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 February 28, 2009


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.




YESþ      NO 





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








Large accelerated
      filerþ
            Accelerated filerNon-accelerated
      filer (Do not check if a smaller reporting
      company)
            Smaller reporting company






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




YES      NO þ








As
of April 1, 2009, 19,435,551 shares of the Company’s common stock, without par
value, were outstanding.











CHATTEM,
INC.





INDEX







PART
I.  FINANCIAL INFORMATION


PAGE
      NO.Item
      1.    Financial StatementsConsolidated
      Balance Sheets as of February 28, 2009 and November 30,
      2008
                        3Consolidated
      Statements of Income for the Three Months Ended
      February 28, 2009 and February 29, 2008
                        5Consolidated
      Statements of Cash Flows for the Three Months Ended February 28,
      2009 and February 29, 2008
                        6Notes
      to Consolidated Financial Statements
                        7Item
      2.    Management's Discussion and Analysis of Financial
      Condition and Results of
      Operations
                        27Item
      3.    Quantitative and Qualitative Disclosures About Market
      Risk
                        36Item
      4.    Controls and Procedures
                        36PART
      II.  OTHER INFORMATIONItem
      1.    Legal Proceedings
                        37Item
      1A. Risk Factors
                        37Item
      2.    Unregistered Sales of Equity Securities and Use of
      Proceeds
                        37Item
      3.    Defaults Upon Senior Securities
                        37Item
      4.    Submission of Matters to a Vote of Security
      Holders
                        37Item
      5.    Other Information
                        37Item
      6.    Exhibits
                        38SIGNATURES
                        39












2


PART 1. FINANCIAL
INFORMATION








Item 1. Financial
Statements








CHATTEM, INC. AND
SUBSIDIARIES





CONSOLIDATED BALANCE
SHEETS


(In
thousands)





ASSETS
              
              FEBRUARY
      28,
                2009
              
              
              NOVEMBER
      30,
                2008(Unaudited)CURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              30,349
              
              
              $
              32,310Accounts
      receivable, less allowances of $10,174 atFebruary
      28, 2009 and $9,718 at November 30, 2008
              
              
              60,635
              
              
              
              49,417Inventories,
      net
              
              
              45,173
              
              
              
              40,933Deferred
      income taxes
              
              
              3,889
              
              
              
              3,968Prepaid
      expenses and other current assets
              
              
              5,129
              
              
              
              2,451Total
      current assets
              
              
              145,175
              
              
              
              129,079PROPERTY,
      PLANT AND EQUIPMENT, NET
              
              
              32,016
              
              
              
              32,243OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
              
              
              616,428
              
              
              
              616,670Debt
      issuance costs, net
              
              
              10,975
              
              
              
              12,253Other
              
              
              2,706
              
              
              
              2,727Total
      other noncurrent assets
              
              
              630,109
              
              
              
              631,650TOTAL
      ASSETS
              
              $
              807,300
              
              
              $
              792,972














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
              
              FEBRUARY
      28,
                2009
              
              
              NOVEMBER
      30,
                2008(Unaudited)CURRENT
      LIABILITIES:Current
      maturities of long-term debt
              
              $
              3,000
              
              
              $
              3,000Accounts
      payable
              
              
              23,906
              
              
              
              18,116Bank
      overdrafts
              
              
              158
              
              
              
              1,184Accrued
      liabilities
              
              
              26,776
              
              
              
              21,293Total
      current liabilities
              
              
              53,840
              
              
              
              43,593LONG-TERM
      DEBT, less current maturities
              
              
              407,550
              
              
              
              456,500DEFERRED
      INCOME TAXES
              
              
              41,615
              
              
              
              35,412OTHER
      NONCURRENT LIABILITIES
              
              
              1,309
              
              
              
              1,609COMMITMENTS
      AND CONTINGENCIES (Note 18)SHAREHOLDERS’
      EQUITY:Preferred
      shares, without par value, authorized 1,000,none
      issued
              
              
              —
              
              
              
              —Common
      shares, without par value, authorized 100,000,issued
      and outstanding 19,484 at February 28, 2009 and18,978
      at November 30, 2008
              
              
              56,574
              
              
              
              28,926Retained
      earnings
              
              
              250,796
              
              
              
              231,230307,370
              
              
              
              260,156Accumulated
      other comprehensive income (loss), net of tax:Interest
      rate hedge adjustment
              
              
              (1,759
              )
              
              
              (1,787
              )Foreign
      currency translation adjustment
              
              
              (1,082
              )
              
              
              (968
              )Unrealized
      actuarial gains and losses
              
              
              (1,543
              )
              
              
              (1,543
              )Total
      shareholders’ equity
              
              
              302,986
              
              
              
              255,858TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
              
              $
              807,300
              
              
              $
              792,972














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 ENDEDFEBRUARY
      28,
                                
                                
                                FEBRUARY
      29,2009
                                
                                
                                2008TOTAL
      REVENUES
                                
                                $
                                116,092
                                
                                
                                $
                                120,773COSTS
      AND EXPENSES:Cost
      of sales
                                
                                
                                35,257
                                
                                
                                
                                34,733Advertising
      and promotion
                                
                                
                                28,589
                                
                                
                                
                                34,496Selling,
      general and administrative
                                
                                
                                15,426
                                
                                
                                
                                15,466Product
      recall expenses
                                
                                
                                —
                                
                                
                                
                                6,043Total
      costs and expenses
                                
                                
                                79,272
                                
                                
                                
                                90,738INCOME
      FROM OPERATIONS
                                
                                
                                36,820
                                
                                
                                
                                30,035OTHER
      INCOME (EXPENSE):Interest
      expense
                                
                                
                                (5,664
                                )
                                
                                
                                (6,552
                                )Investment
      and other income, net
                                
                                
                                111
                                
                                
                                
                                137Loss
      on early extinguishment of debt
                                
                                
                                (696
                                )
                                
                                
                                (526
                                )Total
      other income (expense)
                                
                                
                                (6,249
                                )
                                
                                
                                (6,941
                                )INCOME
      BEFORE INCOME TAXES
                                
                                
                                30,571
                                
                                
                                
                                23,094PROVISION
      FOR INCOME TAXES
                                
                                
                                11,005
                                
                                
                                
                                8,221NET
      INCOME
                                
                                $
                                19,566
                                
                                
                                $
                                14,873NUMBER
      OF COMMON SHARES:
                                  Weighted
      average outstanding - basic
                                
                                
                                19,467
                                
                                
                                
                                19,106Weighted
      average and potential dilutive outstanding
                                
                                
                                19,667
                                
                                
                                
                                19,788NET
      INCOME  PER COMMON SHARE:Basic
                                
                                $
                                1.01
                                
                                
                                $
                                .78Diluted
                                
                                $
                                .99
                                
                                
                                $
                                .75










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)







FOR THE THREE MONTHS ENDEDFEBRUARY
      28,
                            2009
                          
                          
                          FEBRUARY
      29,
                            2008OPERATING
      ACTIVITIES:Net
      income
                          
                          $
                          19,566
                          
                          
                          $
                          14,873Adjustments
      to reconcile net income to net cash provided byoperating
      activities:Depreciation
      and amortization
                          
                          
                          1,894
                          
                          
                          
                          2,119Deferred
      income taxes
                          
                          
                          4,164
                          
                          
                          
                          4,433Stock–based
      compensation expense
                          
                          
                          1,479
                          
                          
                          
                          1,339Loss
      on early extinguishment of debt
                          
                          
                          696
                          
                          
                          
                          526Tax
      benefit realized from stock options exercised
                          
                          
                          (135
                          )
                          
                          
                          (1,812
                          )Other,
      net
                          
                          
                          122
                          
                          
                          
                          112Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          (11,218
                          )
                          
                          
                          (14,381
                          )Inventories
                          
                          
                          (4,082
                          )
                          
                          
                          737Prepaid
      expenses and other current assets
                          
                          
                          (2,678
                          )
                          
                          
                          (3,746
                          )Accounts
      payable and accrued liabilities
                          
                          
                          9,935
                          
                          
                          
                          6,047Net
      cash provided by operating activities
                          
                          
                          19,743
                          
                          
                          
                          10,247INVESTING
      ACTIVITIES:Purchases
      of property, plant and equipment
                          
                          
                          (760
                          )
                          
                          
                          (1,271
                          )Increase
      in other assets, net
                          
                          
                          (362
                          )
                          
                          
                          (1,656
                          )Net
      cash used in investing activities
                          
                          
                          (1,122
                          )
                          
                          
                          (2,927
                          )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
                          
                          
                          (750
                          )
                          
                          
                          (35,750
                          )Proceeds
      from borrowings under revolving credit facility
                          
                          
                          1,000
                          
                          
                          
                          69,500Repayments
      of revolving credit facility
                          
                          
                          (20,500
                          )
                          
                          
                          (43,750
                          )Bank
      overdrafts
                          
                          
                          (1,026
                          )
                          
                          
                          (4,734
                          )Repurchase
      of common shares
                          
                          
                          —
                          
                          
                          
                          (240
                          )Proceeds
      from exercise of stock options
                          
                          
                          573
                          
                          
                          
                          2,057Tax
      benefit realized from stock options exercised
                          
                          
                          135
                          
                          
                          
                          1,812Net
      cash used in financing activities
                          
                          
                          (20,568
                          )
                          
                          
                          (11,105
                          )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
                          
                          
                          (14
                          )
                          
                          
                          (3
                          )CASH
      AND CASH EQUIVALENTS:Decrease
      for the period
                          
                          
                          (1,961
                          )
                          
                          
                          (3,788
                          )At
      beginning of period
                          
                          
                          32,310
                          
                          
                          
                          15,407At
      end of period
                          
                          $
                          30,349
                          
                          
                          $
                          11,619PAYMENTS
      FOR:Interest
                          
                          $
                          2,167
                          
                          
                          $
                          2,932Taxes
                          
                          $
                          1,478
                          
                          
                          $
                          6,104








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 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, 2008.  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.
            RECENT ACCOUNTING
      PRONOUNCEMENTS





In
December 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 141R, “Business
Combinations” (“SFAS 141R”).  SFAS 141R establishes principles and
requirements for how the acquirer in a business combination recognizes and
measures the identifiable assets acquired, liabilities assumed, and intangible
assets acquired and determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination.  The provisions of SFAS 141R are effective for
acquisitions closing after the first annual reporting period beginning after
December 15, 2008.  Accordingly, we will apply the provisions of SFAS
141R prospectively to business combinations consummated beginning in the first
quarter of our fiscal 2010.  We do not expect SFAS 141R to have an
effect on our previous acquisitions.





In
April 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3,
“Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). 
In determining the useful life of intangible assets, FSP FAS 142-3 removes the
requirement to consider whether an intangible asset can be renewed without
substantial cost of material modifications to the existing terms and conditions
and, instead, requires an entity to consider its own historical experience in
renewing similar arrangements. FSP FAS 142-3 also requires expanded disclosure
related to the determination of intangible asset useful lives.  FSP FAS
142-3 is effective for financial statements issued for fiscal years beginning
after December 15, 2008, or our fiscal 2010.  We are currently
evaluating the impact, if any, of FSP FAS 142-3.




In May
2008, the FASB issued FSP Accounting Principles Board (“APB”)
Opinion  No. 14-1, “Accounting for Convertible Debt Instruments That
May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”
(“FSP 14-1”).  FSP 14-1 specifies that issuers of convertible debt
instruments should separately account for the liability and equity components of
the instrument in a manner that will reflect the entity’s non-convertible debt
borrowing rate on the instrument’s issuance date when interest is recognized in
subsequent periods.  Upon adoption of FSP 14-1, the proceeds received
from the issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes
(collectively, the “Convertible Notes”) will be allocated between the liability
and equity component by determining the fair value of the liability component
using our non-convertible debt borrowing rate at the time the Convertible Notes
were issued.  The difference between the proceeds of the Convertible
Notes and the calculated fair value of the liability component will be recorded
as a debt discount with a corresponding increase to common shares in our
consolidated balance sheet.  The debt discount will be amortized as
additional non-cash interest expense over the remaining life of the Convertible
Notes using the effective interest rate method.  Although FSP 14-1
will have no impact on our cash flows, FSP 14-1 will result in additional
non-cash interest expense until maturity or early extinguishment of the
Convertible Notes.  The provisions of FSP 14-1 are to be applied
retrospectively to all periods presented upon adoption and are effective for
fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim
periods within those fiscal years.  Upon adoption of FSP 14-1, we
estimate non-cash interest expense for the fiscal years ended November 30, 2009
and 2008 will increase approximately $6,900 and $7,200,
respectively.  The additional non-cash interest expense is expected to
increase as the Convertible Notes approach their respective maturity dates and
accrete to their face values.





