment for
      foreign tax credits).











17


**18.**
            **PRODUCT
                SEGMENT INFORMATION**





Net
      sales
      of our domestic product categories within our single healthcare business segment
      for the three and six months ended May 31, 2007 and 2006 are as
      follows:





For
                the Three Months
              Ended
                May 31,
            
            
            For
                the Six Months
              Ended
                May 31,2007
            
            
            2006
            
            
            2007
            
            
            2006Topical
                pain care
            
            $
            24,927
            
            
            $
            28,397
            
            
            $
            52,153
            
            
            $
            60,838Medicated
                skin care
            
            
            31,595
            
            
            
            15,389
            
            
            
            59,427
            
            
            
            32,280Oral
                care
            
            
            13,731
            
            
            
            1,703
            
            
            
            22,218
            
            
            
            3,318Internal
                OTC products
            
            
            12,014
            
            
            
            3,032
            
            
            
            20,463
            
            
            
            5,592Medicated
                dandruff shampoos
            
            
            8,339
            
            
            
            8,461
            
            
            
            18,636
            
            
            
            20,278Dietary
                supplements
            
            
            6,824
            
            
            
            8,909
            
            
            
            14,854
            
            
            
            17,762Other
                OTC and toiletry products
            
            
            8,788
            
            
            
            6,262
            
            
            
            13,090
            
            
            
            10,528Total
            
            $
            106,218
            
            
            $
            72,153
            
            
            $
            200,841
            
            
            $
            150,596






**19.**
            **COMMITMENTS AND
                CONTINGENCIES**




GENERAL
      LITIGATION




We
      were
      named as a defendant in a number of lawsuits alleging that the plaintiffs were
      injured as a result of ingestion of products containing phenylpropanolamine
      (“PPA”), which was an active ingredient in most of our *Dexatrim*
      products until November 2000.  The lawsuits filed in federal court
      were transferred to the United States District Court for the Western District
      of
      Washington before United States District Judge Barbara J. Rothstein (*In Re
      Phenylpropanolamine (“PPA”) Products Liability Litigation, MDL No.
      1407*).  The remaining lawsuits were filed in state court in a
      number of different states.




On
      April
      13, 2004, we entered into a class action settlement agreement with
      representatives of the plaintiffs’ settlement class, which provided for a
      national class action settlement of all *Dexatrim* PPA
      claims.  On November 12, 2004, Judge Barbara J. Rothstein of the
      United States District Court for the Western District of Washington entered
      a
      final order and judgment certifying the class and granting approval of the
      *Dexatrim* PPA settlement.




The
      *Dexatrim* PPA settlement included claims against us involving alleged
      injuries by *Dexatrim* products containing PPA in which the alleged
      injury occurred after December 21, 1998, the date we acquired the
*Dexatrim* brand.  In accordance with the terms of the class
      action settlement agreement, we previously published notice of the settlement
      and details as to the manner in which claims could be submitted.  The
      deadline for submission of claims was July 7, 2004.  A total of 391
      claims were certified by the court as timely submitted.  A total of 14
      claimants with alleged injuries that occurred after December 21, 1998 elected
      to
      opt-out of the class settlement.  Subsequently, we have settled twelve
      of the opt-out claims. The other two opt-outs have not filed lawsuits against
      us, and we believe the applicable statutes of limitation have run against their
      claims.  Consequently, we are not currently defending any PPA products
      liability claims.




In
      accordance with the terms of the class action settlement, approximately $70,885
      was initially funded into a settlement trust.  Over the past two
      years, we have resolved all of the claims submitted in the *Dexatrim* PPA
      settlement. All claims in the settlement and expenses of the trust have now
      been
      paid.  On June 14, 2006, we filed a motion to dissolve the settlement
      trust.  The court granted this motion on July 14, 2006.  On
      August 31, 2006, the settlement trust paid us $10,720, which is included as
      a
      component of litigation settlement in our condensed consolidated statement
      of
      income for 2006.  The settlement trust currently has a balance of
      approximately $2,500.




We
      were
      also named as a defendant in approximately 206 lawsuits relating to
*Dexatrim* containing PPA which involve alleged injuries by
*Dexatrim* products containing PPA manufactured and sold prior to
      our
      acquisition of *Dexatrim* on December 21, 1998.  The DELACO
      Company (“DELACO”), successor by merger to the Thompson Medical Company, Inc.,
      which owned the brand prior to December 21, 1998, owed us an indemnity
      obligation for any liabilities arising from these lawsuits.  On
      February 12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United
      States Bankruptcy Court for the Southern District of New York.  We
      filed a claim in DELACO’s bankruptcy.




We
      entered into a settlement agreement with DELACO dated June 30, 2005 that
      resolved DELACO’s indemnity obligations to us (“the DELACO
      Agreement”).  The DELACO Agreement was approved by the DELACO
      bankruptcy court on July 28, 2005.  Pursuant to the DELACO Agreement,
      we agreed to assume responsibility for all claims against DELACO and its
      predecessor, Thompson Medical Company, Inc., or us relating to *Dexatrim*
      products involving an injury date after December 21, 1998, and hold the DELACO
      bankruptcy estate harmless from any such claims.  In exchange, a
      settlement trust that was




18


established
      under DELACO’s bankruptcy plan agreed to pay us $8,750 and assume responsibility
      for all claims related to *Dexatrim* products alleging injury dates on or
      before December 21, 1998. On February 17, 2006, the DELACO bankruptcy court
      entered an order confirming the DELACO bankruptcy plan which incorporated the
      terms of the DELACO Agreement.  In accordance with the DELACO
      bankruptcy plan, the settlement trust established under the plan paid us $8,750
      on March 17, 2006, which is included in our condensed consolidated statement
      of
      income, net of legal expenses, as litigation settlement for 2006.  In
      addition, this order will allow us to dismiss all cases against us with injury
      dates prior to December 21, 1998.  The DELACO settlement trust is
      currently resolving and paying *Dexatrim* claims with injury dates prior
      to December 21, 1998 in accordance with the DELACO bankruptcy plan.




The
      confirmation of the DELACO bankruptcy plan effectively released us from
      liability for all PPA products liability cases with injury dates prior to
      December 21, 1998.  The payment to us by the DELACO settlement trust
      of $8,750 and the channeling of cases to the DELACO settlement trust as
      described above has conclusively compromised and settled our indemnity claim
      filed in the DELACO bankruptcy.





On
      December 30, 2003, the United States Food and Drug Administration ("FDA") issued
      a consumer alert on the safety of dietary supplements containing ephedrine
      alkaloids and on February 6, 2004 published a final rule with respect to these
      products.  The final rule prohibits the sale of dietary supplements
      containing ephedrine alkaloids because such supplements present an unreasonable
      risk of illness or injury.  The final rule became effective on April
      11, 2004.  Although we discontinued the manufacturing and shipment of
*Dexatrim* containing ephedrine until September 2002, the FDA's final
      rule may result in additional lawsuits being filed against us alleging damages
      related to the use or purchase of *Dexatrim* containing
      ephedrine.  There is currently one *Dexatrim* with ephedrine
      products liability lawsuit pending against us.





We
      maintain insurance coverage for product liability claims relating to our
      products, including *Dexatrim* products containing ephedrine, under
      claims-made policies which are subject to annual renewal.   For
      the current annual policy period beginning June 1, 2007, we maintain product
      liability insurance coverage in the amount of $30,000 through our captive
      insurance subsidiary, of which approximately $3,600 has been funded as of July
      2, 2007.  We also have $25,000 of excess coverage through a third
      party reinsurance policy, which excludes coverage for our *Dexatrim*
      products containing ephedrine.





We
      were named as a defendant in a
      putative class action lawsuit filed in the Superior Court of the State of
      California, for County of Los Angeles on February 11, 2004, relating to the
      labeling, advertising, promotion and sale of our *Bullfrog* suncare
      products.  We filed an answer to this lawsuit on June 28,
      2004.  An amended complaint was filed on or about March 29, 2006,
      pursuant to a court order formally consolidating this lawsuit with eight
      existing lawsuits involving other manufacturers of sunscreen products into
      a
      coordinated proceeding in California state court.  The amended lawsuit
      sought class certification of all persons who purchased our *Bullfrog*
      suncare products in California during a four year period prior to February
      11,
      2004.  The amended lawsuit sought restitution and/or disgorgement of
      profits, actual damages, injunctive relief, punitive damages and attorneys
      fees
      and costs.  Following the deposition of Plaintiff William C. Jordan,
      we filed a motion for summary judgment which was heard on April 18,
      2007.  The court found there was no merit to any of the causes of
      action that Jordan asserted against us.  The court entered judgment in
      our favor on May 8, 2007.  There has been no further activity since
      that date and we are no longer participating in the coordinated
      proceedings.




We
        were
        named as a defendant in a putative class action lawsuit filed in the United
        States District Court for the Southern District of California relating to
        the
        labeling, advertising, promotion and sale of our *Garlique*product.  We were served with this lawsuit on July 5,
        2007.  The lawsuit seeks class certification of a nationwide class of
        consumers who purchased this product.  The time period for purchases
        that would apply to the class is not clear from the complaint.  The
        lawsuit seeks restitution and/or disgorgement of profits, punitive damages,
        costs and attorney fees, injunctive relief, and other unspecified
        damages.  We plan to vigorously defend this case.


On
      March
      9, 2006, we were named in a lawsuit filed in the Southern District of New York
      by Novogen Research Pty. Ltd.  Novogen alleged that our product
*New Phase* infringed upon Novogen patents by containing certain
      phytoestrogens from clover or equivalent sources.  On June 8, 2007, we
      entered into an agreement with Novogen to settle this litigation.  A
      Stipulation and Order of Dismissal was entered by the court on June 18,
      2007.  The terms of the settlement agreement had no material effect on
      our financial position or results of operations.





Other
      claims, suits and complaints arise in the ordinary course of our business
      involving such matters as patents and trademarks, product liability,
      environmental matters, employment law issues and other alleged injuries or
      damage. The outcome of such litigation cannot be predicted, but, in the opinion
      of management, based in part upon assessments from counsel, all such other
      pending matters are without merit or are of such kind or involve such other
      amounts as would not have a material adverse effect on our financial position,
      results of operations or cash flows if disposed of unfavorably.




REGULATORY





On
      December 30, 2003, the FDA issued a consumer alert on the safety of dietary
      supplements containing ephedrine alkaloids and on February 6, 2004 published
      a
      final rule with respect to these products.  The final rule prohibits
      the sale of dietary supplements containing ephedrine alkaloids because such
      supplements present an unreasonable risk of illness or injury.  The
      final rule became effective on April 11, 2004.  Although we
      discontinued the manufacturing and shipment of *Dexatrim* containing
      ephedrine in September 2002, the FDA’s final rule may result in lawsuits in
      addition to those we currently have being filed against us alleging damages
      related to the use or purchase of *Dexatrim* containing
      ephedrine.   In April 2005, a Utah federal court called into
      question the 2004 final rule.  The court decision is being appealed
      and may have an effect on the FDA’s enforcement of the ephedrine alkaloid final
      rule.





19


We
      were notified in October 2000 that
      the FDA denied a citizen petition submitted by Thompson Medical Company, Inc.,
      the previous owner of *Sportscreme* and
*Aspercreme.*  The petition sought a determination that 10%
      trolamine salicylate, the active ingredient in *Sportscreme* and
*Aspercreme*, was clinically proven to be an effective active ingredient
      in external analgesic OTC drug products and should be included in the FDA's
      yet-to-be finalized monograph for external analgesics. We have met with the
      FDA
      and submitted a proposed protocol study to evaluate the efficacy of 10%
      trolamine salicylate as an active ingredient in OTC external analgesic drug
      products.  We are working to develop alternate formulations for
*Sportscreme* and *Aspercreme* in the event that the FDA does not
      consider the available clinical data to conclusively demonstrate the efficacy
      of
      trolamine salicylate when the OTC external analgesic monograph is finalized.
      If
      10% trolamine salicylate is not included in the final monograph, we would likely
      be required to discontinue these products as currently formulated and remove
      them from the market after expiration of an anticipated grace period. If this
      occurred, we believe we could still market these products as homeopathic
      products or reformulate them using ingredients included in the FDA
      monograph.  We are uncertain as to when the monograph is likely to
      become final.





