================================================================================

                                  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 AUGUST 31, 2004
                          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



REGISTRANT 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, AND HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.

THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE
ACT).

AS OF SEPTEMBER 29, 2004, 19,785,408 SHARES OF THE COMPANY'S COMMON STOCK,
WITHOUT PAR VALUE, WERE OUTSTANDING.
================================================================================
<PAGE>

                                  CHATTEM, INC.
                                  -------------

                                      INDEX
                                      -----

                                                                        PAGE NO.
                                                                        --------
PART I.  FINANCIAL INFORMATION

  Item 1.  Financial Statements

    Condensed Consolidated Balance Sheets as of August 31, 2004 and
      November 30, 2003                                                     3

    Condensed Consolidated Statements of Income for the Three and Nine
      Months Ended August 31, 2004 and August 31, 2003                      5

    Condensed Consolidated Statements of Cash Flows for the Nine Months
      Ended August 31, 2004 and August 31, 2003                             6

    Notes to Condensed Consolidated Financial Statements                    7

  Item 2.  Management's Discussion and Analysis of Financial Condition
    and Results of Operations                                              25

  Item 3.  Quantitative and Qualitative Disclosures About Market Risks     39

  Item 4.  Controls and Procedures                                         39

PART II.  OTHER INFORMATION

  Item 1.  Legal Proceedings                                               40

  Item 2.  Changes in Securities and Use of Proceeds                       40

  Item 3.  Defaults Upon Senior Securities                                 40

  Item 4.  Submission of Matters to a Vote of Security Holders             40

  Item 5.  Other Information                                               40

  Item 6.  Exhibits and Reports on Form 8-K                                41

SIGNATURES                                                                 42


                                        2
<PAGE>

                          PART 1. FINANCIAL INFORMATION
                          -----------------------------


ITEM 1. FINANCIAL STATEMENTS
----------------------------


                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      -------------------------------------
                                 (In thousands)
<TABLE><CAPTION>

                                                                  AUGUST 31,     NOVEMBER 30,
ASSETS                                                               2004           2003
------                                                            ----------     ----------
                                                                  (Unaudited)
<S>                                                              <C>            <C>
CURRENT ASSETS:
  Cash and cash equivalents                                       $   26,755     $   26,931
  Accounts receivable, less allowances of $3,310 at
    August 31, 2004 and $3,594 at November 30, 2003                   32,241         25,478
  Inventories                                                         19,549         17,559
  Refundable income taxes                                              5,273          4,431
  Deferred income taxes                                                1,635          3,441
  Prepaid expenses and other current assets                            3,369          3,376
                                                                  ----------     ----------
    Total current assets                                              88,822         81,216
                                                                  ----------     ----------

PROPERTY, PLANT AND EQUIPMENT, NET                                    27,993         28,722
                                                                  ----------     ----------

OTHER NONCURRENT ASSETS:
  Patents, trademarks and other purchased product rights, net        245,633        245,847
  Debt issuance costs, net                                             5,348          5,504
  Other                                                                3,559          2,096
                                                                  ----------     ----------
    Total other noncurrent assets                                    254,540        253,447
                                                                  ----------     ----------

      TOTAL ASSETS                                                $  371,355     $  363,385
                                                                  ==========     ==========
</TABLE>

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

                                        3
<PAGE>

                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      -------------------------------------
                                 (In thousands)
<TABLE><CAPTION>

                                                              AUGUST 31,     NOVEMBER 30,
LIABILITIES AND SHAREHOLDERS' EQUITY                            2004            2003
------------------------------------                         ----------      ----------
                                                             (Unaudited)
<S>                                                         <C>             <C>
CURRENT LIABILITIES:
   Current maturities of long-term debt                      $     --        $    7,750
   Accounts payable and other                                    10,396          10,924
   Accrued liabilities                                           12,181          15,979
                                                             ----------      ----------
     Total current liabilities                                   22,577          34,653
                                                             ----------      ----------

LONG-TERM DEBT, less current maturities                         200,000         204,676
                                                             ----------      ----------

DEFERRED INCOME TAXES                                            30,975          26,501
                                                             ----------      ----------

OTHER NONCURRENT LIABILITIES                                      1,738           1,689
                                                             ----------      ----------