7


In
December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (“FSP 132R-1”).  FSP 132R-1
enhances the required disclosures about plan assets in an employer’s defined
benefit pension or other postretirement plan, including investment allocations
decisions, inputs and valuations techniques used to measure the fair value of
plan assets and significant concentrations of risks within plan
assets.  FSP 132R-1 is effective for financial statements issued for
fiscal years ending after December 15, 2009, or our fiscal 2010.  We
are currently evaluating the impact, if any, of FSP 132R-1.






4.
            STOCK-BASED
      COMPENSATION





We
currently provide stock-based compensation under five stock incentive plans that
have been approved by our shareholders.  Our 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.   The 2009 Equity Incentive Plan, which
was adopted by our board of directors on January 28, 2009 and was approved by
our shareholders at the April 8, 2009 annual shareholders’ meeting, provides for
the issuance of up to 1,750 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.





We
account for stock-based compensation under the provisions of SFAS No. 123
(revised 2004), “Share-Based Payment” (“SFAS 123R”), which 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).





The
following table represents the impact of stock-based compensation expense on our
consolidated statements of income during the three months ended February 28,
2009, and February 29, 2008:





2009
                  
                  
                  2008Income
      from operations
                  
                  $
                  1,479
                  
                  
                  $
                  1,339Provision
      for income taxes
                  
                  
                  532
                  
                  
                  
                  477Net
      income
                  
                  $
                  947
                  
                  
                  $
                  862Basic
      net income per share
                  
                  $
                  0.05
                  
                  
                  $
                  0.05Diluted
      net income per share
                  
                  $
                  0.05
                  
                  
                  $
                  0.04





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 $342
and $193 of stock option compensation cost as a component of the carrying cost
of inventory on-hand as of February 28, 2009 and February 29, 2008,
respectively.





The
weighted average fair value of stock options at the date of grant during the
three months ended February 28, 2009 and February 29, 2008 was $24.46 and
$28.55, 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 three months ended February 28, 2009 and February 29, 2008,
respectively:





2009
                    
                    
                    2008Expected
      life
                    
                    6
      years
                    
                    
                    6
      yearsVolatility
                    
                    
                    36%
                    
                    
                    
                    34%Risk-free
      interest rate
                    
                    
                    3.84%
                    
                    
                    
                    4.47%Dividend
      yield
                    
                    
                    0%
                    
                    
                    
                    0%Forfeitures
                    
                    
                    0.3%
                    
                    
                    
                    1.2%





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 the historical price
volatility of our common stock.  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).





8


A summary
of stock option activity for the three-months ended February 28, 2009 is
presented below:





Shares
                  Under
                  Option
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Life
                
                Aggregate
                  Intrinsic
                  ValueOutstanding
      at December 1, 2008
                
                
                1,510
                
                
                $
                50.23Granted
                
                
                7
                
                
                
                62.00Exercised
                
                
                (18
                )
                
                
                32.82Cancelled
                
                
                —
                
                
                
                —Outstanding
      at February 28, 2009
                
                
                1,499
                
                
                $
                50.49
                
                4.3
      years
                
                $
                75,699Exercisable
      at February 28, 2009
                
                
                734
                
                
                $
                38.48
                
                3.6
      years
                
                $
                28,259


The total
fair value of stock options that vested during the three months ended February
28, 2009 and February 29, 2008 was $1,637 and $1,356,
respectively.  The total intrinsic value of stock options exercised
during the three months ended February 28, 2009 and February 29, 2008 was $598
and $4,540, respectively.





As of
February 28, 2009, we had $14,597 of unrecognized compensation cost related to
stock options that will be recorded over a weighted average period of
approximately 2.6 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 February 28, 2009 and February 29, 2008 was $43
and $93, respectively.





Restricted share activity under the
plans during the three months ended February 28, 2009 is summarized as
follows:





Number
                of Shares
              
              
              Weighted
      Average
                Grant
      Date
                FairValueNonvested
      at December 1, 2008
              
              
              1
              
              
              $
              35.37Granted
              
              
              —
              
              
              
              —Vested
              
              
              1
              
              
              
              35.37Forfeited
              
              
              —
              
              
              
              —Nonvested
      at February 28, 2009
              
              
              —
              
              
              $
              —











9





5.
            EARNINGS PER
      SHARE





The
following table presents the computation of earnings per share for the three
months ended February 28, 2009 and February 29, 2008, respectively:





2009
                
                
                2008NET
      INCOME
                
                $
                19,566
                
                
                $
                14,873NUMBER
      OF COMMON SHARES:Weighted
      average outstanding
                
                
                19,467
                
                
                
                19,106Issued
      upon assumed exercise of outstanding stock options
                
                
                19
                
                
                
                195Issued
      upon assumed exercise of convertible notes
                
                
                181
                
                
                
                484Effect
      of issuance of restricted common shares
                
                
                —
                
                
                
                3Weighted
      average and potential dilutive outstanding (1)
                
                
                19,667
                
                
                
                19,788NET
      INCOME PER COMMON SHARE:Basic
                
                $
                1.01
                
                
                $
                .78Diluted
                
                $
                .99
                
                
                $
                .75





(1)  Because
their effects are anti-dilutive, excludes shares issuable under stock option
plans whose grant price was greater than the average market price of common
shares outstanding as follows: 752 and 401 shares for the three months ended
February 28, 2009 and February 29, 2008, respectively.






6.
            LONG-TERM
      DEBT





Long-term
debt consisted of the following as of February 28, 2009 and November 30,
2008:




2009
                  
                  
                  2008Revolving
      Credit Facility due 2010 at a variable rate of 6.07% as of November
      30, 2008
                  
                  $
                  —
                  
                  
                  $
                  19,5002.0%
      Convertible Senior Notes due 2013
                  
                  
                  96,300
                  
                  
                  
                  125,0001.625%
      Convertible Senior Notes due 2014
                  
                  
                  100,000
                  
                  
                  
                  100,000Term
      Loan due 2013 at a variable rate of 2.84% and 6.57% as of February
      28, 2009 and November 30, 2008, respectively
                  
                  
                  106,750
                  
                  
                  
                  107,5007.0%
      Senior Subordinated Notes due 2014
                  
                  
                  107,500
                  
                  
                  
                  107,500
  Total
      long-term debt
                    
                    
                    410,550
                    
                    
                    
                    459,500Less:  current
      maturities
                    
                    
                    3,000
                    
                    
                    
                    3,000Total
      long-term debt, net of current maturities
                    
                    $
                    407,550
                    
                    
                    $
                    456,500






In
February 2004, we entered into a Senior Secured Revolving Credit Facility with a
maturity date of February 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 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 2010.  Upon successful syndication, we
will be 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 amendment to the Amended Revolving Credit Facility providing for up
to a $100,000 revolving credit facility and a




10


$300,000
term loan (the “Credit Facility”).  The Credit Facility includes
“accordion” features that permit 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, subject to successful
syndication.  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 February 28, 2009 and November 30, 2008, we had $0 and $19,500, respectively,
of borrowings outstanding under the revolving credit facility portion of our
Credit Facility.  As of April 1, 2009, we had $0 of borrowings
outstanding under the revolving credit facility portion of our Credit Facility
and our borrowing capacity was $100,000.





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
June 2007.  The principal outstanding after scheduled repayment and
any unscheduled prepayments matures and is payable January 2013.  In
January 2008, we utilized borrowings under the revolving credit facility portion
of our Credit Facility to repay $35,000 of the term loan under the Credit
Facility.  In connection with the term loan repayment, we retired a
proportional share of the term loan debt issuance costs and recorded the
resulting loss on early extinguishment of debt of $526 in the first quarter of
fiscal 2008.





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.  At February 28, 2009, we were in compliance with all
applicable financial and restrictive covenants under the Credit
Facility.





In
February 2004, we issued and sold $125,000 of 7.0% Senior Subordinated Notes due
2014 (the “7.0% Subordinated Notes”).  During fiscal 2005, we
repurchased $17,500 of our 7.0% Subordinated Notes in the open market at an
average premium of 1.6% over the principal amount of the notes.  The
outstanding balance of the remaining 7.0% Subordinated Notes was reduced to
$107,500.





Interest
payments on the 7.0% Subordinated Notes are due semi-annually in March and
September.  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 2009 at 103.500%, March 2010 at
102.333%, March 2011 at 101.167% and March 2012 and thereafter at
100.000%.  As of April 1, 2009, no such redemption has
occurred.





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
November 2006, we entered into an interest rate swap (“swap”) agreement
effective January 2007.  The swap has decreasing notional principal
amounts beginning October 2007 and a swap rate of 4.98% over the life of the
agreement.  During the second quarter and fourth quarter of fiscal
2008, we retired a portion of the swap for approximately $270 and $26,
respectively.  During the first quarter of fiscal 2009, we retired an
additional portion of the swap for approximately $195, which was recorded as
additional interest expense in the accompanying consolidated statements of
income. As of February 28, 2009, we had $105,000 of LIBOR based borrowings
hedged under the provisions of the swap.  During the three months
ended February 28, 2009, the decrease in fair value of the swap of $28, net of
tax, was recorded to other comprehensive income.  The fair value of
the swap of $3,351 is included in accrued liabilities.  As of
February 28, 2009, the swap was deemed to be an effective cash flow
hedge.  The fair value of the swap agreement is valued by a third
party.  The swap agreement terminates in January 2010.





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




11


2.0%,
payable semi-annually in May and November 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 initial conversion price
per share, or $76.59 per share, for 20 of the last 30 consecutive trading days
of the preceding fiscal quarter (the “prescribed measurement
period”).  The evaluation of the classification of the 2.0%
Convertible Notes will occur each fiscal quarter.





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 Notes 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 2,059.





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 1,634 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.





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.





On
December 4, 2008, we issued an aggregate of 487 shares of our common stock in
exchange for $28,700 in aggregate principal amount of our outstanding 2.0%
Convertible Notes.  Upon completion of the transaction, the balance of
the remaining 2.0% Convertible Notes was reduced to $96,300
outstanding.  In connection with this transaction, we retired a
proportional share of the 2.0% Convertible Notes debt issuance costs and
recorded the resulting loss on early extinguishment of debt of $696 in the first
quarter of fiscal 2009.





In April
2007, we completed a private offering of $100,000 of the 1.625% Convertible
Notes to qualified institutional investors pursuant to Rule 144A under the
Securities Act of 1933.  The 1.625% Convertible Notes bear interest at
an annual rate of 1.625%, payable semi-annually in May and November of each
year.  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 initial conversion price per share, or $95.16 per share, for the
prescribed measurement period.  The evaluation of the classification
of the 1.625% Convertible Notes will occur each fiscal quarter.





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




12


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.





Pursuant
to EITF 90-19,“Convertible Bonds with Issuer Option to Settle for Cash upon
Conversion”, (“EITF 90-19”), EITF 00-19, “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
scheduled future maturities of long-term debt to be funded for the next five
successive fiscal years and those thereafter as of February 28, 2009 are as
follows:





2009
                
                $
                2,2502010
                
                
                3,0002011
                
                
                3,0002012
                
                
                3,0002013
                
                
                191,800Thereafter
                
                
                207,500$
                410,550






7.
            FAIR VALUE
      MEASUREMENTS





We
currently measure and record in the accompanying consolidated financial
statements an interest rate swap at fair value.  SFAS 157, which we
adopted December 1, 2007, establishes a fair value hierarchy for those
instruments measured at fair value that distinguishes between assumptions based
on market data (observable inputs) and our own assumptions (unobservable
inputs).  The hierarchy consists of three levels:




Level
      1 -
              Quoted
      market prices in active markets for identical assets or
    liabilities;Level
      2 -
              Inputs
      other than Level 1 inputs that are either directly or indirectly
      observable; andLevel
      3 -
              Unobservable
      inputs developed using estimates and assumptions developed by us, which
      reflect those that a market participant would
  use.





Determining
which category an asset or liability falls within the hierarchy requires
significant judgment.  We evaluate our hierarchy disclosures each
quarter.





13


The
following table summarizes the interest rate swap measured at fair value in the
accompanying consolidated balance sheet as of February 28, 2009:





Fair
      Value Measurements as of
                      February 28, 2009Level 1
                    
                    
                    Level 2
                    
                    
                    Level 3
                    
                    
                    TotalLiabilitiesInterest
      rate swap (1)
                    
                    $
                    —
                    
                    
                    $
                    3,351
                    
                    
                    $
                    —
                    
                    
                    $
                    3,351






(1)
            The
      total fair value of the interest rate swap is classified as a current
      liability as of February 28, 2009 and matures in January
      2010.  We value this instrument using the “Income Approach”
      valuation technique. This method uses valuation techniques to convert
      future amounts to a single present value amount. The measurement is based
      on the value indicated by current market expectations about those future
      amounts.