Certain
      of our topical analgesic products are currently marketed under a FDA tentative
      final external analgesic monograph. The FDA has proposed that the final
      monograph exclude external analgesic products in patch, plaster or poultice
      form, unless the FDA receives additional data supporting the safety and efficacy
      of these products. On October 14, 2003, we submitted to the FDA information
      regarding the safety of our *Icy Hot* patches and arguments to support
      our product’s inclusion in the final monograph. We have also participated in an
      industry effort coordinated by Consumer Healthcare Products Association (“CHPA”)
      to establish with the FDA a protocol of additional research that will allow
      the
      patches to be marketed under the final monograph even if the final monograph
      does not explicitly allow them. The CHPA submission to FDA was made on October
      15, 2003. Thereafter, in April 2004, we launched the *Icy Hot* Sleeve, a
      flexible, non-occlusive fabric patch containing 16% menthol.  In
      February 2006, we launched the *Icy Hot Pro-Therapy* Medicated Foam Pad
      with Knee Wrap containing 5% menthol, and the *Capzasin* Back & Body
      patch containing 0.025% capsaicin.  All of these drug products contain
      levels of active ingredients consistent with levels permitted in the OTC
      monograph.  If additional research is required either as a preliminary
      to final FDA monograph approval and/or as a requirement of future individual
      product sale, we may need to invest in a considerable amount of expensive
      testing and data analysis. Any preliminary cost may be shared with other patch
      manufacturers. Because the submissions made into the FDA docket have been
      forwarded from its OTC Division to its Dermatological Division within the Center
      for Drug Evaluation and Research (“CDER”), we are uncertain as to when this
      matter is likely to become final.  For example, the FDA could choose
      to hold in abeyance a final ruling on alternative dose forms even if the
      monograph is otherwise finalized.  If the final monograph excludes
      such products, we will have to file a new drug application (“NDA”) for
      previously marketed drugs in order to continue to market the *Icy Hot*
      and *Aspercreme*Patches, the *Icy Hot* Sleeve, the *Icy Hot
      Pro-Therapy* Medicated Foam Pad with Knee Wrap, *Capzasin* Back &
Body Patch and/or similar delivery systems under our other topical
      analgesic
      brands. In such case, we would likely have to remove the existing products
      from
      the market one year from the effective date of the final monograph, pending
      FDA
      review and approval of an NDA. The preparation of an NDA would likely take
      us
      six to 18 months and would be expensive. It typically takes the FDA at least
      twelve months to rule on an NDA once it is submitted.





We
      have responded to certain questions
      with respect to efficacy received from the FDA in connection with clinical
      studies for pyrilamine maleate, one of the active ingredients used in certain
      of
      the *Pamprin* and *Prēmsyn PMS* products. While we addressed all
      of the FDA questions in detail, the final monograph for menstrual drug products,
      which has not yet been issued, will determine if the FDA considers pyrilamine
      maleate safe and effective for menstrual relief products. If pyrilamine maleate
      were not included in the final monograph, we would be required to reformulate
      the products to continue to provide the consumer with multi-symptom relief
      benefits.  We have been actively monitoring the process and do not
      believe that either *Pamprin* or *Prēmsyn PMS**,*
      as brands, will be materially affected by the FDA review.  We believe
      that any adverse finding by the FDA would likewise affect our principal
      competitors in the menstrual product category and that finalization of the
      menstrual products monograph is not imminent.  Moreover, we have
      formulated alternative *Pamprin* products that fully comply with both the
      internal analgesic and menstrual product monographs.





In
      early
      2005, infrequent, but serious, adverse cardiovascular events were reported
      to
      the FDA associated with patients who were prescribed a subclass of COX-2
      inhibitor non-steroidal anti-inflammatory drugs (“NSAID’s”) for long periods to
      relieve pain of chronic diseases such as arthritis.  These products
      include Vioxx®, Bextra®, and Celebrex®.  In February 2005, the FDA
      held a joint advisory committee meeting to seek external counsel on the extent
      to which manufacturers might further warn patients of these cardiovascular
      risks
      on prescription product labeling, or prohibit sale of these prescription
      products.  As part of its response on this issue, the FDA has
      recommended labeling changes for both the prescription and OTC NSAID’s.
      Well-known OTC NSAID’s such as ibuprofen and naproxen, which have been sold in
      vast quantities since the 1970s, were affected by this regulatory
      action.   Manufacturers of OTC NSAID’s were asked to revise their
      labeling to provide more specific information about the potential cardiovascular
      and gastrointestinal risks recognizing the limited dose and duration of
      treatment of these products.  Our *Pamprin All Day*product,
      which contains naproxen sodium, is subject to these new labeling
      requirements.






20


*Pamprin
      All Day* is manufactured for us by The Perrigo Company (“Perrigo”), holder
      of an abbreviated NDA for naproxen sodium.  As holder of the
      abbreviated NDA, Perrigo made the mandated labeling changes within the time
      frame required by the FDA. Product with revised labeling compliant with new
      FDA
      regulations began shipping in February 2006.  We are also aware of the
      FDA's concern about the potential toxicity due to concomitant use of OTC and
      prescription products that contain the analgesic ingredient acetaminophen,
      an
      ingredient also found in *Pamprin* and *Prēmsyn
      PMS*.  We are also aware that the FDA will revise acetaminophen
      labeling to reflect the concerns similar to NSAID analgesics such as
      naproxen.  We are participating in an industry-wide effort to reassure
      the FDA that the current recommended dosing regimen is safe and effective and
      that proper labeling and public education by both OTC and prescription drug
      companies are the best policies to abate the FDA's concern.   The
      FDA will address both issues in its effort to finalize the monograph on internal
      analgesic products.  We believe the FDA may issue revised labeling
      requirements within the next year, perhaps prior to monograph closure that
      will
      cause the industry to relabel its analgesic products to better inform
      consumers.





During
      the finalization of the
      monograph on sunscreen products, the FDA chose to hold in abeyance specific
      requirements relating to the characterization of a product’s ability to reduce
      UVA radiation.  A final ruling on this matter would be expected to
      result in new UVA testing requirements and subsequent labeling changes related
      to sun protection factor, or SPF, ratings, and other labeling
      claims.  We expect that the FDA may take action on this matter within
      the next six months.  If implemented, the final rules would likely
      result in new testing requirements and revised labeling of our *Bullfrog*
      product line, and all of our competitors’ products in the suncare category,
      within one year after issuance of the final rules.





Our
      business is also regulated by the
      California Safe Drinking Water and Toxic Enforcement Act of 1986, known as
      Proposition 65.  Proposition 65 prohibits businesses from exposing
      consumers to chemicals that the state has determined cause cancer or
      reproduction toxicity without first giving fair and reasonable warning unless
      the level of exposure to the carcinogen or reproductive toxicant falls below
      prescribed levels.  From time to time, one or more ingredients in our
      products could become subject to an inquiry under Proposition 65.  If
      an ingredient is on the state’s list as a carcinogen, it is possible that a
      claim could be brought in which case we would be required to demonstrate that
      exposure is below a “no significant risk” level for consumers.  Any
      such claims may cause us to incur significant expense, and we may face monetary
      penalties or injunctive relief, or both, or be required to reformulate our
      product to acceptable levels.  The State of California under
      Proposition 65 is also considering the inclusion of titanium dioxide on the
      state’s list of suspected carcinogens.  Titanium dioxide has a long
      history of widespread use as an excipient in prescription and OTC
      pharmaceuticals, cosmetics, dietary supplements and skin care products and
      is an
      active ingredient in our *Bullfrog* Superblock products. We have
      participated in an industry-wide submission to the State of California,
      facilitated through the CHPA, presenting evidence that titanium dioxide presents
      “no significant risk” to consumers.





In
      March
      2006, the FDA conducted a routine site audit of our manufacturing plants and
      laboratories.  There were no material adverse findings resulting from
      the audit.




**20.**
            **CONSOLIDATING
                FINANCIAL STATEMENTS**





The
      consolidating financial statements, for the dates or periods indicated, of
      Chattem, Inc.  (“Chattem”), Signal Investment & Management Co.
      (“Signal”), SunDex, LLC (“SunDex”) and Chattem (Canada) Holdings, Inc.
      (“Canada”), the guarantors of the long-term debt of Chattem, and the
      non-guarantor direct and indirect wholly-owned subsidiaries of Chattem are
      presented below.  Signal is 89% owned by Chattem and 11% owned by
      Canada.  SunDex and Canada are wholly-owned subsidiaries of
      Chattem.  The guarantees of Signal, SunDex and Canada are full and
      unconditional and joint and several.  The guarantees of Signal, SunDex
      and Canada as of May 31, 2007 arose in conjunction with Chattem’s Credit
      Facility and Chattem’s issuance of the 7.0% Subordinated Notes (See Note
      7).  The maximum amount of future payments the guarantors would be
      required to make under the guarantees as of May 31, 2007 is
      $311,500.
















21


Note
      20


**CHATTEM,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATING
          BALANCE SHEETS**




MAY
      31,
      2007


(Unaudited
      and in thousands)




CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            3,961
            
            
            $
            664
            
            
            $
            8,032
            
            
            $
            —
            
            
            $
            12,657Accounts
                receivable, less allowances of $13,284
            
            
            46,433
            
            
            
            17,360
            
            
            
            5,395
            
            
            
            (17,360
            )
            
            
            51,828Interest
                receivable
            
            
            17
            
            
            
            625
            
            
            
            182
            
            
            
            (824
            )
            
            
            —Inventories
            
            
            27,533
            
            
            
            4,069
            
            
            
            2,623
            
            
            
            —
            
            
            
            34,225Refundable
                income taxes
            
            
            1,491
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,491Deferred
                income taxes
            
            
            3,675
            
            
            
            —
            
            
            
            36
            
            
            
            —
            
            
            
            3,711Prepaid
                expenses and other current assets
            
            
            2,561
            
            
            
            —
            
            
            
            1,187
            
            
            
            (30
            )
            
            
            3,718Total
                current assets
            
            
            85,671
            
            
            
            22,718
            
            
            
            17,455
            
            
            
            (18,214
            )
            
            
            107,630PROPERTY,
                PLANT AND EQUIPMENT, NET
            
            
            28,835
            
            
            
            775
            
            
            
            587
            
            
            
            —
            
            
            
            30,197OTHER
                NONCURRENT ASSETS:Patents,
                trademarks and other purchased product rights, net
            
            
            3,668
            
            
            
            674,709
            
            
            
            1,456
            
            
            
            (62,290
            )
            
            
            617,543Debt
                issuance costs, net
            
            
            16,975
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            16,975Investment
                in subsidiaries
            
            
            337,510
            
            
            
            33,000
            
            
            
            66,860
            
            
            
            (437,370
            )
            
            
            —Note
                receivable
            
            
            —
            
            
            
            33,000
            
            
            
            —
            
            
            
            (33,000
            )
            
            
            —Other
            
            
            4,908
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,908Total
                other noncurrent assets
            
            
            363,061
            
            
            
            740,709
            
            
            
            68,316
            
            
            
            (532,660
            )
            
            
            639,426TOTAL
                ASSETS
            
            $
            477,567
            
            
            $
            764,202
            
            
            $
            86,358
            
            
            $
            (550,874
            )
            
            $
            777,253LIABILITIES
                AND SHAREHOLDERS’ EQUITYCURRENT
                LIABILITIES:Current
                maturities of long-term debt
            
            $
            3,000
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            3,000Accounts
                payable and other
            
            
            11,218
            
            
            
            —
            
            
            
            1,613
            
            
            
            —
            
            
            
            12,831Bank
                overdraft
            
            
            4,432
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,432Accrued
                liabilities
            
            
            42,500
            
            
            
            1,130
            
            
            
            3,396
            
            
            
            (18,214
            )
            
            
            28,812Total
                current liabilities
            
            
            61,150
            
            
            
            1,130
            
            
            
            5,009
            
            
            
            (18,214
            )
            
            
            49,075LONG-TERM
                DEBT, less current maturities
            
            
            539,900
            
            
            
            (1,200
            )
            
            
            27,800
            
            
            
            (33,000
            )
            
            
            533,500DEFERRED
                INCOME TAXES
            
            
            (20,085
            )
            
            
            34,185
            
            
            
            —
            
            
            
            —
            
            
            
            14,100OTHER
                NONCURRENT LIABILITIES
            
            
            1,464
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,464INTERCOMPANY
                ACCOUNTS
            
            
            (283,976
            )
            
            
            277,842
            
            
            
            6,134
            
            
            
            —
            
            
            
            —SHAREHOLDERS’
                EQUITY:Preferred
                shares, without par value, authorized 1,000, none
                issued
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
                shares, without par value, authorized 50,000, issued and
                outstanding 19,139
            
            
            44,134
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            44,134Shares
                of subsidiaries
            
            
            —
            
            
            
            329,705
            
            
            
            39,803
            
            
            
            (369,508
            )
            
            
            —Retained
                earnings
            
            
            134,523
            
            
            
            122,540
            
            
            
            7,192
            
            
            
            (129,732
            )
            
            
            134,523Total
            
            
            178,657
            
            
            
            452,245
            
            
            
            46,995
            
            
            
            (499,240
            )
            
            
            178,657Cumulative
                other comprehensive income, net of tax:Interest
                rate swap/cap adjustment
            
            
            485
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            485Foreign
                currency translation adjustment
            
            
            (28
            )
            
            
            —
            
            
            
            420
            
            
            
            (420
            )
            
            
            (28
            )Total
                shareholders’ equity
            
            
            179,114
            
            
            
            452,245
            
            
            
            47,415
            
            
            
            (499,660
            )
            
            
            179,114TOTAL
                LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            477,567
            
            
            $
            764,202
            
            
            $
            86,358
            
            
            $
            (550,874
            )
            