COMMITMENTS AND CONTINGENCIES (Note 18)

SHAREHOLDERS' EQUITY:
  Preferred shares, without par value, authorized 1,000,
    none issued                                                    --              --
  Common shares, without par value, authorized 50,000,
    issued 19,752 at August 31, 2004 and 19,161 at
    November 30, 2003                                            83,425          77,815
  Retained earnings                                              37,543          22,274
                                                             ----------      ----------
                                                                120,968         100,089
  Unamortized value of restricted common shares issued           (2,668)         (2,058)
  Cumulative other comprehensive income, net of taxes:
    Interest rate cap adjustment                                   (259)           --
    Foreign currency translation adjustment                        (336)           (525)
    Minimum pension liability adjustment                         (1,640)         (1,640)
                                                             ----------      ----------
     Total shareholders' equity                                 116,065          95,866
                                                             ----------      ----------

        TOTAL LIABILITIES AND SHAREHOLDERS'
          EQUITY                                             $  371,355      $  363,385
                                                             ==========      ==========
</TABLE>

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

                                        4
<PAGE>

                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------

                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                   -------------------------------------------
             (Unaudited and in thousands, except per share amounts)
<TABLE><CAPTION>

                                                            FOR THE THREE MONTHS          FOR THE NINE MONTHS
                                                               ENDED AUGUST 31,              ENDED AUGUST 31,
                                                          ------------------------      ------------------------
                                                             2004           2003           2004           2003
                                                          ---------      ---------      ---------      ---------
<S>                                                      <C>            <C>            <C>            <C>
REVENUES:
  Net sales                                               $  66,096      $  58,972      $ 196,909      $ 180,366
  Royalties                                                      39            210            555            874
                                                          ---------      ---------      ---------      ---------
    Total revenues                                           66,135         59,182        197,464        181,240
                                                          ---------      ---------      ---------      ---------

COSTS AND EXPENSES:
  Cost of sales                                              19,135         15,995         56,643         51,399
  Advertising and promotion                                  18,666         17,075         56,278         54,009
  Selling, general and administrative                        11,525         10,234         32,831         30,445
  Litigation settlement                                         834           --            4,491           --
                                                          ---------      ---------      ---------      ---------
    Total costs and expenses                                 50,160         43,304        150,243        135,853
                                                          ---------      ---------      ---------      ---------

INCOME FROM OPERATIONS                                       15,975         15,878         47,221         45,387
                                                          ---------      ---------      ---------      ---------

OTHER INCOME (EXPENSE):
  Interest expense                                           (3,284)        (5,057)       (11,678)       (15,431)
  Investment and other income, net                               45             32            205            119
  Loss on early extinguishment of debt                         --             --          (12,958)          --
                                                          ---------      ---------      ---------      ---------
    Total other income (expense)                             (3,239)        (5,025)       (24,431)       (15,312)
                                                          ---------      ---------      ---------      ---------

INCOME BEFORE INCOME TAXES                                   12,736         10,853         22,790         30,075

PROVISION FOR INCOME TAXES                                    4,002          4,016          7,521         11,128
                                                          ---------      ---------      ---------      ---------

NET INCOME                                                $   8,734      $   6,837      $  15,269      $  18,947
                                                          =========      =========      =========      =========

NUMBER OF COMMON SHARES:
  Weighted average outstanding-basic                         19,498         19,148         19,295         19,178
                                                          =========      =========      =========      =========
  Weighted average and potential dilutive outstanding        20,308         19,905         20,148         19,897
                                                          =========      =========      =========      =========

NET INCOME PER COMMON SHARE:
    Basic                                                 $     .45      $     .36      $     .79      $     .99
                                                          =========      =========      =========      =========
    Diluted                                               $     .43      $     .34      $     .76      $     .95
                                                          =========      =========      =========      =========
</TABLE>

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

                                        5
<PAGE>

                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
             (Unaudited and in thousands, except per share amounts)
<TABLE><CAPTION>