SFAS 157 requires separate disclosure
of assets and liabilities measured at fair value on a recurring basis, as
documented above, from those measured at fair value on a nonrecurring
basis.  As of February 28, 2009, no assets or liabilities are measured
at fair value on a nonrecurring basis.





At
February 28, 2009 and November 30, 2008, the carrying value of the 7.0%
Subordinated Notes approximated fair value based on market prices and market
volume for same or similar issues.  At February 28, 2009 and November
30, 2008, the fair value of the 2.0% Convertible Notes was determined to be
$103,676 and $153,965, respectively, based upon consideration of our closing
stock price of $63.43 and $72.57, respectively, and determination of conversion
value as defined in the indenture under which the 2.0% Convertible Notes were
issued.  At February 28, 2009 and November 30, 2008, the fair value of
the 1.625% Convertible Notes was determined to be $86,656 and $99,143,
respectively, based upon consideration of our closing stock price and
determination of conversion value as defined in the indenture under which the
1.625% Convertible Notes were issued.







8.
            ADVERTISING
      EXPENSES





We incur
significant expenditures on television, radio and print advertising to support
our nationally branded over-the-counter (“OTC”) health care products, toiletries
and dietary supplements.  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 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.







9.
            SHIPPING AND
      HANDLING





Shipping
and handling costs of $3,780 and $3,997 are included in selling, general and
administrative expenses for the three months ended February 28, 2009 and
February 29, 2008, respectively.







10.
            PATENTS, 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 $613,328 as of February 28, 2009 and November 30, 2008.  The gross
carrying amount of intangible assets subject to amortization at February 28,
2009 and November 30, 2008, which consist primarily of non-compete agreements
and distribution rights, was $7,028.  The related accumulated
amortization of intangible assets at February 28, 2009 and November 30, 2008 was
$3,928 and $3,687, respectively.  Amortization of our intangible
assets subject to amortization under the provisions of SFAS 142 for the three
months ended February 28, 2009 and February 29, 2008 was $241 and $205,
respectively.





14


Estimated
annual amortization expense for these assets for the next five successive fiscal
years and those thereafter as of February 28, 2009 are as follows:





2009
                
                $
                7042010
                
                
                9252011
                
                
                9252012
                
                
                2082013
                
                
                75Thereafter
                
                
                263$
                3,100






11.
            INVENTORIES





Inventories
consisted of the following as of February 28, 2009 and November 30,
2008:





2009
                
                
                2008Raw
      materials and work in process
                
                $
                18,437
                
                
                $
                16,753Finished
      goods
                
                
                26,736
                
                
                
                24,180Total
      inventories
                
                $
                45,173
                
                
                $
                40,933






12.
            ACCRUED
      LIABILITIES





Accrued
liabilities consisted of the following as of February 28, 2009 and November 30,
2008:





2009
                
                
                2008Interest
                
                $
                5,314
                
                
                $
                3,216Salaries,
      wages and commissions
                
                
                2,391
                
                
                
                5,333Product
      advertising and promotion
                
                
                2,909
                
                
                
                2,611Litigation
      settlement and legal fees
                
                
                1,214
                
                
                
                799Income
      taxes payable
                
                
                11,183
                
                
                
                4,636Interest
      rate swap
                
                
                3,351
                
                
                
                2,602Other
                
                
                414
                
                
                
                2,096Total
      accrued liabilities
                
                $
                26,776
                
                
                $
                21,293






13.
            ACCUMULATED OTHER
      COMPREHENSIVE INCOME





Accumulated
other comprehensive income consisted of the following components for the three
months ended February 28, 2009 and February 29, 2008, respectively:





2009
                
                
                2008Net
      income
                
                $
                19,566
                
                
                $
                14,873Other
      – interest rate hedge adjustment, net of taxes of $17 and $1,013,
      respectively
                
                
                28
                
                
                
                (1,573
                )Other
      – foreign currency translation adjustment
                
                
                (114
                )
                
                
                186Total
                
                $
                19,480
                
                
                $
                13,486






14.
            STOCK
      REPURCHASE





On April
30, 2008, our Board of Directors increased the authorization to a total of
$100,000 of our common stock under the terms of our existing stock repurchase
program.  In the three months ended February 28, 2009, we did not
repurchase any of our common stock.  Subsequent to February 28, 2009
and through April 1, 2009, we repurchased 51 shares of our common stock for
$2,833 at an average price per share of $56.10.  In the three months
ended February 29, 2008, we repurchased 4 shares of our common stock for $240 at
an average price per share of $64.93. The repurchased shares were retired and
returned to unissued.  As of April 1, 2009, the current amount
available under the authorization from the Board of Directors was
$71,080.


15


15.
            POSTRETIREMENT BENEFIT
      PLANS





DEFINED BENEFIT PENSION
PLAN





We have a
noncontributory defined benefit pension plan (the “Pension Plan”), which covers
substantially all employees as of December 31, 2000.  The Pension Plan
provides benefits based upon years of service and employee compensation to
employees who had completed one year of service prior to December 31,
2000.  On December 31, 2000, benefits and participation in the Pension
Plan were frozen.  Contributions to the Pension Plan are calculated by
an independent actuary and have been sufficient to provide benefits to
participants and meet the funding requirements of the Employee Retirement Income
Security Act of 1974.  Plan assets as of February 28, 2009 and
November 30, 2008 were invested primarily in United States government and agency
securities and corporate debt and equity securities.





Net
periodic pension cost (benefit) for the three months ended February 28, 2009 and
February 29, 2008 included the following components:





2009
                  
                  
                  2008Interest
      cost
                  
                  $
                  146
                  
                  
                  $
                  152Amortization
      of loss
                  
                  
                  46
                  
                  
                  
                  —Expected
      return on plan assets
                  
                  
                  (170
                  )
                  
                  
                  (234
                  )Net
      periodic pension cost (benefit)
                  
                  $
                  22
                  
                  
                  $
                  (82
                  )





No
employer contributions were made for the three months ended February 28, 2009
and February 29, 2008, and no employer contributions are expected to be made for
the Pension Plan in fiscal 2009.





DEFINED
CONTRIBUTION PLAN





We
sponsor a defined contribution plan that covers substantially all
employees.  Eligible employees are allowed to contribute their
eligible compensation up to the applicable annual elective deferral and salary
reduction limits as set fourth by the IRS.  We make matching
contributions of 25% on the first 6% of contributed compensation.  The
cost of the matching contribution totaled $90 and $88 for the three months ended
February 28, 2009 and February 29, 2008, respectively.  In addition to
matching contributions, safe harbor contributions equaling 3% of eligible annual
compensation are made on behalf of eligible participants.  Safe harbor
contributions totaled $283 and $288 for the three months ended February 28, 2009
and February 29, 2008, respectively.  Total matching and safe harbor
contributions for fiscal 2009 are expected to approximate amounts funded in
fiscal 2008.  Total matching and safe harbor contributions in fiscal
2008 were $1,172.





POSTRETIREMENT
HEALTH CARE BENEFITS PLAN





We
maintain a postretirement health care benefits plan (the “Retiree Health Plan”)
for certain eligible employees over the age of 65.  On May 31, 2006,
Retiree Health Plan eligibility was restricted to current retirees and those
active employees that were retirement eligible as of that date (age 55 and 10
years of service or age 65). Contributions to the Retiree Health Plan are
limited to approximately $2 per participant per year and are paid monthly on a
fully insured basis.  Participants are required to pay any insurance
premium amount in excess of the employer contribution.   Employer
contributions expected for fiscal 2009 are approximately $95.





Net
periodic postretirement health care benefits cost (benefit) for the three months
ended February 28, 2009 and February 29, 2008, included the following
components:





2009
                
                
                2008Service
      cost
                
                $
                2
                
                
                $
                5Interest
      cost
                
                
                14
                
                
                
                14Recognized
      net actuarial gain
                
                
                (34
                )
                
                
                (24
                )Net
      periodic postretirement benefits
                
                $
                (18
                )
                
                $
                (5
                )








16


16.
            INCOME
      TAXES





We
account for income taxes using the asset and liability approach as prescribed by
SFAS 109, FIN 48 and other applicable FSP’s and FASB
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 tax expense in our
consolidated financial statements based on an estimated annual effective income
tax rate.  Our tax rate for the three months ended February 28, 2009
was 36.0%, as compared to 35.6% for the three months ended February 29,
2008.  As of February 28, 2009, there were no significant changes to
our unrecognized tax benefit as reported in our Form 10-K for the fiscal year
ended November 30, 2008.








17.
            PRODUCT SEGMENT
      INFORMATION





Net sales
within our single healthcare business segment for the three months ended
February 28, 2009 and February 29, 2008 are as follows:


2009
                
                
                2008Medicated
      skin care
                
                $
                41,457
                
                
                $
                37,653Topical
      pain care
                
                
                22,043
                
                
                
                25,315Oral
      care
                
                
                18,285
                
                
                
                15,772Internal
      OTC
                
                
                11,364
                
                
                
                11,210Medicated
      dandruff shampoos
                
                
                9,363
                
                
                
                10,579Dietary
      supplements
                
                
                4,272
                
                
                
                5,374Other
      OTC and toiletry products
                
                
                4,124
                
                
                
                5,412Total
      domestic net sales
                
                
                110,908
                
                
                
                111,315International
      revenues
                
                
                5,184
                
                
                
                9,458Total
      revenues
                
                $
                116,092
                
                
                $
                120,773






18.
            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 DexatrimPPA
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.  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.





In
accordance with the terms of the class action settlement, approximately $70,885
was initially funded into a settlement trust.  We have resolved all
claims in the settlement and paid all trust expenses.  On June 14,
2006, we filed a motion to dissolve the settlement trust.  The court
granted this motion on July 14, 2006.  We dissolved the settlement
trust pursuant to a letter to the trustee dated September 24, 2008.





We were
also named as a defendant in approximately 206 lawsuits relating to Dexatrimcontaining PPA which
involved alleged injuries by Dexatrim products containing
PPA manufactured and sold prior to our acquisition of Dexatrimon 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






17


District
of New York.  We filed a claim for indemnification 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.  In accordance with the DELACO
bankruptcy plan, a settlement trust established under the plan paid us $8,750 on
March 17, 2006, which was included in our consolidated statements of income, net
of legal expenses, as litigation settlement for 2006.  The payment to
us by the DELACO settlement trust of $8,750 has conclusively compromised and
settled our indemnity claim filed in the DELACO bankruptcy. 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.





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.  We discontinued the manufacturing and shipment of Dexatrim containing ephedrine
in September 2002. During April to June 2008, we received notification from an
attorney of 26 individual claims alleging the development of pulmonary arterial
hypertension as a result of ingesting Dexatrim containing ephedrine
and/or PPA in 1998 through 2003.  In September 2008, we resolved all
of these claims for $13,250, of which approximately $2,545 was funded from the
proceeds of theDexatrim settlement trust.  We are not currently aware of any
additional product liability claims relating to Dexatrim.





We were
named as a defendant in a putative class action lawsuit filed by California
consumer Robert O. Wilkinson 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 plaintiff has voluntarily dismissed his claim for class
certification but still seeks injunctive relief and attorney fees.  A
different California consumer using the same counsel filed a lawsuit in the
Eastern District of California seeking injunctive relief, actual and punitive
damages and class certification based on the same set of facts that Mr.Wilkinson
alleged.  We were served with this lawsuit on December 18,
2008.  We are vigorously defending both Garlique cases.





On
February 8, 2008, we initiated a voluntary nationwide recall of our Icy Hot Heat Therapy
products, including consumer “samples” that were included on a limited
promotional basis in cartons of our 3 oz. Aspercreme product, and are
no longer marketing these products.  We conducted the recall to the
consumer level.  We recalled these products because we received some
consumer reports of first, second and third degree burns, as well as skin
irritation resulting from consumer use or possible misuse of the
products.  As of April 1, 2009, there were approximately 170 consumers
with pending claims against us and three products liability lawsuits pending
against us alleging burns and skin irritation from the use of the Icy Hot Heat Therapy
products.  We may receive additional claims and/or lawsuits in the
future alleging burns and/or skin irritation from use of our Heat Therapy
products.  The outcome of any such potential litigation cannot be
predicted.





On July
25, 2008, LecTec Corporation filed a complaint against us in the U.S. District
Court for the Eastern District of Texas, which alleges that our Icy Hot and Capzasin patch products
infringe LecTec’s patents.  In the same lawsuit, LecTec has asserted
patent infringement claims against Endo Pharmaceuticals, Inc.; Johnson &
Johnson Consumer Products Company, Inc.; The Mentholatum Company, Inc.; and
Prince of Peace Enterprises, Inc.  LecTec seeks injunctive relief, and
compensatory and enhanced damages for the alleged infringement, and attorneys’
fees and expenses.  We filed an answer and counterclaim on September
30, 2008 and the trial date is currently scheduled for January 4,
2011.  We are vigorously defending this lawsuit.