            $
            777,253




22


Note
      20


**CHATTEM,
      INC. AND SUBSIDIARIES**


**CONSOLIDATING
          BALANCE SHEETS**


NOVEMBER
      30, 2006


(In
      thousands)


CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            80,198
            
            
            $
            1,967
            
            
            $
            8,362
            
            
            $
            —
            
            
            $
            90,527Accounts
                receivable, less allowances of $10,907
            
            
            25,203
            
            
            
            9,407
            
            
            
            4,649
            
            
            
            (9,407
            )
            
            
            29,852Interest
                receivable
            
            
            17
            
            
            
            625
            
            
            
            —
            
            
            
            (642
            )
            
            
            —Inventories
            
            
            24,444
            
            
            
            4,160
            
            
            
            2,785
            
            
            
            —
            
            
            
            31,389Deferred
                income taxes
            
            
            4,304
            
            
            
            —
            
            
            
            37
            
            
            
            —
            
            
            
            4,341Prepaid
                expenses and other current assets
            
            
            3,666
            
            
            
            —
            
            
            
            2,191
            
            
            
            —
            
            
            
            5,857Total
                current assets
            
            
            137,832
            
            
            
            16,159
            
            
            
            18,024
            
            
            
            (10,049
            )
            
            
            161,966PROPERTY,
                PLANT AND EQUIPMENT, NET
            
            
            28,985
            
            
            
            775
            
            
            
            593
            
            
            
            —
            
            
            
            30,353OTHER
                NONCURRENT ASSETS:Patents,
                trademarks and other purchased product rights, net
            
            
            166
            
            
            
            268,273
            
            
            
            —
            
            
            
            (62,290
            )
            
            
            206,149Debt
                issuance costs, net
            
            
            11,399
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            11,399Investment
                in subsidiaries
            
            
            313,922
            
            
            
            33,000
            
            
            
            66,860
            
            
            
            (413,782
            )
            
            
            —Note
                receivable
            
            
            —
            
            
            
            33,000
            
            
            
            —
            
            
            
            (33,000
            )
            
            
            —Other
            
            
            4,978
            
            
            
            468
            
            
            
            —
            
            
            
            —
            
            
            
            5,446Total
                other noncurrent assets
            
            
            330,465
            
            
            
            334,741
            
            
            
            66,860
            
            
            
            (509,072
            )
            
            
            222,994TOTAL
                ASSETS
            
            $
            497,282
            
            
            $
            351,675
            
            
            $
            85,477
            
            
            $
            (519,121
            )
            
            $
            415,313LIABILITIES
                AND SHAREHOLDERS’ EQUITYCURRENT
                LIABILITIES:Accounts
                payable and other
            
            $
            10,473
            
            
            $
            —
            
            
            $
            1,580
            
            
            $
            (2,105
            )
            
            $
            9,948Bank
                overdraft
            
            
            5,824
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,824Accrued
                liabilities
            
            
            17,869
            
            
            
            1,132
            
            
            
            748
            
            
            
            (7,944
            )
            
            
            11,805Total
                current liabilities
            
            
            34,166
            
            
            
            1,132
            
            
            
            2,328
            
            
            
            (10,049
            )
            
            
            27,577LONG-TERM
                DEBT, less current maturities
            
            
            232,500
            
            
            
            —
            
            
            
            33,000
            
            
            
            (33,000
            )
            
            
            232,500DEFERRED
                INCOME TAXES
            
            
            (16,517
            )
            
            
            34,185
            
            
            
            —
            
            
            
            —
            
            
            
            17,668OTHER
                NONCURRENT LIABILITIES
            
            
            1,987
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,987INTERCOMPANY
                ACCOUNTS
            
            
            109,564
            
            
            
            (114,014
            )
            
            
            4,450
            
            
            
            —
            
            
            
            —SHAREHOLDERS’
                EQUITY:Preferred
                shares, without par value, authorized 1,000, none
                issued
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
                shares, without par value, authorized 100,000, issued
                18,669
            
            
            30,452
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            30,452Share
                capital of subsidiaries
            
            
            —
            
            
            
            329,705
            
            
            
            39,803
            
            
            
            (369,508
            )
            
            
            —Retained
                earnings
            
            
            105,965
            
            
            
            100,667
            
            
            
            5,679
            
            
            
            (106,346
            )
            
            
            105,965Total
            
            
            136,417
            
            
            
            430,372
            
            
            
            45,482
            
            
            
            (475,854
            )
            
            
            136,417Cumulative
                other comprehensive income, net oftaxes:Interest
                rate swap/cap adjustment
            
            
            (597
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (597
            )Foreign
                currency translation adjustment
            
            
            (238
            )
            
            
            —
            
            
            
            217
            
            
            
            (218
            )
            
            
            (239
            )Total
                shareholders’ equity
            
            
            135,582
            
            
            
            430,372
            
            
            
            45,699
            
            
            
            (476,072
            )
            
            
            135,581TOTAL
                LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            497,282
            
            
            $
            351,675
            
            
            $
            85,477
            
            
            $
            (519,121
            )
            
            $
            415,313




23


Note
      20




**CHATTEM,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATING
        STATEMENTS OF INCOME**




FOR
        THE
        SIX MONTHS ENDED MAY 31, 2007
 (Unaudited
        and in thousands)





CHATTEM
            
            
            GUARANTOR
                SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDTOTAL
                REVENUES
            
            $
            189,701
            
            
            $
            47,237
            
            
            $
            10,512
            
            
            $
            (33,655
            )
            
            $
            213,795COSTS
                AND EXPENSES:Cost
                of sales
            
            
            58,130
            
            
            
            4,413
            
            
            
            4,895
            
            
            
            (1,363
            )
            
            
            66,075Advertising
                and promotion
            
            
            50,098
            
            
            
            5,418
            
            
            
            2,935
            
            
            
            —
            
            
            
            58,451Selling,
                general and administrative
            
            
            26,526
            
            
            
            (391
            )
            
            
            762
            
            
            
            —
            
            
            
            26,897Acquisition
                expenses
            
            
            2,057
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,057Equity
                in subsidiary income
            
            
            (23,385
            )
            
            
            —
            
            
            
            —
            
            
            
            23,385
            
            
            
            —Total
                costs and expenses
            
            
            113,426
            
            
            
            9,440
            
            
            
            8,592
            
            
            
            22,022
            
            
            
            153,480INCOME
                FROM OPERATIONS
            
            
            76,275
            
            
            
            37,797
            
            
            
            1,920
            
            
            
            (55,677
            )
            
            
            60,315OTHER
                INCOME (EXPENSE):Interest
                expense
            
            
            (15,650
            )
            
            
            —
            
            
            
            (1,324
            )
            
            
            1,419
            
            
            
            (15,555
            )Investment
                and other income, net
            
            
            709
            
            
            
            1,274
            
            
            
            1,746
            
            
            
            (2,670
            )
            
            
            1,059Loss
                on early extinguishment of debt
            
            
            (2,219
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,219
            )Royalties
            
            
            (29,853
            )
            
            
            (2,439
            )
            
            
            —
            
            
            
            32,292
            
            
            
            —Corporate
                allocations
            
            
            1,363
            
            
            
            (1,331
            )
            
            
            (32
            )
            
            
            —
            
            
            
            —Total
                other income (expense)
            
            
            (45,650
            )
            
            
            (2,496
            )
            
            
            390
            
            
            
            31,041
            
            
            
            (16,715
            )INCOME
                BEFORE INCOME TAXES
            
            
            30,625
            
            
            
            35,301
            
            
            
            2,310
            
            
            
            (24,636
            )
            
            
            43,600PROVISION
                FOR INCOME TAXES
            
            
            2,067
            
            
            
            12,178
            
            
            
            797
            
            
            
            —
            
            
            
            15,042NET
                INCOME
            
            $
            28,558
            
            
            $
            23,123
            
            
            $
            1,513
            
            
            $
            (24,636
            )
            
            $
            28,558



















24


Note
      20


**CHATTEM,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATING
        STATEMENTS OF INCOME**
  FOR
        THE
        SIX MONTHS ENDED MAY 31, 2006
 (Unaudited
        and in thousands)







CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDTOTAL
                REVENUES
            
            $
            136,865
            
            
            $
            42,143
            
            
            $
            10,143
            
            
            $
            (25,716
            )
            
            $
            163,435COSTS
                AND EXPENSES:Cost
                of sales
            
            
            42,951
            
            
            
            5,064
            
            
            
            4,501
            
            
            
            (1,442
            )
            
            
            51,074Advertising
                and promotion
            
            
            44,124
            
            
            
            5,328
            
            
            
            2,516
            
            
            
            —
            
            
            
            51,968Selling,
                general and administrative
            
            
            22,795
            
            
            
            (146
            )
            
            
            470
            
            
            
            —
            
            
            
            23,119Litigation
                settlement
            
            
            (8,505
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (8,505
            )Equity
                in subsidiary income
            
            
            (19,319
            )
            
            
            —
            
            
            
            —
            
            
            
            19,319
            
            
            
            —Total
                costs and expenses
            
            
            82,046
            
            
            
            10,246
            
            
            
            7,487
            
            
            
            17,877
            
            
            
            117,656INCOME
                FROM OPERATIONS
            
            
            54,819
            
            
            
            31,897
            
            
            
            2,656
            
            
            
            (43,593
            )
            
            
            45,779OTHER
                INCOME (EXPENSE):Interest
                expense
            
            
            (5,310
            )
            
            
            —
            
            
            
            (1,228
            )
            
            
            1,238
            
            
            
            (5,300
            )Investment
                and other income, net
            
            
            265
            
            
            
            1,261
            
            
            
            1,389
            
            
            
            (2,487
            )
            
            
            428Loss
                on early extinguishment of debt
            
            
            (2,805
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,805
            )Royalties
            
            
            (21,388
            )
            
            
            (2,886
            )
            
            
            —
            
            
            
            24,274
            
            
            
            —Corporate
                allocations
            
            
            1,682
            
            
            
            (1,652
            )
            
            
            (30
            )
            
            
            —
            
            
            
            —Total
                other income (expense)
            
            
            (27,556
            )
            
            
            (3,277
            )
            
            
            131
            
            
            
            23,025
            
            
            
            (7,677
            )INCOME
                BEFORE INCOME TAXES
            
            
            27,263
            
            
            
            28,620
            
            
            
            2,787
            
            
            
            (20,568
            )
            
            
            38,102PROVISION
                FOR INCOME TAXES
            
            
            2,290
            
            
            
            9,877
            
            
            
            962
            
            
            
            —
            
            
            
            13,129NET
                INCOME
            
            $
            24,973
            
            
            $
            18,743
            
            
            $
            1,825
            
            
            $
            (20,568
            )
            
            $
            24,973























25


Note
      20





**CHATTEM,
      INC. AND SUBSIDIARIES**


**CONSOLIDATING
      STATEMENTS OF CASH FLOWS**





FOR
      THE
      SIX MONTHS ENDED MAY 31, 2007


(Unaudited
        and in thousands)





CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDOPERATING
                ACTIVITIES:Net
                income
            
            $
            28,558
            
            
            $
            23,123
            
            
            $
            1,513
            
            
            $
            (24,636
            )
            
            $
            28,558Adjustments
                to reconcile net income to net cashprovided
                by (used in) operating activities:Depreciation
                and amortization
            
            
            4,192
            
            
            
            —
            
            
            
            86
            
            
            
            —
            
            
            
            4,278Deferred
                income taxes
            
            
            6,648
            
            
            
            —
            
            
            
            (1
            )
            
            
            —
            
            
            
            6,647Tax
                benefit realized from stock options
            
            
            (3,966
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (3,966
            )Stock-based
                compensation
            
            
            2,632
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,632Loss
                on early extinguishment of debt
            
            
            2,219
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,219Other,
                net
            
            
            146
            
            
            
            —
            
            
            
            (29
            )
            
            
            —
            
            
            
            117Equity
                in subsidiary income
            
            
            (24,636
            )
            
            
            —
            
            
            
            —
            
            
            
            24,636
            
            
            
            —Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (21,229
            )
            
            
            (7,953
            )
            
            
            (747
            )
            
            
            7,953
            
            
            
            (21,976
            )Interest
                Receivable
            
            
            —
            
            
            
            —
            
            
            
            (182
            )
            
            
            182
            
            
            
            —Inventories
            
            
            3,001
            
            
            
            92
            
            
            
            162
            
            
            
            —
            
            
            
            3,255Refundable
                income taxes
            
            
            2,475
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,475Prepaid
                expenses and other current assets
            
            
            1,105
            
            
            
            —
            
            
            
            (5
            )
            
            
            30
            
            
            
            1,130Accounts
                payable and accrued liabilities
            
            
            23,492
            
            
            
            (2
            )
            
            
            2,681
            
            
            
            (8,165
            )
            
            
            18,006Net
                cash provided by (used in) operating activities
            
            
            24,637
            
            
            
            15,260
            
            
            
            3,478
            
            
            
            —
            
            
            