                                                                   FOR THE NINE MONTHS ENDED
                                                                   --------------------------
                                                                   AUGUST 31,      AUGUST 31,
                                                                      2004            2003
                                                                   ----------      ----------
<S>                                                               <C>             <C>
OPERATING ACTIVITIES:
  Net income                                                       $   15,269      $   18,947
  Adjustments to reconcile net income to net cash provided by
    operating activities:
      Depreciation and amortization                                     4,609           4,565
      Deferred income taxes                                             6,280           6,104
      Tax benefit realized from stock option exercises                  4,036           1,240
      Loss on early extinguishment of debt                             12,958            --
      Other, net                                                           53             (94)
      Changes in operating assets and liabilities:
        Accounts receivable                                            (6,763)         (2,867)
        Inventories                                                    (1,990)         (1,009)
        Refundable income taxes                                          (842)           (256)
        Prepaid expenses and other current assets                          54            (768)
        Accounts payable and accrued liabilities                       (4,326)         (1,749)
                                                                   ----------      ----------
           Net cash provided by operating activities                   29,338          24,113
                                                                   ----------      ----------

INVESTING ACTIVITIES:
  Purchases of property, plant and equipment                           (1,763)         (3,933)
  Purchases of patents, trademarks and other product rights                (8)           (373)
  Increase in other assets, net                                          (594)           (285)
                                                                   ----------      ----------
           Net cash used in investing activities                       (2,365)         (4,591)
                                                                   ----------      ----------

FINANCING ACTIVITIES:
  Repayment of long-term debt                                        (212,288)        (10,000)
  Proceeds from long-term debt                                        200,000            --
  Proceeds from borrowings under revolving credit facility             25,000            --
  Repayments of revolving credit facility                             (25,000)           --
  Proceeds from exercise of stock options                               5,139           1,533
  Repurchase of common shares                                          (5,015)         (5,351)
  Increase in debt issuance costs                                      (5,729)            (25)
  Retirement of debt issuance costs                                    (7,861)           --
  Premium on interest rate cap agreement                               (1,375)           --
                                                                   ----------      ----------
          Net cash used in financing activities                       (27,129)        (13,843)
                                                                   ----------      ----------

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
                                                                          (20)            118
                                                                   ----------      ----------

CASH AND CASH EQUIVALENTS:
  (Decrease) increase for the period                                     (176)          5,797
  At beginning of period                                               26,931          15,924
                                                                   ----------      ----------
  At end of period                                                 $   26,755      $   21,721
                                                                   ==========      ==========

SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
  Issuance of 70 and 69 shares of restricted common stock at a
  value of $19.98 and $14.50 per share for the nine months
  ended August 31, 2004 and 2003, respectively                     $    1,399      $    1,000

PAYMENTS FOR:
  Interest                                                         $    8,737      $    9,916
  Taxes                                                            $      228      $    2,680
</TABLE>

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

                                        6
<PAGE>

                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
              ----------------------------------------------------
                                   (UNAUDITED)

All monetary and share amounts are expressed in thousands.

1. BASIS OF PRESENTATION
   ---------------------

        The accompanying unaudited condensed consolidated financial statements
   have been prepared in accordance with U.S. generally accepted accounting
   principles for interim financial information and the instructions to Form
   10-Q and Rule 10-01 of Regulation S-X. Accordingly, these condensed
   consolidated financial statements do not include all of the information and
   footnotes required by U.S. generally accepted accounting principles for
   complete financial statements. These condensed 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, 2003. The accompanying unaudited
   condensed consolidated financial statements, in the opinion of management,
   include all adjustments necessary for a fair presentation. All such
   adjustments are of a normal recurring nature.

2. CASH AND CASH EQUIVALENTS
   -------------------------

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

3. RECLASSIFICATIONS
   -----------------

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

4. RECENT ACCOUNTING PRONOUNCEMENTS
   --------------------------------

        In April 2002, the Financial Accounting Standards Board ("FASB") issued
   Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
   FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
   Technical Corrections" ("SFAS 145"). We adopted SFAS 145 on December 1, 2002.
   SFAS 145 requires us to classify gains and losses on extinguishments of debt
   as income or loss from continuing operations rather than as extraordinary
   items as previously required under SFAS No. 4, "Reporting Gains and Losses
   from Extinguishment of Debt". We are also required to reclassify any gain or
   loss on extinguishment of debt previously classified as an extraordinary item
   in prior periods presented. SFAS 145 also provides accounting standards for
   certain lease modifications that have economic effects similar to
   sale-leaseback transactions and various other technical corrections. The
   application of SFAS 145 resulted in recording a loss on early extinguishment
   of debt of $12,958 in the first and second quarters of fiscal 2004, which was
   classified in the condensed consolidated financial statements in accordance
   with the provisions of SFAS 145.