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 that are not reasonably estimable or would not have a material adverse
effect on our financial position, results of operations or cash flows if
disposed of unfavorably.





We
maintain insurance coverage for product liability claims relating to our
products under claims-made policies which are subject to annual
renewal.  For the current annual policy period beginning September 1,
2008, we maintain product liability insurance coverage in the amount of $30,000
through our captive insurance subsidiary, of which approximately $2,638 has been
funded as of April 1, 2009.  We also have $25,000 of excess coverage
through a third party reinsurance policy.








REGULATORY





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




18


OTC drug
products and should be included in the FDA's yet-to-be finalized monograph for
external analgesics. 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 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 other ingredients included in the FDA
monograph.  We believe that the monograph is unlikely to become final
and take effect before mid-2009.





Certain
of our topical analgesic products are currently marketed under an FDA tentative
final monograph. In 2003, the FDA proposed that the final monograph exclude
external analgesic products in patch, plaster or poultice form, unless the FDA
received 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 the inclusion of patch products in the final monograph. We
also participated in an industry-wide effort coordinated by Consumer Healthcare
Products Association (“CHPA”) requesting that patches be included in the final
monograph and seeking to establish with the FDA a protocol of additional
research that would allow the patches to be marketed under the final monograph
even if the final monograph does not explicitly allow them. The CHPA submission
to the FDA was made on October 15, 2003.  The FDA has not responded to
our or CHPA’s submission.  The most recent Unified Agenda of Federal
Regulatory and Deregulatory Actions published in the Federal Register provided a
target final monograph publication date of May 2009. If the final monograph
excludes products in patch, plaster or poultice form, we would have to file and
obtain approval of a new drug application (“NDA”) in order to continue to market
the Icy Hot, Capzasin and Aspercreme patch products,
the Icy Hot Sleeve
and/or similar delivery systems under our other topical analgesic brands. In
such case, we would have to cease marketing the existing products likely within
one year from the effective date of the final monograph, or pending FDA review
and approval of an NDA. The preparation of an NDA would likely take us six to 24
months and would be expensive. It typically takes the FDA at least 12 months to
rule on an NDA once it is submitted and there is no assurance that an NDA would
be approved. Sales of our Icy
Hot, Capzasin,
andAspercreme patches
and Icy Hot Sleeve
products represented approximately 8% of our consolidated total revenues in
fiscal 2008.





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 thePamprin 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 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.





We are
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 found in Pamprin and Prēmsyn
PMS.  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.





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.  In September 2007, the FDA
published a new proposed rule amending the previously stayed final monograph on
sunscreens to include new formulation options, labeling requirements and testing
standards for measuring UVA protection and revised testing for UVB
protection.  When implemented, the final rule will require all
sunscreen manufacturers to conduct new testing and revise the labeling of their
products within eighteen months after issuance of the final rule.  We
will be required to take such actions for our Bullfrog product
line.





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.





19


On
February 8, 2008, we initiated a voluntary nationwide recall of all lots of the
medical device, Icy Hot
Heat Therapy Air Activated Heat patch (Back and Arm, Neck and Leg), including
consumer “samples” that were included on a limited promotional basis in cartons
of our 3 oz. Aspercreme
product.  The recall was due to adverse events reports which
associated the use of the products with temporary or medically reversible health
consequences, skin irritation and burns.  The recall was voluntary and
conducted with the full knowledge of the FDA. On February 5-8, 2008, the FDA
conducted a medical device inspection of our manufacturing plant, manufacturing
records, and consumer complaint handling system related to the manufacture and
distribution of the Heat Therapy device.  On February 8, 2008, the FDA
issued a Form FDA-483 noting three inspectional observations pertaining to
medical device reporting, device correction reports, and corrective and
preventive action procedures.  We responded to the Form FDA-483 on
February 14 and February 20, 2008 committing to correct the cited observations.
On June 10, 2008, we received a warning letter from the FDA asserting the Heat
Therapy devices are misbranded and adulterated based on the inspectional
observations and requesting additional information to correct the
observations.  On June 24, 2008, we responded to the warning letter
addressing the noted violations and providing the requested
documentation.  On September 22, 2008, the FDA responded stating that
our response to the warning letter was thorough and appeared to adequately
address the FDA’s concerns.  We are no longer marketing theIcy Hot Heat Therapy
products.







19.
            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 February 28, 2009 arose in conjunction with our Credit Facility
and our issuance of the 7.0% Subordinated Notes (See Note 6).  The
maximum amount of future payments the guarantors would be required to make under
the guarantees as of February 28, 2009 is $214,250.
































20


Note 19


CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
BALANCE SHEETS





FEBRUARY
      28, 2009


(Unaudited
      and in thousands)


CHATTEM
              
              
              GUARANTOR
       SUBSIDIARY COMPANIES
              
              
              NON-GUARANTOR
       SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              19,694
              
              
              $
              134
              
              
              $
              10,521
              
              
              $
              —
              
              
              $
              30,349Accounts
      receivable, less allowances of $10,174
              
              
              55,776
              
              
              
              18,319
              
              
              
              5,192
              
              
              
              (18,652
              )
              
              
              60,635Interest
      receivable
              
              
              118
              
              
              
              664
              
              
              
              (101
              )
              
              
              (681
              )
              
              
              —Inventories,
      net
              
              
              39,236
              
              
              
              2,145
              
              
              
              3,792
              
              
              
              —
              
              
              
              45,173Deferred
      income taxes
              
              
              3,854
              
              
              
              —
              
              
              
              35
              
              
              
              —
              
              
              
              3,889Prepaid
      expenses and other current assets
              
              
              6,124
              
              
              
              —
              
              
              
              275
              
              
              
              (1,270
              )
              
              
              5,129Total
      current assets
              
              
              124,802
              
              
              
              21,262
              
              
              
              19,714
              
              
              
              (20,603
              )
              
              
              145,175PROPERTY,
      PLANT AND EQUIPMENT, NET
              
              
              30,608
              
              
              
              775
              
              
              
              633
              
              
              
              —
              
              
              
              32,016OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
              
              
              3,100
              
              
              
              674,057
              
              
              
              1,561
              
              
              
              (62,290
              )
              
              
              616,428Debt
      issuance costs, net
              
              
              10,975
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              10,975Investment
      in subsidiaries
              
              
              595,449
              
              
              
              64,682
              
              
              
              97,690
              
              
              
              (757,821
              )
              
              
              —Note
      receivable
              
              
              —
              
              
              
              34,694
              
              
              
              —
              
              
              
              (34,694
              )
              
              
              —Other
              
              
              2,706
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,706Total
      other noncurrent assets
              
              
              612,230
              
              
              
              773,433
              
              
              
              99,251
              
              
              
              (854,805
              )
              
              
              630,109TOTAL
      ASSETS
              
              $
              767,640
              
              
              $
              795,470
              
              
              $
              119,598
              
              
              $
              (875,408
              )
              
              $
              807,300LIABILITIES AND SHAREHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Current
      maturities of long-term debt
              
              $
              3,000
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              3,000Accounts
      payable
              
              
              21,970
              
              
              
              —
              
              
              
              2,102
              
              
              
              (166
              )
              
              
              23,906Bank
      overdrafts
              
              
              158
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              158Accrued
      liabilities
              
              
              39,283
              
              
              
              3,265
              
              
              
              4,664
              
              
              
              (20,436
              )
              
              
              26,776Total
      current liabilities
              
              
              64,411
              
              
              
              3,265
              
              
              
              6,766
              
              
              
              (20,602
              )
              
              
              53,840LONG-TERM
      DEBT, less current maturities
              
              
              408,966
              
              
              
              (3,216
              )
              
              
              36,494
              
              
              
              (34,694
              )
              
              
              407,550DEFERRED
      INCOME TAXES
              
              
              (21,842
              )
              
              
              64,700
              
              
              
              (1,243
              )
              
              
              —
              
              
              
              41,615OTHER
      NONCURRENT LIABILITIES
              
              
              1,309
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,309INTERCOMPANY
      ACCOUNTS
              
              
              11,810
              
              
              
              (19,156
              )
              
              
              7,346
              
              
              
              —
              
              
              
              —SHAREHOLDERS’
      EQUITY:Preferred
      shares, without par value, authorized 1,000, none
    issued
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Common
      shares, without par value, authorized 100,000, issued and outstanding
      19,484
              
              
              56,574
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              56,574Share
      capital of subsidiaries
              
              
              —
              
              
              
              641,659
              
              
              
              78,999
              
              
              
              (720,658
              )
              
              
              —Dividends
              
              
              —
              
              
              
              (16,126
              )
              
              
              —
              
              
              
              16,126
              
              
              
              —Retained
      earnings
              
              
              250,796
              
              
              
              122,650
              
              
              
              (6,458
              )
              
              
              (116,192
              )
              
              
              250,796307,370
              
              
              
              748,183
              
              
              
              72,541
              
              
              
              (820,724
              )
              
              
              307,370Accumulated
      other comprehensive income (loss), net of tax:Interest
      rate hedge adjustment
              
              
              (1,759
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,759
              )Foreign
      currency translation adjustment
              
              
              (1,082
              )
              
              
              1,694
              
              
              
              (2,306
              )
              
              
              612
              
              
              
              (1,082
              )Unrealized
      actuarial gains and losses
              
              
              (1,543
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,543
              )Total
      shareholders’ equity
              
              
              302,986
              
              
              
              749,877
              
              
              
              70,235
              
              
              
              (820,112
              )
              
              
              302,986TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
              
              $
              767,640
              
              
              $
              795,470
              
              
              $
              119,598
              
              
              $
              (875,408
              )
              
              $
              807,300








21


Note 19


CHATTEM,
      INC. AND SUBSIDIARIES


CONSOLIDATING
      BALANCE SHEETS




NOVEMBER
      30, 2008


(In
      thousands)


CHATTEM
              
              
              GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              22,055
              
              
              $
              1,570
              
              
              $
              8,685
              
              
              $
              —
              
              
              $
              32,310Accounts
      receivable, less allowances of $9,718
              
              
              44,175
              
              
              
              16,226
              
              
              
              5,242
              
              
              
              (16,226
              )
              
              
              49,417Interest
      receivable
              
              
              108
              
              
              
              641
              
              
              
              (91
              )
              
              
              (658
              )
              
              
              —Inventories,
      net
              
              
              35,795
              
              
              
              1,811
              
              
              
              3,327
              
              
              
              —
              
              
              
              40,933Deferred
      income taxes
              
              
              3,932
              
              
              
              —
              
              
              
              36
              
              
              
              —
              
              
              
              3,968Prepaid
      expenses and other current assets
              
              
              4,024
              
              
              
              —
              
              
              
              332
              
              
              
              (1,905
              )
              
              
              2,451Total
      current assets
              
              
              110,089
              
              
              
              20,248
              
              
              
              17,531
              
              
              
              (18,789
              )
              
              
              129,079PROPERTY,
      PLANT AND EQUIPMENT, NET
              
              
              30,792
              
              
              
              775
              
              
              
              676
              
              
              
              —
              
              
              
              32,243OTHER
      NONCURRENT ASSETS:Patents,
      trademarks and other purchased product rights, net
              
              
              3,341
              
              
              
              674,057
              
              
              
              1,561
              
              
              
              (62,289
              )
              
              
              616,670Debt
      issuance costs, net
              
              
              12,253
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              12,253Investment
      in subsidiaries
              
              
              597,821
              
              
              
              64,682
              
              
              
              97,690
              
              
              
              (760,193
              )
              
              
              —Note
      receivable
              
              
              —
              
              
              
              34,694
              
              
              
              —
              
              
              
              (34,694
              )
              
              
              —Other
              
              
              2,727
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,727Total
      other noncurrent assets
              
              
              616,142
              
              
              
              773,433
              
              
              
              99,251
              
              
              
              (857,176
              )
              
              
              631,650TOTAL
      ASSETS
              
              $
              757,023
              
              
              $
              794,456
              
              
              $
              117,458
              
              
              $
              (875,965
              )
              
              $
              792,972LIABILITIES AND SHAREHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Current
      maturities of long-term debt
              
              $
              3,000
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              3,000Accounts
      payable
              
              
              16,463
              
              
              
              —
              
              
              
              1,736
              
              
              
              (83
              )
              
              
              18,116Bank
      overdrafts
              
              
              1,184
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,184Accrued
      liabilities
              
              
              34,594
              
              
              
              699
              
              
              
              4,708
              
              
              
              (18,708
              )
              
              
              21,293Total
      current liabilities
              
              
              55,241
              
              
              