            43,375INVESTING
                ACTIVITIES:Purchases
                of property, plant and equipment
            
            
            (1,501
            )
            
            
            —
            
            
            
            (79
            )
            
            
            —
            
            
            
            (1,580
            )Sales
                (purchases) of trademarks and other product rights
            
            
            (8,090
            )
            
            
            (406,435
            )
            
            
            (1,455
            )
            
            
            —
            
            
            
            (415,980
            )Change
                in other assets, net
            
            
            779
            
            
            
            467
            
            
            
            1,212
            
            
            
            —
            
            
            
            2,458Net
                cash used in investing activities
            
            
            (8,812
            )
            
            
            (405,968
            )
            
            
            (322
            )
            
            
            —
            
            
            
            (415,102
            )FINANCING
                ACTIVITIES:Repayment
                of long-term debt
            
            
            (128,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (128,000
            )Intercompany
                debt proceeds (payments)
            
            
            6,400
            
            
            
            (1,200
            )
            
            
            (5,200
            )
            
            
            —
            
            
            
            —Proceeds
                from long–term debt
            
            
            400,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            400,000Proceeds
                from borrowings under revolving credit facility
            
            
            89,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            89,000Repayments
                of revolving credit facility
            
            
            (57,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (57,000
            )Change
                in bank overdraft
            
            
            (1,392
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,392
            )Proceeds
                from exercise of stock options
            
            
            8,434
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            8,434Purchase
                of note hedge
            
            
            (29,500
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (29,500
            )Proceeds
                from issuance of warrants
            
            
            17,430
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            17,430Increase
                in debt issuance costs
            
            
            (9,110
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (9,110
            )Excess
                tax benefit from stock-based compensation
            
            
            3,966
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,966Changes
                in intercompany accounts
            
            
            (392,290
            )
            
            
            391,855
            
            
            
            435
            
            
            
            —
            
            
            
            —Dividends
                paid
            
            
            —
            
            
            
            (1,250
            )
            
            
            1,250
            
            
            
            —
            
            
            
            —Net
                cash (used in) provided by financing activities
            
            
            (92,062
            )
            
            
            389,405
            
            
            
            (3,515
            )
            
            
            —
            
            
            
            293,828EFFECT
                OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            —
            
            
            
            —
            
            
            
            29
            
            
            
            —
            
            
            
            29CASH
                AND CASH EQUIVALENTS:(Decrease)
                increase for the period
            
            
            (76,237
            )
            
            
            (1,303
            )
            
            
            (330
            )
            
            
            —
            
            
            
            (77,870
            )At
                beginning of period
            
            
            80,198
            
            
            
            1,967
            
            
            
            8,362
            
            
            
            —
            
            
            
            90,527At
                end of period
            
            $
            3,961
            
            
            $
            664
            
            
            $
            8,032
            
            
            $
            —
            
            
            $
            12,657




26


Note
      20





**CHATTEM,
      INC. AND SUBSIDIARIES**


**CONSOLIDATING
      STATEMENTS OF CASH FLOWS**





FOR
      THE
      SIX MONTHS ENDED MAY 31, 2006


(Unaudited
        and in thousands)


CHATTEM
            
            
            GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            NON-GUARANTOR
              SUBSIDIARY
              COMPANIES
            
            
            ELIMINATIONS
            
            
            CONSOLIDATEDOPERATING
                ACTIVITIES:Net
                income
            
            $
            24,973
            
            
            $
            18,743
            
            
            $
            1,825
            
            
            $
            (20,568
            )
            
            $
            24,973Adjustments
                to reconcile net income to net cash
              provided
                by (used in) operating activities:Depreciation
                and amortization
            
            
            2,702
            
            
            
            —
            
            
            
            189
            
            
            
            —
            
            
            
            2,891Deferred
                income taxes
            
            
            (884
            )
            
            
            3,091
            
            
            
            (35
            )
            
            
            —
            
            
            
            2,172Excess
                tax benefit from stock-based compensation
            
            
            (661
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (661
            )Stock-based
                compensation
            
            
            2,192
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,192Loss
                on early extinguishment of debt
            
            
            2,805
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,805Other,
                net
            
            
            65
            
            
            
            —
            
            
            
            47
            
            
            
            —
            
            
            
            112Equity
                in subsidiary income
            
            
            (20,568
            )
            
            
            —
            
            
            
            —
            
            
            
            20,568
            
            
            
            —Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            3,827
            
            
            
            (588
            )
            
            
            (547
            )
            
            
            588
            
            
            
            3,280Inventories
            
            
            (4,260
            )
            
            
            (257
            )
            
            
            (383
            )
            
            
            —
            
            
            
            (4,900
            )Refundable
                income taxes
            
            
            804
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            804Prepaid
                expenses and other current assets
            
            
            2,372
            
            
            
            —
            
            
            
            (46
            )
            
            
            (390
            )
            
            
            1,936Accounts
                payable and accrued liabilities
            
            
            (5,759
            )
            
            
            510
            
            
            
            (2,035
            )
            
            
            (198
            )
            
            
            (7,482
            )Net
                cash provided by (used in) operating activities
            
            
            7,608
            
            
            
            21,499
            
            
            
            (985
            )
            
            
            —
            
            
            
            28,122INVESTING
                ACTIVITIES:Purchases
                of property, plant and equipment
            
            
            (1,893
            )
            
            
            —
            
            
            
            (198
            )
            
            
            —
            
            
            
            (2,091
            )Increase
                in other assets, net
            
            
            (905
            )
            
            
            —
            
            
            
            (525
            )
            
            
            —
            
            
            
            (1,430
            )Net
                cash used in investing activities
            
            
            (2,798
            )
            
            
            —
            
            
            
            (723
            )
            
            
            —
            
            
            
            (3,521
            )FINANCING
                ACTIVITIES:Repayment
                of long-term debt
            
            
            (75,000
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (75,000
            )Proceeds
                from borrowings under revolving credit facility
            
            
            38,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            38,000Proceeds
                from exercise of stock options
            
            
            658
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            658Change
                in bank overdraft
            
            
            3,701
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,701Repurchase
                of common shares
            
            
            (21,332
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (21,332
            )Increase
                in debt issuance costs
            
            
            (15
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (15
            )Retirement
                of debt issuance costs
            
            
            (1,501
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,501
            )Excess
                tax benefit from stock-based compensation
            
            
            661
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            661Changes
                in intercompany accounts
            
            
            18,530
            
            
            
            (20,229
            )
            
            
            1,699
            
            
            
            —
            
            
            
            —Dividends
                paid
            
            
            —
            
            
            
            (1,250
            )
            
            
            1,250
            
            
            
            —
            
            
            
            —Net
                cash (used in) provided by financing activities
            
            
            (36,298
            )
            
            
            (21,479
            )
            
            
            2,949
            
            
            
            —
            
            
            
            (54,828
            )EFFECT
                OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
            
            
            —
            
            
            
            —
            
            
            
            (47
            )
            
            
            —
            
            
            
            (47
            )CASH
                AND CASH EQUIVALENTS:(Decrease)
                increase for the period
            
            
            (31,488
            )
            
            
            20
            
            
            
            1,194
            
            
            
            —
            
            
            
            (30,274
            )At
                beginning of period
            
            
            36,647
            
            
            
            1,982
            
            
            
            8,698
            
            
            
            —
            
            
            
            47,327At
                end of period
            
            $
            5,159
            
            
            $
            2,002
            
            
            $
            9,892
            
            
            $
            —
            
            
            $
            17,053






27


**Item 2.**
            **Management’s
                Discussion and Analysis of Financial Condition and****Results
                of Operations**





The
      following discussion and analysis of our financial condition and results of
      operations should be read in conjunction with the audited consolidated financial
      statements and related notes thereto included in our 2006 Annual Report on
      Form
      10-K filed with the Securities and Exchange Commission (“SEC”).  This
      discussion and analysis contains forward-looking statements that involve risks,
      uncertainties and assumptions.  The actual results may differ
      materially from those anticipated in these forward-looking statements as a
      result of a number of factors, including, but not limited to, those described
      in
      our filings with the SEC.





***Overview***





Founded
      in 1879, we are a leading marketer and manufacturer of a broad portfolio of
      branded over-the-counter (“OTC”) healthcare products, toiletries and dietary
      supplements including such categories as topical pain care, medicated skin
      care,
      medicated dandruff shampoos, oral care, internal OTC, dietary supplements,
      and
      other OTC and toiletry products. Our portfolio of products includes
      well-recognized brands such as:





•
            *Icy
                Hot, Capzasin* and *Aspercreme*– topical pain
                care;





•
            *Gold
                Bond, Balmex*and *Cortizone*– medicated skin
                care;





•
            *Selsun
                Blue*and*Selsun
                Salon***–
medicated
                dandruff
                shampoos;





•
            *ACT*
                and *Herpecin-L*– oral
                care;





•
            *Unisom,**Pamprin* and *Kaopectate*– internal
                OTC;





•
            *Dexatrim*,
                *Garlique* and *New Phase*– dietary supplements;
                and





•
            *Bullfrog*,
                *Ultraswim* and *Sun-In***– other OTC and
                toiletry products.





Our
      products target niche markets that are often outside the focus of larger
      companies where we believe we can achieve and sustain significant market share
      through innovation and strong advertising and promotion support. Many of our
      products are among the U.S. market leaders in their respective categories.
      For
      example, our portfolio of topical analgesic brands and our *Gold Bond*
      medicated body powders have the leading U.S. market share in these categories.
      We support our brands through extensive and cost-effective advertising and
      promotion, the expenditures for which represented approximately 27% of our
      total
      revenues in the first half of fiscal 2007. We sell our products nationally
      through mass merchandiser, drug and food channels, principally utilizing our
      own
      sales force.





Our
      experienced management team has grown our business by developing product line
      extensions, increasing market penetration of our existing products and acquiring
      brands. Recent product line extensions include *Icy Hot*Heat Therapy,
*Bullfrog* Marathon Mist and*Dexatrim* Max Evening Appetite
      Control.





***Developments
      During Fiscal 2007***





***Acquisition
      of Brands***





On
      January 2, 2007, we acquired the U.S. rights to five leading consumer and OTC
      brands from Johnson & Johnson (“J&J Acquisition”).  The
      acquired brands are: *ACT*, an anti-cavity mouthwash/mouth rinse;
*Unisom*, an OTC sleep-aid; *Cortizone*, a hydrocortisone
      anti-itch product; *Kaopectate*, an anti-diarrhea product; and
*Balmex*, a diaper rash product.  The J&J Acquisition was
      funded with the proceeds from the new $300.0 million term loan provided under
      our Credit Facility, borrowings under the revolving credit facility portion
      of
      the Credit Facility and through the use of a portion of the proceeds derived
      from the 2.0% Convertible Notes.  The purchase price of the J&J
      Acquisition was $410.0 million plus $2.3 million of costs directly related
      to
      the acquisition, of which $0.5 million was incurred and funded during our fiscal
      year ended November 30, 2006.  The purchase price relates to $5.9
      million of inventory, $1.9 million of assumed liabilities, $0.5 million of
      equipment, $403.9 million of trademarks which were assigned an indefinite life
      and $3.9 million of distribution rights which was assigned a useful life of
      five
      years.  This is a preliminary assignment of values that will be
      completed during fiscal 2007.  Johnson & Johnson will continue to
      manufacture and supply certain of the products for a period of up to 18 months
      from acquisition close, or such earlier date as we are able to move production
      to our facilities.  The price we pay Johnson & Johnson for these
      products is equivalent to the manufacturing cost, which includes all costs
      associated with the manufacturing and delivery of the product.  For a
      period of up to six months from acquisition close, Johnson & Johnson was to
      provide transition services consisting of consumer affairs, distribution and
      collection services (including related financial, accounting and reporting
      services).  We terminated the distribution and collections services
      effective April 2, 2007 and the consumer affairs services effective June 21,
      2007.  The costs charged for these transition services approximates
      the actual costs incurred by Johnson & Johnson.





28


On
      May
      25, 2007, we acquired the worldwide trademark and rights to sell and market
*ACT* in Western Europe from Johnson & Johnson (“*ACT*
      Acquisition”) for $4.1 million in cash plus certain assumed
      liabilities.  The *ACT* Acquisition was funded with existing
      cash.





***Products***





In
      the
      first six months of fiscal 2007, we introduced the following product line
      extensions: *Icy Hot*Heat Therapy, *Icy Hot*Vanishing Scent
      Cream, *Capzasin* No-Mess, *Bullfrog*Marathon Mist,
*Selsun* Naturals and*Dexatrim* Max Evening Appetite
      Control.





***Debt***





In
      January 2007, we completed an amended credit facility providing for up to a
      $100.0 million revolving credit facility and a $300.0 million term loan (the
      “Credit Facility”).  The proceeds from the term loan under the Credit
      Facility were used to finance in part the J&J Acquisition.  The
      Credit Facility includes an “accordion” feature that permits us under certain
      circumstances to increase our borrowings under the revolving credit facility
      by
      $50.0 million and to borrow an additional $50.0 million as a term
      loan.  In April 2007, we entered into an amendment to our Credit
      Facility that, among other things, permitted the sale of the 1.625% Convertible
      Senior Notes due 2014 (the “1.625% Convertible Notes”) and reduced the
      applicable interest rates on the revolving credit facility portion of our Credit
      Facility.