        In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
   Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS
   146 on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force
   ("EITF") Issue No. 94-3. SFAS 146 requires that the liability for a cost
   associated with an exit or disposal activity be recognized when the liability
   is incurred, not at the date of an entity's commitment to an exit or disposal
   plan. SFAS 146 is to be applied prospectively to exit or disposal activities
   initiated after December 31, 2002. As of August 31, 2004, the application of
   SFAS 146 resulted in recording $35 of accrued liabilities related to the
   restructuring of the United Kingdom ("U.K.") operations. We expect to record
   additional charges related to the restructuring of the U.K. operations in the
   fourth quarter of fiscal 2004.

        In January 2003, the FASB issued Interpretation No. 46, "Consolidation
   of Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to
   consolidate a variable interest entity ("VIE"), as defined, when the company
   will absorb a majority of the VIE's expected losses, receives a majority of
   the VIE's expected residual returns or both. FIN 46 also requires
   consolidation of existing, non-controlled affiliates if the VIE is unable to
   finance its operations without investor support, or where the other investors
   do not have exposure to the significant risks and rewards of ownership. FIN
   46 applies immediately to a VIE created or acquired after January 31, 2003.
   For a VIE created before February 1, 2003, FIN 46 applies in the first fiscal
   year or interim period beginning after March 15, 2004, our third fiscal
   quarter beginning June 1, 2004. Application of FIN 46 is also required in
   financial statements that have interests in structures that are commonly
   referred to as special-purpose entities for periods ending after December 15,
   2003. The adoption of FIN 46 did not have an impact on our financial
   position, results of operations or cash flows.

                                        7
<PAGE>

        In December 2003, the FASB issued SFAS No. 132 (revised 2003),
   "Employers' Disclosure about Pensions and Other Postretirement Benefits"
   ("SFAS 132"). The revision of SFAS 132 provides for additional disclosures
   including the description of the types of plan assets, investment strategy,
   measurement date(s), plan obligations, cash flows and components of net
   periodic benefit cost recognized in interim periods. The revisions of SFAS
   132 are effective for financial statements with fiscal years ending after
   December 15, 2003 and interim periods beginning after December 15, 2003. The
   adoption of the revised SFAS 132 did not have an impact on our financial
   position, results of operations or cash flows.

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

        Our 1998 Non-Statutory Stock Option Plan provides for the issuance of up
   to 1,400 shares of common stock to key employees, while the 1999
   Non-Statutory Stock Option Plan for Non-Employee Directors allows for the
   issuance of up to 200 shares of common stock. Our 2000 Non-Statutory Stock
   Option Plan provides for the issuance of up to 1,500 shares of common stock.
   Our 2003 Stock Incentive Plan provides for the issuance of up to 1,500 shares
   of common stock. Options granted under the plans vest ratably over four years
   and are exercisable for a period of up to ten years from the date of grant.

        For SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
   purposes, as amended by SFAS No. 148, "Accounting for Stock Based
   Compensation-Transition and Disclosure", the fair value of each option grant
   has been estimated as of the date of grant using the Black-Scholes
   option-pricing model with the following weighted average assumptions for
   grants in 2004 and 2003: expected dividend yield of 0%, expected volatility
   of 59% and 64%, respectively, risk-free interest rates of 4.12% and 4.47%,
   respectively, and expected lives of approximately five and six years,
   respectively.