              699
              
              
              
              6,444
              
              
              
              (18,791
              )
              
              
              43,593LONG-TERM
      DEBT, less current maturities
              
              
              455,900
              
              
              
              (1,200
              )
              
              
              36,494
              
              
              
              (34,694
              )
              
              
              456,500DEFERRED
      INCOME TAXES
              
              
              (24,111
              )
              
              
              60,766
              
              
              
              (1,243
              )
              
              
              —
              
              
              
              35,412OTHER
      NONCURRENT LIABILITIES
              
              
              1,609
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,609INTERCOMPANY
      ACCOUNTS
              
              
              12,526
              
              
              
              (18,962
              )
              
              
              6,436
              
              
              
              —
              
              
              
              —SHAREHOLDERS’
      EQUITYPreferred
      shares, without par value, authorized 1,000, none issued
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Common
      shares, without par value, authorized 100,000, issued and outstanding
      18,978
              
              
              28,926
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              28,926Share
      capital of subsidiaries
              
              
              —
              
              
              
              641,659
              
              
              
              77,935
              
              
              
              (719,594
              )
              
              
              —Dividends
              
              
              —
              
              
              
              (69,628
              )
              
              
              —
              
              
              
              69,628
              
              
              
              —Retained
      earnings
              
              
              231,230
              
              
              
              179,428
              
              
              
              (6,416
              )
              
              
              (173,012
              )
              
              
              231,230260,156
              
              
              
              751,459
              
              
              
              71,519
              
              
              
              (822,978
              )
              
              
              260,156Accumulated
      other comprehensive income (loss), net of tax:Interest
      rate hedge adjustment
              
              
              (1,787
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,787
              )Foreign
      currency translation adjustment
              
              
              (968
              )
              
              
              1,694
              
              
              
              (2,192
              )
              
              
              498
              
              
              
              (968
              )Unrealized
      actuarial gains and losses
              
              
              (1,543
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,543
              )Total
      shareholders’ equity
              
              
              255,858
              
              
              
              753,153
              
              
              
              69,327
              
              
              
              (822,480
              )
              
              
              255,858TOTAL
      LIABILITIES AND  SHAREHOLDERS’ EQUITY
              
              $
              757,023
              
              
              $
              794,456
              
              
              $
              117,458
              
              
              $
              (875,965
              )
              
              $
              792,972




22


Note
19


CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME





FOR THE
THREE MONTHS ENDED FEBRUARY 28, 2009


(Unaudited
and in thousands)


CHATTEM
              
              
              GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDTOTAL
      REVENUES
              
              $
              108,012
              
              
              $
              22,639
              
              
              $
              4,672
              
              
              $
              (19,231
              )
              
              $
              116,092COSTS
      AND EXPENSES:Cost
      of sales
              
              
              32,780
              
              
              
              1,170
              
              
              
              2,184
              
              
              
              (877
              )
              
              
              35,257Advertising
      and promotion
              
              
              26,365
              
              
              
              1,157
              
              
              
              1,067
              
              
              
              —
              
              
              
              28,589Selling,
      general and administrative
              
              
              14,374
              
              
              
              230
              
              
              
              822
              
              
              
              —
              
              
              
              15,426Product
      recall expenses
              
              
              (479
              )
              
              
              —
              
              
              
              479
              
              
              
              —
              
              
              
              —Equity
      in subsidiary income
              
              
              (12,160
              )
              
              
              —
              
              
              
              —
              
              
              
              12,160
              
              
              
              —Total
      costs and expenses
              
              
              60,880
              
              
              
              2,557
              
              
              
              4,552
              
              
              
              11,283
              
              
              
              79,272INCOME
      FROM OPERATIONS
              
              
              47,132
              
              
              
              20,082
              
              
              
              120
              
              
              
              (30,514
              )
              
              
              36,820OTHER
      INCOME (EXPENSE):Interest
      expense
              
              
              (5,677
              )
              
              
              —
              
              
              
              (670
              )
              
              
              683
              
              
              
              (5,664
              )Investment
      and other income, net
              
              
              69
              
              
              
              684
              
              
              
              686
              
              
              
              (1,328
              )
              
              
              111Loss
      on extinguishment of debt
              
              
              (696
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (696
              )Royalties
              
              
              (17,657
              )
              
              
              (685
              )
              
              
              (9
              )
              
              
              18,351
              
              
              
              —Corporate
      allocations
              
              
              447
              
              
              
              (407
              )
              
              
              (40
              )
              
              
              —
              
              
              
              —Total
      other income (expense)
              
              
              (23,514
              )
              
              
              (408
              )
              
              
              (33
              )
              
              
              17,706
              
              
              
              (6,249
              )INCOME
      BEFORE INCOME TAXES
              
              
              23,618
              
              
              
              19,674
              
              
              
              87
              
              
              
              (12,808
              )
              
              
              30,571PROVISION
      FOR INCOME TAXES
              
              
              4,052
              
              
              
              6,824
              
              
              
              129
              
              
              
              —
              
              
              
              11,005NET
      INCOME (LOSS)
              
              $
              19,566
              
              
              $
              12,850
              
              
              $
              (42
              )
              
              $
              (12,808
              )
              
              $
              19,566












23


Note
19


CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF INCOME





FOR THE
THREE MONTHS ENDED FEBRUARY 29, 2008


(Unaudited
and in thousands)


CHATTEM
              
              
              GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDTOTAL
      REVENUES
              
              $
              110,464
              
              
              $
              23,044
              
              
              $
              6,071
              
              
              $
              (18,806
              )
              
              $
              120,773COSTS
      AND EXPENSES:Cost
      of sales
              
              
              31,876
              
              
              
              1,431
              
              
              
              2,502
              
              
              
              (1,076
              )
              
              
              34,733Advertising
      and promotion
              
              
              30,760
              
              
              
              1,822
              
              
              
              1,914
              
              
              
              —
              
              
              
              34,496Selling,
      general and administrative
              
              
              14,741
              
              
              
              110
              
              
              
              615
              
              
              
              —
              
              
              
              15,466Product
      recall expenses
              
              
              5,555
              
              
              
              —
              
              
              
              488
              
              
              
              —
              
              
              
              6,043Equity
      in subsidiary income
              
              
              (11,994
              )
              
              
              —
              
              
              
              —
              
              
              
              11,994
              
              
              
              —Total
      costs and expenses
              
              
              70,938
              
              
              
              3,363
              
              
              
              5,519
              
              
              
              10,918
              
              
              
              90,738INCOME
      FROM OPERATIONS
              
              
              39,526
              
              
              
              19,681
              
              
              
              552
              
              
              
              (29,724
              )
              
              
              30,035OTHER
      INCOME (EXPENSE):Interest
      expense
              
              
              (6,529
              )
              
              
              —
              
              
              
              (642
              )
              
              
              619
              
              
              
              (6,552
              )Investment
      and other income, net
              
              
              12
              
              
              
              646
              
              
              
              723
              
              
              
              (1,244
              )
              
              
              137Loss
      on early extinguishment of debt
              
              
              (526
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (526
              )Royalties
              
              
              (16,873
              )
              
              
              (858
              )
              
              
              —
              
              
              
              17,731
              
              
              
              —Corporate
      allocations
              
              
              509
              
              
              
              (469
              )
              
              
              (40
              )
              
              
              —
              
              
              
              —Total
      other income (expense)
              
              
              (23,407
              )
              
              
              (681
              )
              
              
              41
              
              
              
              17,106
              
              
              
              (6,941
              )INCOME
      BEFORE INCOME TAXES
              
              
              16,119
              
              
              
              19,000
              
              
              
              593
              
              
              
              (12,618
              )
              
              
              23,094PROVISION
      FOR INCOME TAXES
              
              
              1,246
              
              
              
              6,764
              
              
              
              211
              
              
              
              —
              
              
              
              8,221NET
      INCOME (LOSS)
              
              $
              14,873
              
              
              $
              12,236
              
              
              $
              382
              
              
              $
              (12,618
              )
              
              $
              14,873















24





Note 19


CHATTEM,
INC. AND SUBSIDIARIES


CONSOLIDATING
STATEMENTS OF CASH FLOWS





FOR THE
THREE MONTHS ENDED FEBRUARY 28, 2009


(Unaudited
and in thousands)


CHATTEM
              
              
              GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDOPERATING
      ACTIVITIES:Net
      income (loss)
              
              $
              19,566
              
              
              $
              12,850
              
              
              $
              (42
              )
              
              $
              (12,808
              )
              
              $
              19,566Adjustments
      to reconcile net income (loss) to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
              
              
              1,857
              
              
              
              —
              
              
              
              37
              
              
              
              —
              
              
              
              1,894Deferred
      income taxes
              
              
              230
              
              
              
              3,933
              
              
              
              1
              
              
              
              —
              
              
              
              4,164Stock-based
      compensation expense
              
              
              1,479
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,479Loss
      on early extinguishment of debt
              
              
              696
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              696Tax
      benefit realized from stock options exercised
              
              
              (135
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (135
              )Other,
      net
              
              
              108
              
              
              
              —
              
              
              
              14
              
              
              
              —
              
              
              
              122Equity
      in subsidiary income
              
              
              (12,808
              )
              
              
              —
              
              
              
              —
              
              
              
              12,808
              
              
              
              —Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              (11,600
              )
              
              
              (2,093
              )
              
              
              50
              
              
              
              2,425
              
              
              
              (11,218
              )Interest
      Receivable
              
              
              (10
              )
              
              
              (23
              )
              
              
              10
              
              
              
              23
              
              
              
              —Inventories
              
              
              (3,284
              )
              
              
              (335
              )
              
              
              (463
              )
              
              
              —
              
              
              
              (4,082
              )Prepaid
      expenses and other current assets
              
              
              (2,099
              )
              
              
              —
              
              
              
              56
              
              
              
              (635
              )
              
              
              (2,678
              )Accounts
      payable and accrued liabilities
              
              
              8,859
              
              
              
              2,569
              
              
              
              320
              
              
              
              (1,813
              )
              
              
              9,935Net
      cash provided by (used in) operating activities
              
              
              2,859
              
              
              
              16,901
              
              
              
              (17
              )
              
              
              —
              
              
              
              19,743INVESTING
      ACTIVITIES:Purchases
      of property, plant and equipment
              
              
              (753
              )
              
              
              —
              
              
              
              (7
              )
              
              
              —
              
              
              
              (760
              )Increase
      in other assets, net
              
              
              (251
              )
              
              
              —
              
              
              
              (111
              )
              
              
              —
              
              
              
              (362
              )Net
      cash used in investing activities
              
              
              (1,004
              )
              
              
              —
              
              
              
              (118
              )
              
              
              —
              
              
              
              (1,122
              )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
              
              
              (750
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (750
              )Intercompany
      debt proceeds (payments)
              
              
              2,017
              
              
              
              (2,017
              )
              
              
              —
              
              
              
              —
              
              
              
              —Proceeds
      from borrowings under revolving credit facility
              
              
              1,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,000Repayments
      of revolving credit facility
              
              
              (20,500
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (20,500
              )Bank
      overdrafts
              
              
              (1,026
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,026
              )Proceeds
      from exercise of stock options
              
              
              573
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              573Tax
      benefit realized from stock options exercised
              
              
              135
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              135Changes
      in intercompany accounts
              
              
              (1,146
              )
              
              
              (194
              )
              
              
              1,340
              
              
              
              —
              
              
              
              —Dividends
      paid
              
              
              15,481
              
              
              
              (16,126
              )
              
              
              645
              
              
              
              —
              
              
              
              —Net
      cash (used in) provided by financing activities
              
              
              (4,216
              )
              
              
              (18,337
              )
              
              
              1,985
              
              
              
              —
              
              
              
              (20,568
              )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              —
              
              
              
              (14
              )
              
              
              —
              
              
              
              (14
              )CASH
      AND CASH EQUIVALENTS:(Increase)
      decrease for the period
              
              
              (2,361
              )
              
              
              (1,436
              )
              
              
              1,836
              
              
              
              —
              
              
              
              (1,961
              )At
      beginning of period
              
              
              22,055
              
              
              
              1,570
              
              
              
              8,685
              
              
              
              —
              
              
              
              32,310At
      end of period
              
              $
              19,694
              
              
              $
              134
              
              
              $
              10,521
              
              
              $
              —
              
              
              $
              30,349











25


Note 19


CHATTEM,
      INC. AND SUBSIDIARIES


CONSOLIDATING
      STATEMENTS OF CASH FLOWS





FOR
      THE THREE MONTHS ENDED FEBRUARY 29,
2008


(Unaudited
      and in thousands)


CHATTEM
              
              
              GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              NON-GUARANTOR
                SUBSIDIARY
                COMPANIES
              