Borrowings
      under the revolving credit facility portion of our Credit Facility bear interest
      at LIBOR plus applicable percentages of 0.875% to 1.5% or the higher of the
      federal funds rate plus 0.5% or the prime rate (the “Base Rate”).  The
      applicable percentages are calculated based on our leverage ratio.  As
      of May 31, 2007 and November 30, 2006, we had $32.0 million and $0,
      respectively, of borrowings outstanding under the revolving credit facility
      portion of our Credit Facility.  As of July 2, 2007, we had $29.0
      million of borrowings outstanding under the revolving credit facility portion
      of
      our Credit Facility and our borrowing capacity was $71.0 million.





The
      term
      loan under the Credit Facility bears interest of either LIBOR plus 1.75% or
      the
      Base Rate plus 0.75%.  The term loan borrowings are to be repaid in
      increments of $0.8 million each calendar quarter, with the first principal
      payment paid on June 30, 2007.  The principal outstanding after
      scheduled repayment and any unscheduled prepayments is due January 2, 2013.
      On
      April 16, 2007, we utilized the net proceeds from the 1.625% Convertible Notes
      and borrowings under the revolving credit facility portion of our Credit
      Facility to repay $128.0 million of the term loan under the Credit
      Facility.  In connection with this repayment, we retired a
      proportional share of the term loan debt issuance costs, which resulted in
      a
      loss on early extinguishment of debt of $2.2 million during the second quarter
      of fiscal 2007.





Borrowings
      under the Credit Facility are secured by substantially all of our assets, except
      real property, and shares of capital stock of our domestic subsidiaries held
      by
      us and by the assets of the guarantors (our domestic
      subsidiaries).  The Credit Facility contains covenants,
      representations, warranties and other agreements by us that are customary in
      credit agreements and security instruments relating to financings of this
      type.  The significant financial covenants include fixed charge
      coverage ratio, leverage ratio, senior secured leverage ratio and brand value
      calculations.





In
      April
      2007, we completed a private offering of $100.0 million of the 1.625%
      Convertible Notes, the proceeds of which were used to repay a portion of the
      amount outstanding under the Credit Facility term loan, pay for a note hedge
      and
      pay approximately $2.5 million in debt issuance costs.  The 1.625%
      Convertible Notes bear interest at an annual rate of 1.625%, payable
      semi-annually on May 1 and November 1 of each year, with the first interest
      payment due on November 1, 2007.  Concurrently with the sale of the
      1.625% Convertible Notes, we purchased a note hedge for $29.5 million and issued
      warrants for proceeds of $17.4 million with an affiliate of Merrill Lynch (the
      “Counterparty”).  The note hedge and warrants are separate and legally
      distinct instruments that bind us and the Counterparty and have no binding
      effect on the holders of the 1.625% Convertible Notes.








29


***Results
      of Operations***





The
      following table sets forth, for the
      periods indicated, certain items from our Consolidated Statements of Income
      expressed as a percentage of total revenues:




For
                the Three Months Ended
            
            
            For
                the Six Months EndedMay
                31, 2007
            
            
            May
                31, 2006
            
            
            May
                31, 2007
            
            
            May
                31, 2006TOTAL
                REVENUES
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %COSTS
                AND EXPENSES:Cost
                of sales
            
            
            31.1
            
            
            
            31.6
            
            
            
            30.9
            
            
            
            31.3Advertising
                and promotion
            
            
            26.2
            
            
            
            31.2
            
            
            
            27.3
            
            
            
            31.8Selling,
                general and administrative
            
            
            12.7
            
            
            
            14.5
            
            
            
            12.6
            
            
            
            14.1Acquisition
                expense
            
            
            0.8
            
            
            
            —
            
            
            
            1.0
            
            
            
            —Litigation
                settlement
            
            
            —
            
            
            
            0.1
            
            
            
            —
            
            
            
            (5.2
            )Total
                costs and expenses
            
            
            70.8
            
            
            
            77.4
            
            
            
            71.8
            
            
            
            72.0INCOME
                FROM OPERATIONS
            
            
            29.2
            
            
            
            22.6
            
            
            
            28.2
            
            
            
            28.0OTHER
                INCOME (EXPENSE):Interest
                expense
            
            
            (7.4
            )
            
            
            (3.1
            )
            
            
            (7.3
            )
            
            
            (3.3
            )Investment
                and other income, net
            
            
            0.3
            
            
            
            0.3
            
            
            
            0.5
            
            
            
            0.3Loss
                on early extinguishment of debt
            
            
            (2.0
            )
            
            
            —
            
            
            
            (1.0
            )
            
            
            (1.7
            )Total
                other income (expense)
            
            
            (9.1
            )
            
            
            (2.8
            )
            
            
            (7.8
            )
            
            
            (4.7
            )INCOME
                BEFORE INCOME TAXES
            
            
            20.1
            
            
            
            19.8
            
            
            
            20.4
            
            
            
            23.3PROVISION
                FOR INCOME TAXES
            
            
            6.9
            
            
            
            6.9
            
            
            
            7.0
            
            
            
            8.0NET
                INCOME
            
            
            13.2
            %
            
            
            12.9
            %
            
            
            13.4
            %
            
            
            15.3
            %







***Critical
      Accounting Policies***





The
      preparation of financial statements in accordance with U.S. generally accepted
      accounting principles requires management to use estimates.  Several
      different estimates or methods can be used by management that might yield
      different results.  The following are the significant estimates used
      by management in the preparation of the unaudited consolidated financial
      statements for the three and six months ended May 31, 2007.





***Allowance
      for Doubtful Accounts***





As
      of May
      31, 2007, an estimate was made of the collectibility of the outstanding accounts
      receivable balances.   This estimate requires the utilization of
      outside credit services, knowledge about the customer and the customer’s
      industry, new developments in the customer’s industry and operating results of
      the customer as well as general economic conditions and historical
      trends.  When all these facts are compiled, a judgment as to the
      collectibility of the individual account is made.   Many factors
      can impact this estimate, including those noted in this
      paragraph.  The adequacy of the estimated allowance may be impacted by
      the deterioration in the financial condition of a large customer, weakness
      in
      the economic environment resulting in a higher level of customer bankruptcy
      filings or delinquencies and the competitive environment in which the customer
      operates.  During the second quarter of fiscal 2007, we performed a
      detailed assessment of the collectibility of trade accounts receivable and
      did
      not make any significant adjustments to our estimate of allowance for doubtful
      accounts.  The balance of allowance for doubtful accounts was $0.4 and
      $0.3 million at May 31, 2007 and November 30, 2006,
      respectively.





***Revenue
      Recognition***





Revenue
      is recognized when our products are shipped to our customers.  It is
      generally our policy across all classes of customers that all sales are
      final.   As is common in the consumer products industry,
      customers return products for a variety of reasons including products damaged
      in
      transit, discontinuance of a particular size or form of product and shipping
      errors.  As sales are recorded, we accrue an estimated amount for
      product returns, as a reduction of these sales, based upon our historical
      experience and consideration of discontinued products, products divestitures,
      estimated inventory levels held by our customers




30


and
      retail point of sale data on existing and newly introduced
      products.  The level of returns may fluctuate from our estimates due
      to several factors including weather conditions, customer inventory levels
      and
      competitive conditions.  We charge the allowance account resulting
      from this accrual with any authorized deduction from remittance by the customer
      or product returns upon receipt of the product.





We
      separate returns into the two categories of seasonal and non-seasonal
      products.  We use the historical return detail of seasonal and
      non-seasonal products for at least the most recent three fiscal years on
      generally all products, which is normalized for any specific occurrence that
      is
      not reasonably likely to recur, to determine the amount of product return as
      a
      percentage of sales, and estimate an allowance for potential returns based
      on
      product sold in the current period.  To consider product sold in
      current and prior periods, an estimate of inventory held by our retail customers
      is calculated based on customer inventory detail.  This estimate of
      inventory held by our customers, along with historical returns as a percentage
      of sales, is used to determine an estimate of potential product
      returns.  This estimate of the allowance for seasonal and non-seasonal
      returns is further analyzed by considering retail customer point of sale
      data.  We also consider specific events, such as discontinued product
      or product divestitures, when determining the adequacy of the
      allowance.  Based on consideration of the sales of *Icy Hot
      Pro-Therapy* performing below expectations, review of retail point of sales
      data and an estimate of inventory on hand at customers, an allowance for returns
      of $3.3 million was recorded as of November 30, 2006.  As of May 31,
      2007, the allowance remaining for *Icy Hot Pro-Therapy* returns after
      fiscal 2007 returns activity through May 31, 2007 is $2.3
      million.  Our estimate of product returns for seasonal and
      non-seasonal products as of May 31, 2007 was $2.5 million and $1.2 million,
      respectively, and $1.2 million and $1.3 million, respectively, as of November
      30, 2006.  For the six months ended May 31, 2007, we increased our
      estimate of returns for seasonal products by approximately $1.3 million which
      resulted in a decrease to net sales in our consolidated financial statements
      and
      decreased our estimate for non-seasonal returns by approximately $0.1 million
      which resulted in an increase to net sales in our consolidated financial
      statements.  During the six months ended May 31, 2006, we increased
      our estimate of returns for seasonal products and non-seasonal returns by
      approximately $1.5 million and $0.2 million, respectively, which resulted in
      a
      decrease to net sales in our consolidated financial statements.  Each
      percentage point change in the seasonal return rate would impact net sales
      by
      approximately $0.2 million.  Each percentage point change in the
      non-seasonal return rate would impact net sales by approximately $0.5
      million.





We
      routinely enter into agreements with customers to participate in promotional
      programs.  The cost of these programs is recorded as either
      advertising and promotion expense or as a reduction of sales as prescribed
      by
      Emerging Issues Task Force 01-9, “Accounting for Consideration Given by a Vendor
      to a Customer (Including a Reseller of the Vendor’s Products)”.  A
      significant portion of the programs are recorded as a reduction of sales and
      generally take the form of coupons and vendor allowances, which are normally
      taken via temporary price reductions, scan downs, display activity and
      participations in in-store programs provided uniquely by the
      customer.  We also enter into cooperative advertising programs with
      certain customers, the cost of which is recorded as advertising and promotion
      expense.  In order for retailers to receive reimbursement under such
      programs, the retailer must meet specified advertising guidelines and provide
      appropriate documentation of the advertisement being run.





We
      analyze promotional programs in two primary categories -- coupons and vendor
      allowances.  Customers normally utilize vendor allowances in the form
      of temporary price reductions, scan downs, display activity and participations
      in in-store programs provided uniquely by the customer.  We estimate
      the accrual for outstanding coupons by utilizing a third-party clearinghouse
      to
      track coupons issued, coupon value, distribution and expiration dates, quantity
      distributed and estimated redemption rates that are provided by
      us.  We estimate the redemption rates based on internal analysis of
      historical coupon redemption rates and expected future retail sales by
      considering recent point of sale data.  The estimate for vendor
      allowances is based on estimated unit sales of a product under a program and
      amounts committed for such programs in each fiscal year.  Estimated
      unit sales are determined by considering customer forecasted sales, point of
      sale data and the nature of the program being offered.  The three most
      recent years of expected program payments versus actual payments made and
      current year retail point of sale trends are analyzed to determine future
      expected payments.  Customer delays in requesting promotional program
      payments due to their audit of program participation and resulting request
      for
      reimbursement is also considered to evaluate the accrual for vendor
      allowances.  The costs of these programs is often variable based on
      the number of units actually sold.  As of May 31, 2007, the coupon
      accrual and reserve for vendor allowances were $2.0 million and $5.9 million,
      respectively, and $1.2 million and $3.7 million, respectively, as of November
      30, 2006.  Each percentage point change in promotional program
      participation and advertising and promotion expense would impact net sales
      by an
      insignificant amount.





***Income
      Taxes***





We
      account for income taxes using the asset and liability approach as prescribed
      by
      SFAS 109 and applicable FASB Staff Positions and
      Interpretations.  This approach requires recognition of deferred tax
      assets and liabilities for the expected future tax consequences of events that
      have been included in our consolidated financial statements or tax
      returns.  Using the enacted tax rates in effect for the year in which
      the differences are expected to reverse, deferred tax assets and liabilities
      are
      determined based on the differences between the financial reporting and the
      tax
      basis of an asset or liability.  We record income




31


tax
      expense in our consolidated financial statements based on an estimated annual
      effective income tax rate.  Our effective tax rate was 34.5% for each
      of the six months ended May 31, 2007 and 2006.





For
      a
      summary of our significant accounting policies, see Note 2 of Notes to
      Consolidated Financial Statements included in our Annual Report on Form 10-K
      for
      the year ended November 30, 2006 filed with the Securities and Exchange
      Commission.