        Had compensation expense for stock option grants been determined based
   on the fair value at the grant dates consistent with the method prescribed by
   SFAS 123, our net income and net income per share would have been adjusted to
   the pro forma amounts for the three and nine months ended August 31, 2004 and
   2003, respectively, as indicated below:
<TABLE><CAPTION>

                                                  For the Three Months Ended    For the Nine Months Ended
                                                          August 31,                    August 31,
                                                  -------------------------     -------------------------
                                                     2004           2003           2004           2003
                                                  ----------     ----------     ----------     ----------
<S>                                              <C>            <C>            <C>            <C>
   Net income:
     As reported                                  $    8,734     $    6,837     $   15,269     $   18,947
     Fair value method compensation cost, net          1,348            516          3,228          1,552
                                                  ----------     ----------     ----------     ----------
     Pro forma                                    $    7,386     $    6,321     $   12,041     $   17,395
                                                  ==========     ==========     ==========     ==========

   Net income per share, basic:
     As reported                                  $      .45     $      .36     $      .79     $      .99
     Pro forma                                    $      .38     $      .33     $      .62     $      .91

   Net income per share, diluted:
     As reported                                  $      .43     $      .34     $      .76     $      .95
     Pro forma                                    $      .36     $      .32     $      .60     $      .87
</TABLE>







                                        8
<PAGE>

6. EARNINGS PER SHARE
   ------------------

        The following table presents the computation of per share earnings for
   the three and nine months ended August 31, 2004 and 2003, respectively:
<TABLE><CAPTION>

                                           For the Three Months Ended    For the Nine Months Ended
                                                   August 31,                    August 31,
                                           -------------------------     -------------------------
                                              2004           2003           2004           2003
                                           ----------     ----------     ----------     ----------
<S>                                        <C>            <C>            <C>            <C>
   NET INCOME                              $    8,734     $    6,837     $   15,269     $   18,947
                                           ==========     ==========     ==========     ==========

   NUMBER OF COMMON SHARES:
      Weighted average outstanding             19,498         19,148         19,295         19,178
      Issued upon assumed exercise of
        outstanding stock options                 735            647            795            617
      Effect of issuance of restricted
         common shares                             75            110             58            102
                                           ----------     ----------     ----------     ----------
      Weighted average and potential           20,308         19,905         20,148         19,897
                                           ==========     ==========     ==========     ==========
         dilutive outstanding (1)


   NET INCOME PER COMMON SHARE:
       Basic                               $      .45     $      .36     $      .79     $      .99
                                           ==========     ==========     ==========     ==========
       Diluted                             $      .43     $      .34     $      .76     $      .95
                                           ==========     ==========     ==========     ==========
</TABLE>

        (1) Because their effects are anti-dilutive, excludes shares issuable
        under stock option plans and restricted stock issuance whose grant
        price was greater than the average market price of common shares
        outstanding as follows: 5 and 85 shares for the three months ended
        August 31, 2004 and 2003, respectively, and 247 and 87 shares for the
        nine months ended August 31, 2004 and 2003, respectively.

7. ADVERTISING EXPENSES
   --------------------

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

8. SHIPPING AND HANDLING
   ---------------------

        Shipping and handling costs of $2,036 and $1,602 are included in selling
   expenses for the three months ended August 31, 2004 and 2003, respectively,
   and $5,469 and $4,647 for the nine months ended August 31, 2004 and 2003,
   respectively.

9. 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 $244,797 and $244,790 as of August 31, 2004 and November
   30, 2003, respectively. After reviewing pertinent information relating to the
   revaluation of these intangible assets and performing the impairment test as
   prescribed by SFAS 142 as of August 31, 2004, we determined that the
   revaluation of these intangible assets was not required. The gross carrying
   amount of finite-lived intangible assets subject to amortization at both
   August 31, 2004 and November 30, 2003, which consist primarily of non-compete
   agreements, was $2,400. The related accumulated amortization of finite-lived
   intangible assets at August 31, 2004 and November 30, 2003 was $1,564 and
   $1,343, respectively. Amortization of our finite-lived intangible assets
   subject to amortization under the provisions of

                                        9
<PAGE>

   SFAS 142 for the three months ended August 31, 2004 and 2003 was $73 and
   $85, respectively, and for the nine months ended August 31, 2004 and 2003
   was $222 and $255, respectively. Estimated annual amortization expense for
   these assets for the years ended November 30, 2005, 2006, 2007, 2008 and
   2009 is $290, $290, $123, $40 and $20, respectively.