              
              ELIMINATIONS
              
              
              CONSOLIDATEDOPERATING
      ACTIVITIES:Net
      income (loss)
              
              $
              14,873
              
              
              $
              12,236
              
              
              $
              382
              
              
              $
              (12,618
              )
              
              $
              14,873Adjustments
      to reconcile net income (loss) to net cashprovided
      by (used in) operating activities:Depreciation
      and amortization
              
              
              2,090
              
              
              
              —
              
              
              
              29
              
              
              
              —
              
              
              
              2,119Deferred
      income taxes
              
              
              500
              
              
              
              3,934
              
              
              
              (1
              )
              
              
              —
              
              
              
              4,433Stock-based
      compensation expense
              
              
              1,339
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,339Loss
      on early extinguishment of debt
              
              
              526
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              526Tax
      benefit realized from stock options exercised
              
              
              (1,812
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,812
              )Other,
      net
              
              
              109
              
              
              
              —
              
              
              
              3
              
              
              
              —
              
              
              
              112Equity
      in subsidiary income
              
              
              (12,618
              )
              
              
              —
              
              
              
              —
              
              
              
              12,618
              
              
              
              —Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              (14,629
              )
              
              
              (1,011
              )
              
              
              248
              
              
              
              1,011
              
              
              
              (14,381
              )Interest
      Receivable
              
              
              10
              
              
              
              (25
              )
              
              
              (10
              )
              
              
              25
              
              
              
              —Inventories
              
              
              302
              
              
              
              631
              
              
              
              (196
              )
              
              
              —
              
              
              
              737Prepaid
      expenses and other current assets
              
              
              (3,752
              )
              
              
              —
              
              
              
              66
              
              
              
              (60
              )
              
              
              (3,746
              )Accounts
      payable and accrued liabilities
              
              
              6,542
              
              
              
              166
              
              
              
              315
              
              
              
              (976
              )
              
              
              6,047Net
      cash provided by (used in) operating activities
              
              
              (6,520
              )
              
              
              15,931
              
              
              
              836
              
              
              
              —
              
              
              
              10,247INVESTING
      ACTIVITIES:Purchases
      of property, plant and equipment
              
              
              (1,258
              )
              
              
              —
              
              
              
              (13
              )
              
              
              —
              
              
              
              (1,271
              )(Increase)
      decrease in other assets, net
              
              
              (1,792
              )
              
              
              —
              
              
              
              136
              
              
              
              —
              
              
              
              (1,656
              )Net
      cash provided by (used in) investing activities
              
              
              (3,050
              )
              
              
              —
              
              
              
              123
              
              
              
              —
              
              
              
              (2,927
              )FINANCING
      ACTIVITIES:Repayment
      of long-term debt
              
              
              (35,750
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (35,750
              )Proceeds
      from borrowings under revolving credit facility
              
              
              69,500
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              69,500Repayments
      of revolving credit facility
              
              
              (43,750
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (43,750
              )Bank
      overdrafts
              
              
              (4,734
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (4,734
              )Repurchase
      of common shares
              
              
              (240
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (240
              )Proceeds
      from exercise of stock options
              
              
              2,057
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,057Tax
      benefit realized from stock options exercised
              
              
              1,812
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,812Changes
      in intercompany accounts
              
              
              259
              
              
              
              679
              
              
              
              (938
              )
              
              
              —
              
              
              
              —Dividends
      paid
              
              
              16,063
              
              
              
              (16,688
              )
              
              
              625
              
              
              
              —
              
              
              
              —Net
      cash (used in) provided by financing activities
              
              
              5,217
              
              
              
              (16,009
              )
              
              
              (313
              )
              
              
              —
              
              
              
              ( 11,105
              )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              —
              
              
              
              (3
              )
              
              
              —
              
              
              
              (3
              )CASH
      AND CASH EQUIVALENTS:Increase
      (decrease) for the period
              
              
              (4,353
              )
              
              
              (78
              )
              
              
              643
              
              
              
              —
              
              
              
              (3,788
              )At
      beginning of period
              
              
              4,685
              
              
              
              590
              
              
              
              10,132
              
              
              
              —
              
              
              
              15,407At
      end of period
              
              $
              332
              
              
              $
              512
              
              
              $
              10,775
              
              
              $
              —
              
              
              $
              11,619








26


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 2008 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 in such categories as medicated skin care, topical pain care, oral
care, internal OTC, medicated dandruff shampoos, dietary supplements and other
OTC and toiletry products. Our portfolio of products includes well-recognized
brands such as:




•
            Gold Bond, Cortizone-10
      and Balmex–
      medicated skin care;





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





•
            ACT and Herpecin-L– oral
      care;





•
            Unisom, Pamprin and Kaopectate– internal
      OTC;





•
            Selsun Blue – medicated
      dandruff shampoos;





•
            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 product 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, our Cortizone-10 anti-itch
ointment, 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
25% of our total revenues in the first quarter of fiscal 2009. 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 acquiring brands,
developing product line extensions and increasing market penetration of our
existing products.





Developments
During the First Quarter of Fiscal 2009





Products





In the
first quarter of fiscal 2009, we introduced the following product line
extensions: ACT Total
Care, Gold Bond
Ultimate Protecting Lotion, Gold Bond Anti-Itch Lotion,
Gold Bond Foot Pain
Cream, Cortizone-10
Cooling Gel, Cortizone-10 Easy Relief
Applicator, Icy Hot
No-Mess Applicator, Icy
Hot Medicated Roll, Capzasin Quick Relief and
Selsun Blue Itchy Dry
Scalp.





2.0%
Convertible Notes





On
December 4, 2008 we issued an aggregate of 487,123 shares of our common stock in
exchange for $28.7 million in aggregate principal amount of our outstanding 2.0%
Convertible Senior Notes due 2013 (“2.0% Convertible Notes”).  Upon
completion of the transaction, the balance of the remaining 2.0% Convertible
Notes was reduced to $96.3 million outstanding.  In connection with
this transaction, we retired a proportional share of the 2.0% Convertible Notes
debt issuance costs and recorded the resulting loss on early extinguishment of
debt of $0.7 million in the first quarter of fiscal 2009.





27


Results
of Operations





The following table sets forth certain
items from our unaudited consolidated statements of income expressed as a
percentage of total revenue for the three months ended February 28, 2009 and
February 29, 2008, respectively:




2009
                
                
                2008TOTAL
      REVENUES
                
                
                100.0
                %
                
                
                100.0
                %COSTS
      AND EXPENSES:Cost
      of sales
                
                
                30.4
                
                
                
                28.8Advertising
      and promotion
                
                
                24.6
                
                
                
                28.6Selling,
      general and administrative
                
                
                13.3
                
                
                
                12.8Product
      recall expenses
                
                
                —
                
                
                
                5.0Total
      costs and expenses
                
                
                68.3
                
                
                
                75.2INCOME
      FROM OPERATIONS
                
                
                31.7
                
                
                
                24.8OTHER
      INCOME (EXPENSE):Interest
      expense
                
                
                (4.9
                )
                
                
                (5.4
                )Investment
      and other income, net
                
                
                0.1
                
                
                
                0.1Loss
      on early extinguishment of debt
                
                
                (0.6
                )
                
                
                (0.4
                )Total
      other income (expense)
                
                
                (5.4
                )
                
                
                (5.7
                )INCOME
      BEFORE INCOME TAXES
                
                
                26.3
                
                
                
                19.1PROVISION
      FOR INCOME TAXES
                
                
                9.4
                
                
                
                6.8NET
      INCOME
                
                
                16.9
                %
                
                
                12.3
                %





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 February 28, 2009 unaudited consolidated
financial statements:





Allowance
for Doubtful Accounts





As of
February 28, 2009, 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 first quarter of fiscal 2009, 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 $0.5
million and $0.4 million as of February 28, 2009 and November 30, 2008,
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 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.





28


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 returned 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, our estimate of product returns of
Icy Hot Pro Therapy was
$0.7 million as of November 30, 2008.  As of February 28, 2009, the
allowance for Icy Hot Pro
Therapy returns is $0.5 million.





Our
estimate of product returns for seasonal and non-seasonal products as of
February 28, 2009 was $1.3 million and $1.1 million, respectively, and $1.4
million and $1.3 million, respectively, as of November 30,
2008.  During the three months ended February 28, 2009, we decreased
our estimate of returns for seasonal and non-seasonal products by approximately
$0.1 million and $0.2 million, respectively, which resulted in an increase to
net sales in our consolidated financial statements.  For the three
months ended February 29, 2008, we increased our estimate of returns for
seasonal products by $0.3 million, which resulted in a decrease to net sales in
our consolidated financial statements.  For the three months ended
February 29, 2008, we decreased our estimate of non-seasonal returns by
approximately $0.1 million, which resulted in an increase to net sales in our
consolidated financial statements.  Each percentage point change in
the seasonal return rate would impact net sales by an insignificant
amount.  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 February 28, 2009, the
coupon accrual and reserve for vendor allowances were $1.9 million and $5.6
million, respectively, and $1.8 million and $4.9 million, respectively, as of
November 30, 2008.  Each percentage point change in promotional
program participation and advertising and promotion expense would impact net
sales by $0.1 million and an insignificant amount, respectively, for the three
months ended February 28, 2009.





Income
Taxes





We
account for income taxes using the asset and liability approach as prescribed by
SFAS 109, FIN 48, FSP FIN 48-1 and other applicable FSP’s and FASB
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 adopted FIN 48, as amended by FSP
FIN 48-1, on December 1, 2007.  FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in accordance
with SFAS 109.  We record income tax expense in our consolidated
financial statements based on an estimated annual effective income tax
rate.  Our tax rate for the three months ended February 28, 2009 was
36.0%, as compared to 35.6% for the three months ended February 29,
2008.





29


Accounting
for Acquisitions and Intangible Assets





We
account for our acquisitions under the purchase method of accounting for
business combinations as prescribed by SFAS No. 141, “Business Combinations”
(“SFAS 141”).  Under SFAS 141, the cost, including transaction costs,
are allocated to the underlying net assets, based on their respective estimated
fair values.  Business combinations consummated beginning in the first
quarter of our fiscal 2010 will be accounted for under SFAS 141R.





We
account for our Intangible Assets in accordance with SFAS 142.  Under
SFAS 142, intangible assets with indefinite useful lives are not amortized but
are reviewed for impairment at least annually. Intangible assets with finite
lives are amortized over their estimated useful lives using the straight-line
method.





The
judgments made in determining the estimated fair value and expected useful lives
assigned to each class of assets and liabilities acquired can significantly
affect net income.  For example, the useful life of property, plant,
and equipment acquired will differ substantially from the useful life of brand
licenses and trademarks.  Consequently, to the extent a longer-lived
asset is ascribed greater value under the purchase method than a shorter-lived
asset or a value is assigned to an indefinite-lived asset, net income in a given
period may be higher.





Determining
the fair value of certain assets and liabilities acquired is judgmental in
nature and often involves the use of significant estimates and
assumptions.  An area that requires significant judgment is the fair
value and useful lives of intangible assets.  In this process, we
often obtain the assistance of a third party valuation firm for certain
intangible assets.





Our
intangible assets consist of exclusive brand licenses, trademarks and other
intellectual property, customer relationships and non-compete
agreements.  We have determined that our trademarks have indefinite
useful lives, as cash flows from the use of the trademarks are expected to be
generated indefinitely. The useful lives of our intangible assets are reviewed
as circumstances dictate in accordance with the provisions of SFAS
142.





The value
of our intangible assets is exposed to future adverse changes if we experience
declines in operating results or experience significant negative industry or
economic trends.  We review our indefinite-lived intangible assets for
impairment at least annually by comparing the carrying value of the intangible
assets to its estimated fair value.  The estimate of fair value is
determined by discounting the estimate of future cash flows of the intangible
assets.  Consistent with our policy, we perform the annual impairment
testing of our indefinite-lived intangible assets during the quarter ended
November 30, with the most recent test performed in the quarter ended November
30, 2008.  No impairment or adjustment to the carrying value of our
indefinite-lived intangible assets was required as a result of this
testing.





Fair
Value Measurements




On December 1, 2007, we adopted
SFAS No. 157 which provides guidance for using fair value to measure assets and
liabilities.  SFAS 157 applies to items recognized and reported at
fair value in the financial statements and to items disclosed at fair value in
the notes to the financial statements.  SFAS 157 does not change
existing accounting rules governing what can or must be recognized and reported
at fair value and clarifies that fair value is defined as the price received to
sell an asset, or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date.  Additionally,
SFAS 157 does not eliminate practicability exceptions that exist in accounting
pronouncements amended by SFAS 157 when measuring fair value.  As a
result, we are not required to recognize any new assets or liabilities at fair
value.