***Comparison
      of Three Months Ended May 31, 2007 and 2006***





To
      facilitate discussion of our operating results for the three months ended May
      31, 2007 and 2006, we have included the following selected data from our
      Consolidated Statements of Income:





Increase
                (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
                in thousands)Domestic
                net sales
            
            $
            106,218
            
            
            $
            72,153
            
            
            $
            34,065
            
            
            
            47.2
            %International
                revenues (including royalties)
            
            
            6,746
            
            
            
            7,258
            
            
            
            (512
            )
            
            
            (7.1
            )Total
                revenues
            
            
            112,964
            
            
            
            79,411
            
            
            
            33,553
            
            
            
            42.3Cost
                of sales
            
            
            35,095
            
            
            
            25,054
            
            
            
            10,041
            
            
            
            40.1Advertising
                and promotion expense
            
            
            29,664
            
            
            
            24,781
            
            
            
            4,883
            
            
            
            19.7Selling,
                general and administrative expense
            
            
            14,311
            
            
            
            11,528
            
            
            
            2,783
            
            
            
            24.1Acquisition
                expenses
            
            
            886
            
            
            
            —
            
            
            
            886
            
            
            
            100.0Litigation
                settlement
            
            
            —
            
            
            
            108
            
            
            
            (108
            )
            
            
            (100.0
            )Interest
                expense
            
            
            8,319
            
            
            
            2,456
            
            
            
            5,863
            
            
            
            238.7Loss
                on early extinguishment of debt
            
            
            2,219
            
            
            
            —
            
            
            
            2,219
            
            
            
            100.0Net  income
            
            
            14,908
            
            
            
            10,200
            
            
            
            4,708
            
            
            
            46.2





**Domestic
      Net Sales**





Domestic
      net sales for the three months ended May 31, 2007 increased $34.1 million,
      or
      47.2%, to $106.2 million from $72.2 million in the prior year
      quarter.   A comparison of domestic net sales for the categories
      of products included in our portfolio of OTC healthcare products is as
      follows:


Increase
                (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
                in thousands)Topical
                pain care
            
            $
            24,927
            
            
            $
            28,397
            
            
            $
            (3,470
            )
            
            
            (12.2
            )%Medicated
                skin care
            
            
            31,595
            
            
            
            15,389
            
            
            
            16,206
            
            
            
            105.3Oral
                care
            
            
            13,731
            
            
            
            1,703
            
            
            
            12,028
            
            
            
            706.3Internal
                OTC products
            
            
            12,014
            
            
            
            3,032
            
            
            
            8,982
            
            
            
            296.2Medicated
                dandruff shampoos
            
            
            8,339
            
            
            
            8,461
            
            
            
            (122
            )
            
            
            (1.4
            )Dietary
                supplements
            
            
            6,824
            
            
            
            8,909
            
            
            
            (2,085
            )
            
            
            (23.4
            )Other
                OTC and toiletry products
            
            
            8,788
            
            
            
            6,262
            
            
            
            2,526
            
            
            
            40.3Total
            
            $
            106,218
            
            
            $
            72,153
            
            
            $
            34,065
            
            
            
            47.2





Net
      sales
      in the topical pain care category decreased $3.5 million, or 12.2%, for the
      second quarter of fiscal 2007 compared to the same prior year quarter, due
      primarily to reduced sales from *Icy Hot* Pro-Therapy. Excluding sales of
*Icy Hot*Pro-Therapy*,* the category declined 5.0% compared to
      the prior year quarter, due to lower sales of our smaller topical pain care
      brands and the launch of the *Capzasin* Back and Body Patch in fiscal
      2006.





Net
      sales
      in the medicated skin care category increased $16.2 million, or 105%, in the
      second quarter of fiscal 2007 compared to the prior year quarter.  The
      category increase was primarily attributable to the *Cortizone* and
*Balmex*brands acquired in the J&J Acquisition.  Net sales
      of *Gold Bond* increased 22.8% compared to the prior year quarter, led by
      sales of *Gold Bond* Ultimate Softening Lotion launched in the fourth
      quarter of fiscal 2006.





Net
      sales
      in the oral care category increased $12.0 million, or 706%, in the second
      quarter of fiscal 2007 compared to the prior year quarter.  This
      increase was led by *ACT*, which was acquired in the J&J
      Acquisition.





Net
      sales
      in the internal OTC category increased $9.0 million, or 296%, in the second
      quarter of fiscal 2007 compared to the prior year quarter.  This
      increase was led by *Unisom* and *Kaopectate*, which were acquired
      in the J&J Acquisition.





32


Net
      sales
      in the medicated dandruff shampoos category decreased $0.1 million, or 1.4%,
      in
      the second quarter of fiscal 2007 compared to the prior year
      quarter*.*  Sales of *Selsun Blue* declined 2.0% for the
      quarter as a result of lower end of season shipments as well as media and
      promotional support weighted toward *Selsun Salon,*offset by a 4.0%
      increase in sales of *Selsun Salon*.





Net
      sales
      in the dietary supplements category decreased $2.1 million, or 23.4%, for the
      second quarter of fiscal 2007 compared to the prior year quarter.  Net
      sales of *Dexatrim* decreased 14.3% as a result of initial sales of
*Dexatrim Max**2**O*
      in the prior year quarter.   Net sales of *Garlique*
      decreased 40.2% and *New Phase* decreased 42.8% for the second quarter of
      fiscal 2007 from the prior year period as a result of lower advertising
      support.





Net
      sales
      in the other OTC and toiletry products category increased $2.5 million, or
      40.3%, in the second quarter of fiscal 2007 compared to the prior year as a
      result of a 61.7% increase in *Bullfrog* sales, behind the fiscal 2007
      introduction of *Bullfrog* Marathon Mist, new packaging on all
*Bullfrog* products and timing of shipments for certain retailers
      in the
      second fiscal quarter of 2007 versus the first fiscal quarter of
      2007.  *Sun-In* also contributed to the higher category results
      with increased sales of 26.6% for the quarter as a result of new packaging
      and
      increased advertising.





Domestic
      sales variances were principally the result of changes in unit sales
      volumes.





**International
      Revenues**





For
      the
      second quarter of fiscal 2007, international revenues decreased $0.5 million,
      or
      7.1%, compared to the second quarter of fiscal 2006 due principally to timing
      of
      sales to certain customers in the quarter compared to the prior year
      quarter.  Sales variances for our international operations were
      principally the result of changes in unit sales volume.





**Cost
      of Sales**





Cost
      of
      sales as a percentage of total revenues was 31.1% for the second quarter of
      fiscal 2007 as compared to 31.6% in the prior year quarter.  Gross
      margin for the second quarter of fiscal 2007 was 68.9% compared to 68.4% in
      the
      prior year quarter.  The gross margin increase was largely
      attributable to decreased sales of *Icy Hot* Pro-Therapy which has a
      lower margin compared to our other brands.





**Advertising
      and Promotion Expense**





Advertising
      and promotion expenses in the second quarter of fiscal 2007 increased $4.9
      million, or 19.7%, as compared to the prior year quarter and were 26.2% of
      total revenues for the three months ended May 31, 2007 compared to 31.2% for
      the
      prior year quarter.  The decrease in advertising and promotion expense
      as a percentage of revenue for the current period reflected higher advertising
      and promotion spending for *Icy Hot*Pro-Therapy and *Selsun
      Salon* during the fiscal 2006 launch period.





**Selling,
      General and Administrative Expense**





Selling,
      general and administrative expenses increased $2.8 million, or 24.1%, compared
      to the prior year quarter.  Selling, general and administrative
      expenses were 12.7% and 14.5% of total revenues for the second quarter of fiscal
      2007 and 2006, respectively.  The decrease as a percentage of revenue
      was attributable to increased revenue without commensurate increases in selling,
      general and administrative expenses.





**Acquisition
      Expenses**





Acquisition
      expenses of $0.9 million were recorded in the second quarter of fiscal 2007
      related to transition services provided by Johnson & Johnson under a
      transition services agreement entered into in connection with the J&J
      Acquisition.  The transition services provided by Johnson &
Johnson included consumer affairs, distribution and collection services, which
      included related financial accounting and reporting services.  The
      distribution and collection services were terminated effective April 2, 2007
      and
      the consumer affairs services were terminated June 21, 2007.





**Interest
      Expense**





Interest
      expense increased $5.9 million, or 239%, in the second quarter of fiscal 2007
      as
      compared to the prior year quarter as a result of additional indebtedness
      incurred to finance the J&J Acquisition. Until our indebtedness is reduced
      substantially, interest expense will continue to represent a significant
      percentage of our income from operations.





33


**Loss
      on Early Extinguishment of Debt**





During
      the second quarter of fiscal
      2007, we utilized the net proceeds from the 1.625% Convertible Notes and
      borrowings under the revolving credit facility portion of our Credit Facility
      to
      repay $128.0 million of the term loan under the Credit Facility.  In
      connection with the repayment, we retired a proportional share of the term
      loan
      debt issuance costs, which resulted in a loss on early extinguishment of debt
      of
      $2.2 million during the second quarter of fiscal 2007.  No
      corresponding charge was incurred in the second quarter of fiscal
      2006.





**Comparison
      of Six Months Ended May 31, 2007 and 2006**





To
      facilitate discussion of our operating results for the six months ended May
      31,
      2007 and 2006, we have included the following selected data from our
      Consolidated Statements of Operations:





Increase
                (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
                in thousands)Domestic
                net sales
            
            $
            200,841
            
            
            $
            150,596
            
            
            $
            50,245
            
            
            
            33.4
            %International
                revenues (including royalties)
            
            
            12,954
            
            
            
            12,839
            
            
            
            115
            
            
            
            0.9Total
                revenues
            
            
            213,795
            
            
            
            163,435
            
            
            
            50,360
            
            
            
            30.8Cost
                of sales
            
            
            66,075
            
            
            
            51,074
            
            
            
            15,001
            
            
            
            29.4Advertising
                and promotion expense
            
            
            58,451
            
            
            
            51,968
            
            
            
            6,483
            
            
            
            12.5Selling,
                general and administrative expense
            
            
            26,897
            
            
            
            23,119
            
            
            
            3,778
            
            
            
            16.3Acquisition
                expenses
            
            
            2,057
            
            
            
            —
            
            
            
            2,057
            
            
            
            100.0Litigation
                settlement
            
            
            —
            
            
            
            (8,505
            )
            
            
            8,505
            
            
            
            (100.0
            )Interest
                expense
            
            
            15,555
            
            
            
            5,300
            
            
            
            10,255
            
            
            
            193.5Loss
                on early extinguishment of debt
            
            
            2,219
            
            
            
            2,805
            
            
            
            (586
            )
            
            
            (20.9
            )Net
                income
            
            
            28,558
            
            
            
            24,973
            
            
            
            3,585
            
            
            
            14.4





**Domestic
      Net Sales**





Domestic
      net sales for the six months ended May 31, 2007 increased $50.2 million,
      or 33.4%, as compared to the corresponding period of
      2006.   A comparison of domestic net sales for the categories of
      products included in our portfolio of OTC healthcare products is as
      follows:


Increase
                (Decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percentage(dollars
                in thousands)Topical
                pain care
            
            $
            52,153
            
            
            $
            60,838
            
            
            $
            (8,685
            )
            
            
            (14.3
            )%Medicated
                skin care
            
            
            59,427
            
            
            
            32,280
            
            
            
            27,147
            
            
            
            84.1Oral
                Care
            
            
            22,218
            
            
            
            3,318
            
            
            
            18,900
            
            
            
            569.6Internal
                OTC products
            
            
            20,463
            
            
            
            5,592
            
            
            
            14,871
            
            
            
            265.9Medicated
                dandruff shampoos
            
            
            18,636
            
            
            
            20,278
            
            
            
            (1,642
            )
            
            
            (8.1
            )Dietary
                supplements
            
            
            14,854
            
            
            
            17,762
            
            
            
            (2,908
            )
            
            
            (16.4
            )Other
                OTC and toiletry products
            
            
            13,090
            
            
            
            10,528
            
            
            
            2,562
            
            
            
            24.3Total
            
            $
            200,841
            
            
            $
            150,596
            
            
            $
            50,245
            
            
            
            33.4





Net
      sales
      growth in the topical pain care products category decreased $8.7 million, or
      14.3%, for the first six months of fiscal 2007 compared to the same period
      in
      fiscal 2006, due to the initial product introduction of *Icy Hot*
      Pro-Therapy in fiscal 2006.  Excluding sales of *Icy Hot*Pro-Therapy, the category increased 9.0% compared to the same period
      of
      prior year led by the introduction of *Icy Hot* Heat
      Therapy.





Net
      sales
      in the medicated skin care category increased $27.1 million, or 84.1%, for
      the
      first six months of fiscal 2007 compared to the same period in fiscal 2006
      as a
      result of the acquisition of *Cortizone* and *Balmex* in the first
      fiscal quarter of 2007 and sales of *Gold Bond* Ultimate Softening Lotion
      launched in the fourth quarter of fiscal 2006.  The Gold Bond
      franchise had sales increases of 24.8% for the first six months of fiscal 2007
      compared to the same prior year period.