10. INVENTORIES
    -----------

        Inventories consisted of the following as of August 31, 2004 and
   November 30, 2003:

                                                        2004         2003
                                                     ----------   ----------

        Raw materials and work in process            $    9,191   $    9,740
        Finished goods                                   12,046        9,507
        Excess of current cost over LIFO values          (1,688)      (1,688)
                                                     ----------   ----------
            Total inventories                        $   19,549   $   17,559
                                                     ==========   ==========

11. ACCRUED LIABILITIES
    -------------------

        Accrued liabilities consisted of the following as of August 31, 2004 and
   November 30, 2003:

                                                        2004         2003
                                                     ----------   ----------

        Interest                                     $    5,356   $    3,115
        Salaries, wages and commissions                   3,669        3,604
        Product advertising and promotion                   118        5,348
        Insurance                                           520        1,151
        Pension                                           1,054        1,040
        Other                                             1,464        1,721
                                                     ----------   ----------
            Total accrued liabilities                $   12,181   $   15,979
                                                     ==========   ==========

12. LONG-TERM DEBT
    --------------

        Long-term debt consisted of the following as of August 31, 2004 and
   November 30, 2003:

                                                        2004         2003
                                                     ----------   ----------
        Revolving Credit Facility due 2009
         at a variable rate of 5.00% as of
         August 31, 2004                             $      --    $      --

        Term loan payable to banks at variable
         rates of 3.42% and 3.39% as of
         February 26, 2004 (termination date)
         and November 30, 2003, respectively                --         7,750

        8.875% Senior Subordinated Notes, plus
         unamortized premium of $138
         for 2003                                           --       204,676

        Floating Rate Senior Notes due 2010
         at a variable rate of 4.31% as of
         August 31, 2004                                 75,000          --

        7.0% Senior Subordinated Notes due 2014         125,000          --
                                                     ----------   ----------
        Total long-term debt                            200,000      212,426

        Less:  current maturities                           --         7,750
                                                     ----------   ----------

        Total long-term debt, net of current
         maturities                                  $  200,000   $  204,676
                                                     ==========   ==========

        On February 26, 2004, we entered into a new Senior Secured Revolving
   Credit Facility that matures February 26, 2009 (the "Revolving Credit
   Facility") with Bank of America, N.A. that provided an initial borrowing
   capacity of $25,000 and an additional $25,000, subject to successful
   syndication. On March 9, 2004, we entered into a new commitment agreement
   with a syndicate of commercial banks led by Bank of America, N.A., as agent,
   that enables us to borrow up to a total of $50,000 under the Revolving Credit
   Facility. Borrowings under our Revolving Credit Facility bear interest at
   LIBOR plus applicable percentages of 1.75% to 2.50% or a base rate (the
   higher of the federal funds rate plus 0.5% or the prime rate) plus applicable
   percentages of 0.25% to 1.0%. The applicable percentages are calculated based
   on our leverage ratio. As of August 31, 2004, no amounts have been borrowed
   under the Revolving Credit Facility, and the variable rate was 5.0%.

                                       10
<PAGE>

   Borrowings under our Revolving 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 Revolving 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, net worth and brand
   value calculations. On September 29, 2004, we had no borrowings outstanding
   under our Revolving Credit Facility.

        On March 28, 2002, we obtained a $60,000 senior secured credit facility
   from a syndicate of commercial banks led by Bank of America, N.A., as agent
   (the "Credit Facility"). The Credit Facility included a $15,000 revolving
   credit line and a $45,000 term loan. The remaining balance of the term loan
   under the Credit Facility was repaid as part of the refinancing transactions
   discussed herein, and the revolving credit line under the Credit Facility was
   terminated on February 26, 2004.

        On February 10, 2004, we commenced a cash tender offer and consent
   solicitation for the $204,538 outstanding principal amount of our 8.875%
   Senior Subordinated Notes due 2008 (the "8.875% Subordinated Notes"). The
   consent solicitation expired on February 24, 2004, and a total of
   approximately $174,530, or approximately 85.3% of the 8.875% Subordinated
   Notes, were tendered and accepted for payment on February 26, 2004. The
   remaining principal outstanding, call premium, accrued interest and interest
   to call date amounting to $32,227 was placed in escrow with the indenture
   trustee to fund the purchase of additional 8.875% Subordinated Notes tendered
   prior to March 9, 2004, the expiration date of the tender offer, and the
   redemption of the remaining 8.875% Subordinated Notes not tendered. The
   remaining 8.875% Subordinated Notes not tendered in such offer were called in
   accordance with their terms on April 1, 2004 at a redemption price of
   102.9583% of their aggregate principal amount. On April 1, 2004, the
   remaining amount held in escrow was released for payment and all outstanding
   8.875% Subordinated Notes were redeemed.