SFAS 157
also establishes a framework for measuring fair value.  Fair value is
generally determined based on quoted market prices in active markets for
identical assets or liabilities.  If quoted market prices are not
available, SFAS 157 provides guidance on alternative valuation techniques that
place greater reliance on observable inputs and less reliance on unobservable
inputs.




Stock-Based
Compensation





We
account for stock-based compensation under the provisions of SFAS 123R, which
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.  The fair value of
each stock option grant is estimated using a Flex Lattice Model.  The
input assumptions used in determining fair value are the expected life of the
stock options, the expected volatility of our common stock, the risk-free
interest rate over the expected life of the option and the expected forfeiture
rate of the options granted.  We recognize stock option compensation
expense over the period during which an employee provides service in exchange
for the award (the vesting period).




30


Comparison
of Three Months Ended February 28, 2009 and February 29, 2008





To
facilitate discussion of our operating results for the three months ended
February 28, 2009 and February 29, 2008, we have included the following selected
data from our unaudited consolidated statements of income:





Increase (Decrease)2009
                  
                  
                  2008
                  
                  
                  Amount
                  
                  
                  Percentage(dollars
      in thousands)Domestic
      net sales
                  
                  $
                  110,908
                  
                  
                  $
                  111,315
                  
                  
                  $
                  (407
                  )
                  
                  
                  (0.4
                  )%International
      revenues
                  
                  
                  5,184
                  
                  
                  
                  9,458
                  
                  
                  
                  (4,274
                  )
                  
                  
                  (45.2
                  )Total
      revenues
                  
                  
                  116,092
                  
                  
                  
                  120,773
                  
                  
                  
                  (4,681
                  )
                  
                  
                  (3.9
                  )Cost
      of sales
                  
                  
                  35,257
                  
                  
                  
                  34,733
                  
                  
                  
                  524
                  
                  
                  
                  1.5Advertising
      and promotion expense
                  
                  
                  28,589
                  
                  
                  
                  34,496
                  
                  
                  
                  (5,907
                  )
                  
                  
                  (17.1
                  )Selling,
      general and administrative expense
                  
                  
                  15,426
                  
                  
                  
                  15,466
                  
                  
                  
                  (40
                  )
                  
                  
                  (0.3
                  )Product
      recall expenses
                  
                  
                  —
                  
                  
                  
                  6,043
                  
                  
                  
                  (6,043
                  )
                  
                  
                  (100.0
                  )Interest
      expense
                  
                  
                  5,664
                  
                  
                  
                  6,552
                  
                  
                  
                  (888
                  )
                  
                  
                  (13.6
                  )Loss
      on early extinguishment of debt
                  
                  
                  696
                  
                  
                  
                  526
                  
                  
                  
                  170
                  
                  
                  
                  32.3Net
      income
                  
                  
                  19,566
                  
                  
                  
                  14,873
                  
                  
                  
                  4,693
                  
                  
                  
                  31.6





Domestic
Net Sales





Domestic
net sales in the first quarter of fiscal 2009 decreased $0.4 million,
or 0.4%, to $110.9 million from $111.3 million in the prior year
quarter.  The domestic sales decline was a result of reduced inventory
carrying levels at certain retailers, utilization by retailers of promotion
programs to reduce the retail price to consumers that were accounted for as a
reduction of net sales rather than as advertising and promotion expense in our
consolidated statements of income and the discontinuance of shipping of Icy Hot Heat Therapy in the
first quarter of fiscal 2008 following the February 8, 2008 voluntary recall of
the product.  Excluding the sales of Icy Hot Heat Therapy in the
first quarter of fiscal 2008 prior to the voluntary product recall, domestic net
sales increased $1.5 million, or 1.4%, as compared to 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)2009
                
                
                2008
                
                
                Amount
                
                
                Percentage(dollars
      in thousands)Medicated
      skin care
                
                $
                41,457
                
                
                $
                37,653
                
                
                $
                3,804
                
                
                
                10.1
                %Topical
      pain care
                
                
                22,043
                
                
                
                25,315
                
                
                
                (3,272
                )
                
                
                (12.9
                )Oral
      care
                
                
                18,285
                
                
                
                15,772
                
                
                
                2,513
                
                
                
                15.9Internal
      OTC
                
                
                11,364
                
                
                
                11,210
                
                
                
                154
                
                
                
                1.4Medicated
      dandruff shampoos
                
                
                9,363
                
                
                
                10,579
                
                
                
                (1,216
                )
                
                
                (11.5
                )Dietary
      supplements
                
                
                4,272
                
                
                
                5,374
                
                
                
                (1,102
                )
                
                
                (20.5
                )Other
      OTC and toiletry products
                
                
                4,124
                
                
                
                5,412
                
                
                
                (1,288
                )
                
                
                (23.8
                )Total
                
                $
                110,908
                
                
                $
                111,315
                
                
                $
                (407
                )
                
                
                (0.4
                )








Net sales
in the medicated skin care products category increased 10.1% for the first
quarter of fiscal 2009 compared to the prior year quarter primarily due to the
launch of Gold Bond
Anti-Itch Lotion, Gold
Bond Foot Pain Cream, and Gold Bond Ultimate Protecting
Lotion during the first quarter of fiscal 2009 and the continued growth of the
existing lotion business.





Net sales
in the topical pain care category decreased 12.9% for the first quarter of
fiscal 2009 compared to the prior year quarter primarily as a result of the
discontinuance of shipments of Icy Hot Heat Therapy
following the voluntary recall of the product announced on February 8, 2008 and
reduced inventory carrying levels at certain of our retail
customers.  Excluding sales ofIcy Hot Heat Therapy, sales
in the category decreased 5.8% compared to the prior year period.





Net sales
in the oral care products category increased 15.9% for the first quarter of
fiscal 2009 compared to the prior year quarter due in part to the launch and
initial sell-in of ACT
Total Care in the first quarter of fiscal 2009 and the continued performance of
ACT Restoring and ACT Rinse.





31


Net sales
in the internal OTC category increased 1.4% for the first quarter of fiscal 2009
compared to the prior year quarter as a result of sales of Unisom SleepMelts which were
introduced in the second quarter of fiscal 2008, and increased distribution of
Pamprin, offset by
declining sales of Kaopectate.





Net sales
in the medicated dandruff shampoos category decreased 11.5% in the first quarter
of fiscal 2009 compared to the prior year quarter as a result of a decline in
sales of Selsun Salon
products due to distribution changes to accommodate the launch and initial
sell-in of Selsun Blue
Itchy Dry Scalp in the first quarter of fiscal 2009 and reduced inventory
carrying levels by certain of our retail customers.





Net sales
in the dietary supplements category decreased 20.5% for the first quarter of
fiscal 2009 compared to the prior year quarter primarily as a result of declines
in the Dexatrim and
Garliqueproducts.  Dexatrim’s reduced sales
resulted from declines in Dexatrim Max and Dexatrim Max2O, partially offset by the
launch of Dexatrim Max
Complex 7 during the fourth quarter of fiscal 2008.  Garlique’s reduced sales
resulted from lower retail sales in the garlic category.





Net sales
in the other OTC and toiletry products category decreased 23.8% for the first
quarter of fiscal 2009 compared to the prior year quarter primarily as a result
of the timing of shipments of Bullfrog.





Domestic
sales variances were principally the result of changes in unit sales volumes
with the exception of certain selected products for which we implemented a unit
sales price increase.





International
Revenues





For the
first quarter of fiscal 2009, international revenues decreased $4.3 million, or
45.2%, compared to the first quarter of fiscal 2008, primarily as a result of
terminating shipments to certain distributors serving the Latin American market
to reduce the potential for diversion of English language packaging back to the
United States market and unfavorable exchange rates that decreased net sales by
approximately $0.8 million.  We are seeking Latin American
distributors for these markets and are converting the packaging for the major
products sold in these markets to local Spanish language.





Cost
of Sales





Cost of
sales in the first quarter of fiscal 2009 was $35.3 million, a 1.5% increase
over the same period of fiscal 2008, or 30.4% as a percentage of total revenues
for the first quarter of fiscal 2009 as compared to 28.8% in the prior year
quarter.  Gross margin for the first quarter of fiscal 2009 was 69.6%
compared to 71.2% in the prior year quarter.  The decrease in gross
margin was attributable to the increased cost of certain raw material input
components and an increased utilization by retailers of programs to reduce
prices to consumers that are recorded as a reduction of our net sales rather
than advertising and promotion expense.





Advertising
and Promotion Expense





Advertising
and promotion expenses in the first quarter of fiscal 2009 decreased $5.9
million, or 17.1%, as compared to the same quarter of fiscal 2008 and were
24.6% of total revenues in the first quarter of fiscal 2009 compared to 28.6%
for the prior year quarter.  The decrease in expense was a result of
greater utilization of price reduction promotion programs by retailers that are
recorded as a reduction of net sales rather than advertising and promotion
expense, reduced sampling programs and cost efficiencies realized in the media
market.





Selling,
General and Administrative Expense





Selling,
general and administrative expenses in the first quarter of fiscal 2009 were
consistent with amounts in the first quarter of fiscal 2008 and were 13.3% of
total revenues compared to the prior year quarter of 12.8%.





Product
Recall Expenses





The $6.0 million of product recall
expenses in the first quarter of fiscal 2008 was related to the voluntary recall
of our Icy Hot Heat
Therapy product initiated in February 2008.  Based in part on
consideration of on-hand inventory and retail point of sales data, the $6.0
million of product recall expenses related to product returns, inventory
obsolescence, destruction costs, consumer refunds, legal fees and other
estimated expenses.  As of February 28, 2009, we do not expect to
record additional expenses related to the recall of Icy Hot Heat
Therapy.








32


Interest
Expense





Interest
expense decreased $0.9 million, or 13.6%, in the first quarter of fiscal 2009 as
compared to the prior year quarter, as a result of the exchange of $28.7 million
in aggregate principal of our 2.0% Convertible Notes on December 4, 2008 for
487,123 shares of our common stock and the retirement of $58.8 million of our
Credit Facility subsequent to the first quarter of our fiscal
2008.  Until our indebtedness is reduced substantially, interest
expense will continue to represent a significant percentage of our total
revenues.





Loss
on Early Extinguishment of Debt





On December 4, 2008, we issued an
aggregate of 487,123 shares of our common stock in exchange for $28.7 million in
aggregate principal of our outstanding 2.0% Convertible Notes.  In
connection with this transaction, we retired a proportional share of the 2.0%
Convertible Notes debt issuance costs and recorded the resulting loss on early
extinguishment of debt of $0.7 million in the first quarter of fiscal
2009.  In January 2008, we utilized borrowings under the revolving
credit facility portion of our Credit Facility to repay $35.0 million of the
term loan under the Credit Facility.  In connection with the term loan
repayment, we retired a proportional share of the term loan debt issuance costs
and recorded the resulting loss on extinguishment of debt of $0.5 million in the
first quarter of fiscal 2008.





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
$19.7 million and $10.2 million was provided by operations in the first
quarter of fiscal 2009 and fiscal 2008, respectively.  The increase in
cash flow from operations in the first quarter of fiscal 2009 as compared to the
same prior year period was primarily the result of higher net income, and an
increase in accounts payable and accrued liabilities, partially offset by an
increase in inventory as the carrying amount of inventory was increased in
support of the launch of the new products for fiscal 2009.





Investing activities used cash of $1.1
million and $2.9 million in the first quarter of fiscal 2009 and fiscal 2008,
respectively.  Cash flow used in investing activities was primarily a
result of purchases of manufacturing equipment.





Financing
activities used cash of $20.6 million and $11.1 million in the first quarter of
fiscal 2009 and 2008, respectively.  Cash flow used in financing
activities in each period was a result of the repayment of amounts outstanding
under the revolving credit facility portion of our Credit Facility and the term
loan portion of our Credit Facility.





As of
February 28, 2009, our total debt was $410.6 million, consisting of the 7.0%
Subordinated Notes of $107.5 million, the 2.0% Convertible Notes of $96.3
million, the 1.625% Convertible Notes of $100.0 million and $106.8 million
outstanding under the term loan portion of our Credit Facility.  As of
February 28, 2009, no amounts were outstanding under the revolving credit
facility portion of our Credit Facility and we were in compliance with all
applicable financial and restrictive covenants under the Credit
Facility.





We
believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under the revolving credit facility
portion of our Credit Facility will be sufficient to fund our capital
expenditures, debt service and working capital requirements for the foreseeable
future as our business is currently conducted.  It is likely that any
acquisitions we make in the future will require us to obtain additional
financing.  If additional financing is required, there are no
assurances that it will be available, or, if available, that it can be obtained
on terms favorable to us or not dilutive to our future earnings.