Net
      sales
      in the oral care category increased $18.9 million, or 570%, for the first six
      months of fiscal 2007 compared to the same period in 2006.  This
      increase was led by *ACT*, which was acquired in the J&J
      Acquisition.





34


Net
      sales
      in the internal OTC category increased $14.9 million, or 266%, for the first
      six
      months of fiscal 2007 compared to the same period in 2006.  This
      increase was led by *Unisom* and *Kaopectate,* which were acquired
      in the J&J Acquisition.





Net
      sales
      in the medicated dandruff shampoos category decreased $1.6 million, or 8.1%,
      for
      the first six months of fiscal 2007 compared to the same period in 2006,
      primarily due to the launch and initial sell-in of *Selsun Salon* in the
      first quarter of fiscal 2006.





Net
      sales
      in the dietary supplements category decreased $2.9 million, or 16.4%, for the
      first six months of fiscal 2007 as compared to the same period in
      2006.  Net sales of *Garlique* decreased 32.9% compared to the
      prior year period as a result of the initial product introduction of
*Garlique*Cardio Assist in the same period of fiscal 2006.





Net
      sales
      in the other OTC and toiletry products category increased $2.6 million, or
      24.3%, for the first six months of fiscal 2007 compared to the same period
      in
      fiscal 2006 as a result of the launch of *Bullfrog*Marathon Mist and new
      packaging introductions for the *Bullfrog*and *Sun-In* product
      lines.





Domestic
      sales variances were principally the result of changes in unit sales
      volume.





**International
      Revenues**





For
      the
      six months ended May 31, 2007, international revenues increased $0.1 million,
      or
      0.9%, as compared to the same period in fiscal 2006. Sales variances for our
      international operations were principally the result of changes in unit sales
      volume.





**Cost
      of Sales**





Cost
      of
      sales as a percentage of total revenues was 30.9% for the six months ended
      May
      31, 2007 as compared to 31.3% for the comparable period of fiscal
      2006.   Gross margin for the six months ended May 31, 2007 was
      69.1% compared to 68.7% for the same period in fiscal 2006. The increase in
      gross margin was largely attributable to the launch of *Icy Hot*
      Pro-Therapy in fiscal 2006, which has a lower gross margin than our other
      brands.





**Advertising
      and Promotion Expense**





Advertising
      and promotion expenses for the six months ended May 31, 2007 increased $6.5
      million, or 12.5%, as compared to the same period in fiscal 2006 and were 27.3%
      of total revenues for the six months ended May 31, 2007 compared to 31.8% for
      the comparable period of fiscal 2006.  The decrease in advertising and
      promotion expense as a percentage of revenue for the first six months of fiscal
      2007 reflected higher advertising and promotion spending for *Icy Hot*
      Pro-Therapy and *Selsun Salon* during the fiscal 2006 launch
      period.





**Selling,
      General and Administrative Expense**





Selling,
      general and administrative expenses for the six months ended May 31, 2007
      increased $3.8 million, or 16.3%, as compared to the same period of fiscal
      2006.  Selling, general and administrative expenses were 12.6%
      and 14.1% of total revenues for the six months ended May 31, 2007 and 2006,
      respectively.  The decrease as a percentage of total revenues was
      attributable to increased revenue without commensurate increases in selling,
      general and administrative expenses.





**Acquisition
      Expenses**





Acquisition
      expenses of $2.1 million were recorded in the six months ended May 31, 2007
      related to transition services provided by Johnson & Johnson under a
      transition services agreement entered into in connection with the J&J
      Acquisition.





**Litigation
      Settlement**





Litigation
      settlement for the six
      months ended May 31, 2006 reflects the $8.75 million recovery from the DELACO
      settlement trust ($8.5 million net of legal expenses for the first six months
      of
      2006) in the *Dexatrim* litigation settlement.  No
      corresponding benefit was recorded in fiscal 2007.





35


**Interest
      Expense**





Interest
      expense increased $10.3 million, or 194%, for the six months ended May 31,
      2007
      as compared to the same period in fiscal 2006.  The increase was the
      result of additional indebtedness incurred to finance the J&J
      Acquisition.  Until our indebtedness is reduced substantially,
      interest expense will continue to represent a significant percentage of our
      income from operations.





**Loss
      on Early Extinguishment of Debt**





During
      the second quarter of fiscal
      2007, we utilized the net proceeds from the 1.625% Convertible Notes and
      borrowings under the revolving credit facility portion of our Credit Facility
      to
      repay $128.0 million of the term loan under the Credit Facility.  In
      connection with the repayment, we retired a proportional share of the term
      loan
      debt issuance costs, which resulted in a loss on early extinguishment of debt
      of
      $2.2 million during the second quarter of fiscal 2007.  Our $75.0
      million of Floating Rate Senior Notes were fully redeemed in the first quarter
      of fiscal 2006.   As a result of the redemption, a loss on early
      extinguishment of debt of $2.8 million was recorded in the six months ended
      May
      31, 2006.





***Liquidity
      and Capital Resources***





We
      have
      historically financed our operations with a combination of internally generated
      funds and borrowings.  Our principal uses of cash are for operating
      expenses, servicing long-term debt, acquisitions, working capital, repurchases
      of our common stock, payment of income taxes and capital
      expenditures.





Cash
      of
      $43.4 million and $28.1 million was provided by operations for the six
      months ended May 31, 2007 and 2006, respectively.  The increase in
      cash flows from operations over the prior year period was primarily attributable
      to increased accounts payable and accrued liabilities (net of acquisitions),
      decreased inventories (net of acquisitions) and increased net income offset
      by
      increased accounts receivable.





Investing
      activities used cash of
      $415.1 million and $3.5 million in the six months ended May 31, 2007 and 2006,
      respectively.  The increase in the use of cash was related to amounts
      used to fund the J&J Acquisition on January 2, 2007and the *ACT*
      Acquisition on May 25, 2007.





Financing
      activities provided cash of $293.8 million and used cash of $54.8 million in
      the
      six months ended May 31, 2007 and 2006, respectively.  The increase
      was primarily attributable to amounts borrowed to fund the J&J
      Acquisition.








***Foreign
      Operations***





Historically,
      our primary foreign operations have been conducted through our Canadian and
      United Kingdom (“U.K.”) subsidiaries.  Effective November 1, 2004, we
      transitioned our European business to Chattem Global Consumer Products Limited,
      a wholly-owned subsidiary located in Limerick, Ireland.  The
      functional currencies of these subsidiaries are Canadian dollars and Euros,
      respectively.  Fluctuations in exchange rates can impact operating
      results, including total revenues and expenses, when translations of the
      subsidiary financial statements are made in accordance with SFAS No. 52,
“Foreign Currency Translation”.  For the six months ended May 31, 2007
      and 2006, these subsidiaries accounted for 6% and 8% of total revenues,
      respectively, and 2% and 4% of total assets, respectively.  It has not
      been our practice to hedge our assets and liabilities in Canada, the U.K. or
      Ireland or our intercompany transactions due to the inherent risks associated
      with foreign currency hedging transactions and the timing of payments between
      us
      and our foreign subsidiaries. Historically, gains or losses from foreign
      currency transactions have not had a material impact on our operating results.
      A
      gain of $0.1 million for the six months ended May 31, 2007 and an insignificant
      loss for the six months ended May 31, 2006 resulted from foreign currency
      transactions and are included in selling, general and administrative expenses
      in
      the Consolidated Statements of Income.





***Recent
      Accounting Pronouncements***





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
      123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of
      SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS
      123”).  SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock
      Issued to Employees” (“APB 25”) and amends SFAS No. 95, “Statement of Cash
      Flows”.  SFAS 123R focuses primarily on accounting for transactions in
      which an entity obtains employee services in share-based payment transactions
      and requires all share-based payments to employees, including grants of employee
      stock options, to be recognized as additional compensation expense in the
      financial statements based on the calculated fair value of the
      awards.  SFAS 123R also requires the benefits of tax deductions in
      excess of recognized compensation costs to be reported as a financing cash
      flow.  We adopted SFAS 123R effective for our fiscal year
      beginning






36


December
      1, 2005.  We have described the impact of adopting SFAS 123R in our
      consolidated financial statements in Note 5, Stock-Based
      Compensation.





In
      July 2006, FASB issued Interpretation No. 48 (“FIN 48”), “Accounting
      for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty
      in income taxes recognized in the financial statements in accordance with FASB
      Statement No. 109, “Accounting for Income Taxes”. FIN 48 provides guidance
      on the financial statement recognition and measurement of a tax position taken
      or expected to be taken in a tax return. FIN 48 also provides guidance on
      de-recognition, classification, interest and penalties, accounting in interim
      periods, disclosures, and transition. FIN 48 is effective for fiscal years
      beginning after December 15, 2006, or our fiscal year beginning December 1,
      2007.  We are evaluating the impact of adopting FIN 48 on our
      consolidated financial statements.





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
      157”).  SFAS 157 provides guidance for using fair value to measure
      assets and liabilities and is intended to respond to investors’ requests for
      expanded information about the extent to which companies measure assets and
      liabilities at fair value, the information used to measure fair value, and
      the
      effect of fair value measurements on earnings.  SFAS 157 applies
      whenever other standards require (or permit) assets or liabilities to be
      measured at fair value but does not expand the use of fair value in any new
      circumstances.  SFAS 157 also requires expanded disclosure of the
      effect on earnings for items measured using unobservable data, establishes
      a
      fair value hierarchy that prioritizes the information used to develop those
      assumptions and requires separate disclosure by level within the fair value
      hierarchy.  The provisions of SFAS 157 are effective for interim
      financial statements issued for fiscal years beginning after November 15, 2007,
      or our fiscal 2008.





In
      September 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined
      Benefit Pension and Other Postretirement Plans -- An Amendment of FASB
      Statements No. 87, 88, 106, and 132R” (“SFAS 158”).  SFAS 158 requires
      an employer to recognize in its balance sheet an asset or liability for a
      plan’s funded status, measure a plan’s assets and obligations as of the end of
      the employer’s fiscal year and recognize changes in the funded status in the
      year in which the changes occur.  SFAS 158 also enhances the current
      disclosure requirements for pension and other postretirement plans to include
      disclosure related to certain effects on net periodic benefit
      cost.  The requirement to recognize the funded status of a benefit
      plan and the disclosure requirements are effective as of the end of the fiscal
      year ending after December 15, 2006, or our fiscal 2007.  The
      requirement to measure plan assets and benefit obligations as of the employer’s
      fiscal year-end is effective for fiscal years ending after December 15, 2008,
      or
      our fiscal 2009.  We are evaluating the impact of adopting SFAS 158 on
      our consolidated financial statements.





In
      September 2006, the Securities and Exchange Commission released Staff Accounting
      Bulletin 108 (“SAB 108”). SAB 108 provides interpretative guidance on how the
      effects of the carryover or reversal of prior year misstatements should be
      considered in quantifying a current year misstatement.  SAB 108 is
      effective for fiscal years ending after November 15, 2006.  SAB 108
      did not have an impact on the accompanying consolidated financial
      statements.





In
        February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
        Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
        permits entities to choose to measure certain financial assets and liabilities
        at fair value.  Unrealized gains and losses on items for which the
        fair value option has been elected are reported in earnings.  SFAS 159
        is effective for fiscal years beginning after November 15, 2007.  We
        are evaluating the impact of adopting SFAS 159 on our consolidated financial
        statements.