        The completion of our refinancing of the Credit Facility and purchase of
   approximately $174,530 of our 8.875% Subordinated Notes that were tendered on
   February 26, 2004 resulted in a loss on early extinguishment of debt of
   $11,309 and a tax benefit of $3,958 in the first quarter of fiscal 2004. In
   the second quarter of fiscal 2004, we recorded a loss on early extinguishment
   of debt of $1,649 and a related tax benefit of $577 related to the redemption
   of the remaining $30,008 of our 8.875% Subordinated Notes. These related tax
   benefits were adjusted to reflect the annual estimated effective tax rate of
   33% in the third quarter of fiscal 2004 to $3,732 and $544, respectively.

        Also on February 26, 2004, we issued and sold $75,000 of Floating Rate
   Senior Notes due March 1, 2010 (the "Floating Rate Notes") and $125,000 of
   7.0% Senior Subordinated Notes due March 1, 2014 (the "7.0% Subordinated
   Notes"), the proceeds of which were used to purchase our 8.875% Subordinated
   Notes and refinance the Credit Facility as discussed above.

        The Floating Rate Notes bear interest at a three-month LIBOR plus 3.00%
   per year (4.31% as of August 31, 2004). Interest payments are due quarterly
   in arrears commencing on June 1, 2004. On March 8, 2004, we entered into an
   interest rate cap agreement effective June 1, 2004 with decreasing notional
   principal amounts and cap rates ranging from 4.0% to 5.0% over the life of
   the agreement. We paid a $1,375 premium to enter into the interest rate cap
   agreement, which will be amortized over the life of the agreement. The
   current portion of the premium on the interest rate cap agreement of $47 is
   included in prepaid expenses and other current assets, and the long-term
   portion of $922 is included in other noncurrent assets. The amortized value
   of the premium on the interest rate cap was compared to its fair value as of
   August 31, 2004, and a charge of $259, net of tax, was recorded to other
   comprehensive income. The interest rate cap agreement terminates on March 1,
   2010. Our domestic subsidiaries are guarantors of the Floating Rate Notes.
   The guarantees of the Floating Rate Notes are unsecured senior obligations of
   the guarantors and rank equally with all of the current and future unsecured
   senior debt of the guarantors. The guarantees of the Floating Rate Notes
   effectively rank junior to any secured debt of the guarantors, including the
   guarantors' guarantee of our indebtedness under the Revolving Credit
   Facility. At any time after March 1, 2005, we may redeem any of the Floating
   Rate 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 liquidated damages, if any, to the applicable
   redemption rate, if redeemed during the twelve-month periods beginning March
   1, 2005 at 102.0%, March 1, 2006 at 101.0% and March 1, 2007 and thereafter
   at 100.0%. At any time prior to March 1, 2005, we may redeem up to 35.0% of
   the aggregate principal amount of the Floating Rate Notes (including any
   additional Floating Rate Notes) at a redemption price of 100.0% of the
   principal amount thereof, plus a premium equal to the interest rate per annum
   on the Floating Rate Notes applicable on the date on which notice of the
   redemption is given, together with accrued and unpaid interest and liquidated
   damages, if any, with the net cash proceeds of one or more qualified equity
   offerings; provided, that (i) at least 65.0% of the aggregate principal
   amount of Floating Rate Notes remains outstanding immediately after the
   occurrence of each redemption (excluding Floating Rate Notes held by us and
   our subsidiaries); and (ii) the redemption must occur within 90 days of the
   date of the closing of such qualified equity offering.