Foreign
Operations





Historically,
our primary foreign operations have been through our Canadian and United Kingdom
(“U.K.”) subsidiaries.  Since November 1, 2004, our European business
has been conducted through Chattem Global Consumer Products Limited, a
wholly-owned subsidiary located in Limerick, Ireland.   In
connection with the acquisition of ACT in Western Europe in May
2007, we established Chattem Greece, a wholly-owned subsidiary located in Alimos
Attica, Greece.  In November 2008, we established Chattem Peru SRL
(“Chattem Peru”), a wholly-owned subsidiary located in Lima,
Peru.  Chattem Peru utilizes third party distributors to sell certain
of our Selsun Blue
products throughout Peru.  The functional currencies of these
subsidiaries are Canadian dollars, British pounds, Euros and Peruvian Sol,
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 three months ended February
28, 2009 and February 29, 2008, these subsidiaries accounted for 4% and 8% of
total revenues, respectively, and 2% and 2% of total assets,
respectively.  It has not been our practice to hedge our assets and
liabilities 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.  Losses of $0.2 million and  gains of
$0.1 million, respectively, resulting from foreign currency transactions for the
three months ended February 28, 2009 and February 29, 2008 are included in
selling, general and administrative expenses in the unaudited consolidated
statements of income.





33


Recent
Accounting Pronouncements





In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS
141R”).  SFAS 141R establishes principles and requirements for how the
acquirer in a business combination recognizes and measures the identifiable
assets acquired, liabilities assumed, and intangible assets acquired and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination.  The provisions of SFAS 141R are effective for
acquisitions closing after the first annual reporting period beginning after
December 15, 2008.  Accordingly, we will apply the provisions of SFAS
141R prospectively to business combinations consummated beginning in the first
quarter of our fiscal 2010.  We do not expect SFAS 141R to have an
effect on our previous acquisitions.





In
April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the
Useful Life of Intangible Assets” (“FSP FAS 142-3”).  In determining the
useful life of intangible assets, FSP FAS 142-3 removes the requirement to
consider whether an intangible asset can be renewed without substantial cost of
material modifications to the existing terms and conditions and, instead,
requires an entity to consider its own historical experience in renewing similar
arrangements. FSP FAS 142-3 also requires expanded disclosure related to the
determination of intangible asset useful lives.  FSP FAS 142-3 is effective
for financial statements issued for fiscal years beginning after
December 15, 2008, or our fiscal 2010.  We are currently
evaluating the impact, if any, of FSP FAS 142-3.




In May
2008, the FASB issued FSP Accounting Principles Board Opinion No. 14-1,
“Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)” (“FSP 14-1”).  FSP
14-1 specifies that issuers of convertible debt instruments should separately
account for the liability and equity components of the instrument in a manner
that will reflect the entity’s non-convertible debt borrowing rate on the
instrument’s issuance date when interest is recognized in subsequent
periods.  Upon adoption of FSP 14-1, the proceeds received from the
issuance of the 2.0% Convertible Notes and the 1.625% Convertible Notes
(collectively, the “Convertible Notes”) will be allocated between the liability
and equity component by determining the fair value of the liability component
using our non-convertible debt borrowing rate at the time the Convertible Notes
were issued.  The difference between the proceeds of the Convertible
Notes and the calculated fair value of the liability component will be recorded
as a debt discount with a corresponding increase to common shares in our
consolidated balance sheet.  The debt discount will be amortized as
additional non-cash interest expense over the remaining life of the Convertible
Notes using the effective interest rate method.  Although FSP 14-1
will have no impact on our cash flows, FSP 14-1 will result in additional
non-cash interest expense until maturity or early extinguishment of the
Convertible Notes.  The provisions of FSP 14-1 are to be applied
retrospectively to all periods presented upon adoption and are effective for
fiscal years beginning after December 15, 2008, or our fiscal 2010, and interim
periods within those fiscal years.  Upon adoption of FSP 14-1, we
estimate non-cash interest expense for the fiscal years ended November 30, 2009
and 2008 will increase approximately $6.9 million and $7.2 million,
respectively.  The additional non-cash interest expense is expected to
increase as the Convertible Notes approach their respective maturity dates and
accrete to their face values.





In
December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (“FSP 132R-1”).  FSP 132R-1
enhances the required disclosures about plan assets in an employer’s defined
benefit pension or other postretirement plan, including investment allocations
decisions, inputs and valuations techniques used to measure the fair value of
plan assets and significant concentrations of risks within plan
assets.  FSP 132R-1 is effective for financial statements issued for
fiscal years ending after December 15, 2009, or our fiscal 2010.  We
are currently evaluating the impact, if any, of FSP 132R-1.





Forward Looking
Statements





We may
from time to time make written and oral forward-looking statements.
Forward-looking statements may appear in writing 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




34


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:





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


•
            our
      business could be adversely affected by a prolonged downturn or recession
      in the United States and/or the other countries in which we conduct
      significant business;


•
            we
      may be adversely effected by factors affecting our customer’s
      businesses;


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


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


•
            our
      initiation of a voluntary recall of our Icy Hot Heat Therapy
      products could expose us to additional product liability
      claims;


•
            we
      may receive additional claims that allege personal injury from ingestion
      of Dexatrim;


•
            litigation
      may adversely affect our business, financial condition and results of
      operations;


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


•
            we
      may discontinue products or product lines, which could result in returns
      and asset write-offs, and/or engage in product recalls, any of which would
      reduce our cash flow and earnings;


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


•
            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;


•
            our
      projections of earnings are highly subjective and our future earnings
      could vary in a material amount from our
  projections;


•
            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-10brands;


•
            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 or defend claims of infringement by
      others;


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


•
            we
      depend on sole or limited source suppliers for ingredients in certain of
      our products, and our inability to buy these ingredients would prevent us
      from manufacturing these products;


•
            we
      are subject to the risk of doing business
  internationally;


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


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


•
            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 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;


•
            we
      have no current intentions of paying dividends to holders of our common
      stock;


•
            we
      can be affected adversely and unexpectedly by the implementation of new,
      or changes in the interpretation of existing, accounting principles
      generally accepted in the United States of America
    (“GAAP”);


•
            identification
      of a material weakness in our internal controls over financial reporting
      may adversely affect our financial
results;


•
            the
      convertible note hedge and warrant transactions may affect the value of
      our common stock and our convertible
notes;


•
            conversion
      of our convertible notes may dilute the ownership interest of existing
      shareholders, including holders who had previously converted their
      convertible notes;


•
            virtually
      all of our assets consists of intangibles;
and


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





35


Item 3.  
Quantitative and Qualitative Disclosures About Market Risk





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 1.50% or the higher of the federal funds rate plus
0.50% 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 February 28, 2009, we had no borrowings outstanding
under the revolving credit facility portion of our Credit Facility and $106.8
million was outstanding under the term loan portion of our Credit
Facility.  The variable rate for the term loan was LIBOR plus 1.75%,
or 2.84%, as of February 28, 2009.  The 7.0% Subordinated Notes, the
1.625% Convertible Notes and the 2.0% Convertible Notes are fixed interest rate
obligations.




In
November 2006, we entered into an interest rate swap (“swap”) agreement
effective January 2007.  The swap has decreasing notional principal
amounts beginning in October 2007 and a swap rate of 4.98% over the life of the
agreement.  As of February 28, 2009, the decrease in fair value of an
insignificant amount was recorded to accumulated other comprehensive income and
the swap was deemed to be an effective cash flow hedge.  The swap
agreement terminates in January 2010.




The
impact on our results of operations of a one-point rate change on the April 1,
2009 outstanding $106.0 million term loan balance of our Credit Facility for the
next twelve months would be approximately $0.5 million, net of
tax.  As of April 1, 2009, we had no borrowings outstanding under the
revolving credit facility portion of our Credit Facility.




We are
subject to risk from changes in the foreign exchange rates relating to our
Canadian, U.K., Irish, Grecian and Peruvian subsidiaries. Assets and liabilities
of these subsidiaries are translated to U.S. dollars at period-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 selling, general and
administrative expenses in our 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 $1.3 million as of
February 28, 2009.




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
principal 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 February 28, 2009 (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.










36


PART II.  OTHER
INFORMATION






Item
1.   Legal Proceedings





See Note 18 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 fiscal year ended November 30, 2008.








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





A summary of the common stock
repurchase activity for our first quarter of fiscal 2009 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
      that may yet
                    be
      Purchased under
                    the
      Plans or
                    Programs (2)December
      1 – December 31
                  
                  
                  —
                  
                  
                  $
                  —
                  
                  
                  
                  —
                  
                  
                  
                  73,913,336January
      1 – January 31
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  73,913,336February
      1 – February 28
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  73,913,336Total
      First Quarter
                  
                  
                  —
                  
                  
                  $
                  —
                  
                  
                  
                  —
                  
                  
                  
                  73,913,336





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




(2)
            On
      April 30, 2008, our Board of Directors increased the authorization to a
      total of $100.0 million of our common stock under the terms of our
      existing stock repurchase program.






Item
3.   Defaults Upon Senior Securities




None.







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




None.







Item 5.   Other
Information





At the
annual meeting of shareholders held on April 8, 2009, our shareholders approved
the Chattem, Inc. 2009 Equity Incentive Plan (the “2009 Plan”) and the related
performance goals (“Performance Goals”) which are a part of the 2009 Plan. Our
Board of Directors had previously adopted the 2009 Plan and the Performance
Goals on January 28, 2009, subject to shareholder approval in accordance with
Nasdaq rules and Section 162(m) of the Internal Revenue Code of 1986, as
amended (the “Code”).  The primary purpose of the 2009 Plan is to
attract and retain eligible employees and outside directors, provide an
incentive to eligible employees and outside directors to work to increase the
value of our common stock, and provide eligible employees and outside directors
with a stake in our future which corresponds to the stake of each of our
shareholders.





The 2009
Plan, which is administered by the Compensation Committee of our Board of
Directors (the “Committee”), provides for the grant of stock options (“Options”)
and stock appreciation rights (“SARs”) and for stock grants (“Stock Grants”) and
grants of restricted stock units (“RSU Grants”) to eligible employees and to
outside directors. The maximum number of shares of common stock that may be
issued under the 2009 Plan is 1,750,000, provided that no more than 1,000,000
shares of common stock may be issued pursuant to Stock Grants and RSU Grants. In
addition, no eligible employee in any calendar year may (i) be granted an Option
to purchase more than 200,000 shares of common stock or an SAR based on the
appreciation with respect to more than 200,000 shares of common stock, or (ii)
be awarded Stock Grants or RSU Grants that are intended to satisfy the
requirements of Section 162(m) of the Code for more than 200,000 shares of
common stock. The Committee has the discretion to increase each such grant limit
to 400,000 shares of common stock if deemed necessary or appropriate in
connection with hiring any individual who would when hired be an eligible
employee. The foregoing grant limits are subject to adjustment in the event of
any equity restructuring or change in capitalization or any other transaction
under Section 424 of the Code that does not constitute a change in control
of our company. The number of Options, SARs, Stock Grants and RSU Grants that
will be awarded to our executive officers pursuant to the 2009 Plan is within
the discretion of the Committee and is therefore not currently determinable. The
2009 Plan has a term of ten years.





37


For a
more detailed description of the 2009 Plan and the Performance Goals, refer to
the information set forth under the heading “Item 2—Approval of the Chattem,
Inc. 2009 Equity Incentive Plan” on pages 6 through 13 of our Definitive Proxy
Statement on Schedule 14A, filed with the Securities and Exchange Commission on
February 27, 2009 (the “2009 Proxy Statement”).  The foregoing summary
description of the 2009 Plan and the Performance Goals is qualified in its
entirety by reference to the full text of the 2009 Plan, which was included as
Appendix A to the 2009 Proxy Statement and is incorporated by reference
herein.








Item 6.  
Exhibits





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





Exhibit
      Number
                    
                    Description10.1
                    
                    Chattem,
      Inc. 2009 Equity Incentive Plan (incorporated by reference to Appendix A
      to the registrant’s Definitive Proxy Statement on Schedule 14A filed on
      February 27, 2009 (File No. 000-05905))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


































38


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:  April 9,
      2009
                  
                  /s/ Zan
      GuerryZan
      GuerryChairman
      and Chief Executive Officer




Dated:  April 9,
      2009
                          
                          /s/ Robert
      B. LongRobert
      B. LongVice
      President and Chief Financial Officer


















39


Chattem, Inc. and
Subsidiaries


Exhibit
Index













Exhibit
      Number
                
                Description of
      Exhibit10.1
                
                Chattem,
      Inc. 2009 Equity Incentive Plan (incorporated by reference to Appendix A
      to the registrant’s Definitive Proxy Statement on Schedule 14A filed on
      February 27, 2009 (File No. 000-05905))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




































40