***Forward
      Looking Statements***





We
      may
      from time to time make written and oral forward-looking statements. Written
      forward-looking statements may appear in documents filed with the Securities
      and
      Exchange Commission, in press releases and in reports to shareholders or be
      made
      orally in publicly accessible conferences or conference calls. The Private
      Securities Litigation Reform Act of 1995 contains a safe harbor for
      forward-looking statements. We rely on this safe harbor in making such
      disclosures. These forward-looking statements generally can be identified by
      use
      of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,”
“forecast” or other similar words or phrases.  These forward-looking
      statements relate to, among other things, our strategic and business initiatives
      and plans for growth or operating changes; our financial condition and results
      of operation; future events, developments or performance; and management’s
      expectations, beliefs, plans, estimates and projections.  The
      forward-looking statements are based on management’s current beliefs and
      assumptions about expectations, estimates, strategies and projections. These
      statements are not guarantees of future performance and involve risks,
      uncertainties and assumptions that are difficult to predict. Therefore, actual
      outcomes and results may differ materially from what is expressed or forecasted
      in such forward-looking statements. We undertake no obligation to update
      publicly any forward-looking statements whether as a result of new information,
      future events or otherwise. Factors that could cause our actual results to
      differ materially from those anticipated in the forward-looking statements
      in
      this Form 10-Q and the documents incorporated herein by reference include the
      following:







37


·
            we
                may not be able to successfully integrate the five brands acquired
                from
                Johnson & Johnson on January 2, 2007 into our portfolio of consumer
                brands or achieve other synergies associated with the
                acquisition;


·
            we
                have a significant amount of debt that could adversely affect our
                business
                and growth prospects;


·
            we
                face significant competition in the OTC healthcare, toiletries and
                dietary
                supplements markets;


·
            we
                may face additional lawsuits alleging injury from the use of
                *Dexatrim* products containing ephedrine, which we discontinued
                manufacturing and shipping in September 2002, or from other products
                that
                we currently produce or may produce in the
                future;


·
            our
                product liability insurance coverage may be insufficient to cover
                existing
                or future liability claims;


·
            our
                acquisition strategy is subject to risk and may not be
                successful;


·
            our
                business is regulated by numerous federal, state and foreign governmental
                authorities, which subjects us to elevated compliance costs and risks
                of
                non-compliance;


·
            our
                success depends on our ability to anticipate and respond in a timely
                manner to changing consumer
                preferences;


·
            we
                rely on a few large customers, particularly Wal-Mart Stores, Inc.,
                for a
                significant portion of our sales;


·
            we
                may be adversely affected by fluctuations in buying decisions of
                mass
                merchandise, drug and food trade buyers and the trend toward retail
                trade
                consolidation;


·
            we
                rely on third party manufacturers for a portion of our product portfolio,
                including products under our *Gold Bond, Icy Hot, Selsun*,
                *Dexatrim, ACT, Unisom*and *Cortizone*brands;


·
            our
                dietary supplement business could suffer as a result of injuries
                caused by
                dietary supplements in general, unfavorable scientific studies or
                negative
                press;


·
            our
                business could be adversely affected if we are unable to successfully
                protect our intellectual property;


·
            because
                most of our operations are located in Chattanooga, Tennessee, we
                are
                subject to regional and local
                risks;


·
            we
                depend on sole source suppliers for three active ingredients used
                in our
                *Pamprin*and *Prēmsyn PMS*products and a limited source of
                supply for selenium sulfide, the active ingredient in *Selsun
                Blue*, and if we are unable to buy these ingredients, we will not
                be
                able to manufacture these products;


·
            we
                are subject to the risks of doing business
                internationally;


·
            the
                terms of our outstanding debt obligations limit certain of our
                activities;


·
            our
                operations are subject to significant environmental laws and
                regulations;


·
            we
                are dependent on certain key executives, the loss of whom could have
                a
                material adverse effect on our
                business;


·
            our
                shareholder rights plan and restated charter contain provisions that
                may
                delay or prevent a merger, tender offer or other change of control
                of
                us;


·
            the
                trading price of our common stock may be
                volatile;


·
            to
                service our indebtedness, we will require a significant amount of
                cash;
                and


·
            other
                risks described in our Securities and Exchange Commission
                filings.





**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risks**





We
      are
      exposed to market risk from changes in interest rates and foreign currency
      exchange rates, which may adversely affect our results of operations and
      financial condition.  We seek to minimize the risks from these
      interest rates and foreign currency exchange rate fluctuations through our
      regular operating and financing activities.





Our
      exposure to interest rate risk currently relates to amounts outstanding under
      our Credit Facility.  Loans under the revolving credit facility
      portion of our Credit Facility bear interest at LIBOR plus applicable
      percentages of 0.875% to 1.5% or the higher of the federal funds rate plus
      0.5%
      or the prime rate (the “Base Rate”).  The applicable percentages are
      calculated based on our leverage ratio.  The term loan under our
      Credit Facility bears interest at either LIBOR plus 1.75% or the Base Rate
      plus
      0.75%.  As of May 31, 2007, $32.0 million was outstanding under the
      revolving credit facility and $172.0 million was outstanding under the term
      loan
      portion of our Credit Facility.  The variable rate for the revolving
      credit facility was LIBOR plus 1.5%, or 6.82% as of May 31, 2007, and the
      variable rate for the term loan portion was LIBOR plus 1.75%, or 7.11%, as
      of
      May 31, 2007.  The 7.0% Subordinated Notes, the 1.625% Convertible
      Notes and the 2.0% Convertible Notes are fixed interest rate
      obligations.





In
      March
      2004, we entered into an interest rate cap agreement effective June 1, 2004
      with
      decreasing annual notional principal amounts of $15.0 million beginning March
      1,
      2006 and cap rates ranging from 4.0% to 5.0% over the life of the
      agreement.  During the second quarter of fiscal 2007, the interest
      rate cap was sold for $0.4 million. As a result, an insignificant charge was
      recorded as additional interest expense in the accompanying consolidated
      statement of income.





In
      November 2006, we entered into a forward starting swap agreement effective
      January 15, 2007.  The forward starting swap has decreasing notional
      principal amounts beginning October 15, 2007 and a swap rate of 4.98% over
      the
      life of the agreement.  As of May 31, 2007, the increase in fair value
      of $0.7 million, net of tax, was recorded to other comprehensive
      income.  The swap was deemed to be an effective cash flow
      hedge.  The forward starting swap agreement terminates on January 15,
      2010.





38


In
      November 2006, we entered into a forward starting cap agreement effective
      January 15, 2007.  The forward starting cap had decreasing notional
      principal amounts beginning October 15, 2007 and a cap rate of 5.0% over the
      life of the agreement.  During the second quarter of fiscal 2007, the
      interest rate cap was sold for $0.6 million. As a result, $0.1 million was
      recorded as additional interest expense in the accompanying consolidated
      statement of income.





In
      April
      2007, we entered into an interest rate cap agreement.  The cap has
      decreasing notional principal amounts beginning May 15, 2007 and a cap rate
      of
      5.0% over the life of the agreement.  As of May 31, 2007, the value of
      the premium on the cap was compared to the fair value of the cap, and the
      insignificant increase in the market value of the premium was recorded to other
      comprehensive income.  A portion of the interest rate cap was deemed
      an ineffective cash flow hedge due to the reduction of variable rate debt
      resulting in an insignificant charge recorded as additional interest expense
      in
      the consolidated statement of income for the second quarter of fiscal
      2007.  The balance of the cash flow hedge was deemed to be
      effective.  The cap agreement terminates on September 15, 2008.





The
      impact on our results of operations of a one-point rate change on the July
      2,
      2007 outstanding revolving credit facility balance of $29.0 million and $172.0
      million term loan balance of our Credit Facility for the next twelve months
      would be approximately $1.3 million, net of tax.





We
      are subject to risk from changes in
      the foreign exchange rates relating to our Canadian, U.K. and Irish
      subsidiaries. Assets and liabilities of these subsidiaries are translated to
      U.S. dollars at year-end exchange rates. Income and expense items are translated
      at average rates of exchange prevailing during the year.  Translation
      adjustments are accumulated as a separate component of shareholders' equity.
      Gains and losses, which result from foreign currency transactions, are included
      in the consolidated statements of income.  The potential loss
      resulting from a hypothetical 10.0% adverse change in the quoted foreign
      currency exchange rate amounts to approximately $1.0 million as of May 31,
      2007.





This
      market risk discussion contains
      forward-looking statements.  Actual results may differ materially from
      this discussion based upon general market conditions and changes in financial
      markets.





**Item
                4.**
            **Controls
                and Procedures**





Under
      the
      supervision and with the participation of our management, including our Chief
      Executive Officer and Principal Financial Officer, we have evaluated the
      effectiveness of our disclosure controls and procedures (as such terms are
      defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
      of
      1934, as amended (the “Exchange Act”)), as of May 31, 2007 (the “Evaluation
      Date”).  Based on such evaluation, such officers have concluded that,
      as of the Evaluation Date, our disclosure controls and procedures were effective
      in alerting them on a timely basis to material information relating to us
      (including our consolidated subsidiaries) required to be included in our reports
      filed or submitted under the Exchange Act.










39


**PART
      II.  OTHER INFORMATION**


**Item
                1.**
            **Legal
                Proceedings**





See
      Note 19 of Notes to Consolidated
      Financial Statements included in Part 1, Item 1 of this Report.





**Item
                1A.**
            **Risk
                Factors**





There
      have been no material changes
      from the risk factors previously disclosed in our Annual Report on Form 10-K
      for
      the year ended November 30, 2006.





**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





(a)
      Not applicable.





(b)
      Not applicable.





(c)
      A summary of the common stock
      repurchase activity for our second quarter of fiscal 2007 is as
      follows:





Period
            
            Total
                Number of Shares Purchased
            
            
            Average
                Price Paid Per Share (1)
            
            
            Total
                Number of Shares Purchased as Part of Publicly Announced Plans or
                 Programs (2)
            
            
            Approximate
                Dollar Value of Shares that may yet be Purchased under the Plans
                or
                 Programs (2)March
                1– March 31
            
            
            —
            
            
            $
            —
            
            
            
            —
            
            
            
            88,147,224April
                1 – April 30
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            88,147,224May
                1 – May 31
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            88,147,224Total
                Second Quarter
            
            
            —
            
            
            $
            —
            
            
            
            —
            
            
            
            88,147,224





(1)
            Average
                price paid per share includes broker
                commissions.




(2)
            In
                January 2005, our board of directors increased the total authorization
                to
                repurchase our common stock under our stock buyback program to $30.0
                million.  A total of $17.3 million remained available under the
                stock buyback authority prior to July 29, 2005, when our board of
                directors increased the total buyback authorization back to $30.0
                million.  Subsequent to share purchases made in the fourth
                quarter of fiscal 2005, our board of directors again increased the
                total
                buyback authorization back to $30.0 million, effective November 29,
                2005.  On June 26, 2006 our board of directors authorized the
                repurchase of up to an additional $100.0 million of our common stock
                under
                our existing stock repurchase program.  There is no expiration
                date specified for our stock buyback
                program.





**Item
                3.**
            **Defaults
                Upon Senior Securities**




None.





**Item
                4.**
            **Submission
                of Matters to a Vote of Security
                Holders**





Our
      annual meeting of shareholders was
      held on April 25, 2007 in Chattanooga, Tennessee.  At the meeting, the
      following items were submitted to a vote of shareholders:





(1)
            The
                following persons were elected as directors to serve for a three-year
                term:  Zan Guerry (12,455,898 votes for and 4,666,720 votes
                withheld), and Bill W. Stacy (16,200,280 votes for and 922,338 votes
                withheld).  Other directors whose terms of office continued
                after the annual meeting are: Gary D. Chazen, Robert E. Bosworth,
                Ruth W.
                Brinkley, Samuel E. Allen and Philip H.
                Sanford.


(2)
            Ratifications
                of the Compensation Committee’s interpretation that the maximum total
                number of shares that were issuable pursuant to grants under the
                Chattem,
                Inc. Non-Statutory Stock Option Plan – 1998, the Chattem, Inc.
                Non-Statutory Stock Option Plan – 2000 and the Chattem, Inc. Stock
                Incentive Plan – 2003 (collectively, the “Plans”) to any employee was the
                maximum number of shares issuable under the Plans (11,779,310 votes
                for;
                2,331,231 votes against; 27,068 abstentions; and 2,965,009 broker
                non-votes).


(3)
            Ratification
                of the amendment of the Chattem, Inc. Stock Incentive Plan – 2003 (the
                “2003 Plan”).  The amendment limits the maximum number of awards
                an employee may be granted under the 2003 Plan to 250,000 shares
                in any
                one fiscal year (11,447,001 votes for; 2,678,970 votes against; 31,638
                abstentions; and 2,965,009 broker
                non-votes).






40





(4)
            Ratification
                of Grant Thornton, LLP as the Company’s independent auditors for fiscal
                2007 (16,864,432 votes for; 240,860 votes against; and 17,325
                abstentions.







**Item
                5.**
            **Other
                Information**




None.





**Item
                6.**
            **Exhibits**





Exhibits
      (numbered in accordance with Item 601 of Regulation S-K):





Exhibit
                Number
            
            Description31.1
            
            Certification
                required by Rule 13a-14(a) under the Securities Exchange Act of
                193431.2
            
            Certification
                required by Rule 13a-14(a) under the Securities Exchange Act of
                193432
            
            Certification
                required by Rule 13a-14(b) under the Securities Exchange Act of 1934
                and
                18 U.S.C. Section 1350


























41


**CHATTEM,
      INC.**


**SIGNATURES**








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












**CHATTEM,
              INC.**(Registrant)Dated:    
                July 10, 2007
            
            /s/ Zan
              GuerryZan
              GuerryChairman
              and Chief Executive Officer




Dated:    
                  July 10, 2007
              
              /s/ Robert
                E. BosworthRobert
                E. BosworthPresident
                and Chief Operating Officer






























42


**Chattem,
      Inc. and Subsidiaries**


**Exhibit
      Index**













**Exhibit
                Number**
            
            **Description
                of Exhibit**31.1
            
            Certification
                required by Rule 13a-14(a) under the Securities Exchange Act of
                193431.2
            
            Certification
                required by Rule 13a-14(a) under the Securities Exchange Act of
                193432
            
            Certification
                required by Rule 13a-14(b) under the Securities Exchange Act of 1934
                and
                18 U.S.C. Section 1350


























































43