        Interest payments on the 7.0% Subordinated Notes are due semi-annually
   in arrears on March 1 and September 1, commencing on September 1, 2004. Our
   domestic subsidiaries are guarantors of the 7.0% Subordinated Notes. The

                                       11
<PAGE>

   guarantees of the 7.0% Subordinated Notes are unsecured senior subordinated
   obligations of the guarantors. At any time after March 1, 2009, we may redeem
   any of the 7.0% Subordinated Notes upon not less than 30 nor more than 60
   days' notice at redemption prices (expressed in percentages of principal
   amount), plus accrued and unpaid interest, if any, and liquidation damages,
   if any, to the applicable redemption rate, if redeemed during the
   twelve-month periods beginning March 1, 2009 at 103.500%, March 1, 2010 at
   102.333%, March 1, 2011 at 101.167% and March 1, 2012 and thereafter at
   100.000%. At any time prior to March 1, 2007, we may redeem up to 35% of the
   aggregate principal amount of the 7.0% Subordinated Notes (including any
   additional 7.0% Subordinated Notes) at a redemption price of 107.0% of the
   principal amount thereof, plus accrued and unpaid interest and liquidated
   damages, if any, thereon to the applicable redemption rate, with the net cash
   proceeds of one or more qualified equity offerings; provided, that (i) at
   least 65.0% of the aggregate principal amount of the 7.0% Subordinated Notes
   remains outstanding immediately after the occurrence of such redemption
   (excluding 7.0% Subordinated Notes held by us and our subsidiaries); and (ii)
   the redemption must occur within 90 days of the date of the closing of such
   qualified equity offering.

        The indentures governing the Floating Rate Notes and 7.0% Subordinated
   Notes, among other things, limit 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 Floating
   Rate Notes and 7.0% Subordinated Notes at 101.0% of their principal amount
   plus accrued and unpaid interest.

        The future maturities of long-term debt outstanding as of August 31,
   2004 are as follows:

        2005                                         $      --
        2006                                                --
        2007                                                --
        2008                                                --
        2009                                                --
        Thereafter                                      200,000
                                                     ----------
                                                     $  200,000
                                                     ==========

13. COMPREHENSIVE INCOME
    --------------------

        Comprehensive income, net of taxes, consisted of the following
   components for the three and nine months ended August 31, 2004 and 2003,
   respectively:

                                For the Three Months       For the Nine Months
                                   Ended August 31,          Ended August 31,
                               -----------------------   -----------------------
                                  2004         2003         2004         2003
                               ----------   ----------   ----------   ----------

   Net income                  $    8,734    $   6,837   $   15,269   $   18,947
   Other - interest rate cap
     adjustment                      (259)         --          (259)         --
   Other - foreign currency
     translation adjustment           120          268          189          307
                               ----------   ----------   ----------   ----------
      Total                    $    8,595   $    7,105   $   15,199   $   19,254
                               ==========   ==========   ==========   ==========

14. STOCK BUYBACK
    -------------

        In January 2004, our board of directors increased the total
   authorization to repurchase our common stock under our stock buyback program
   to $20,000. During the nine months ended August 31, 2004, we repurchased 190
   shares for $5,015. All repurchased shares were retired and returned to
   unissued. We are limited in our ability to repurchase shares due to
   restrictions under the terms of our Revolving Credit Facility and the
   indentures pursuant to which the Floating Rate Notes and 7.0% Subordinated
   Notes were issued.


                                       12
<PAGE>

15. RETIREMENT PLANS AND POSTRETIREMENT HEALTH CARE BENEFITS
    --------------------------------------------------------

        RETIREMENT PLANS

        We have a noncontributory defined benefit pension plan ("the Plan"),
   which covers substantially all employees. The Plan provides benefits based
   upon years of service and the employee's compensation. Our contributions are
   based on computations by independent actuaries. Plan assets at August 31,
   2004 and November 30, 2003 were invested primarily in United States
   government and agency securities and corporate debt and equity securities. In
   October 2000, our board of directors adopted an amendment to the Plan that
   freezes benefits of the Plan and prohibits new entrants to the Plan effective
   December 31, 2000.

        Net periodic pension cost for the three and nine months ended August 31,
   2004 and 2003 comprised the following components:

                                    For the Three Months  For the Nine Months
                                      Ended August 31,      Ended August 31,
                                    -------------------   -------------------
                                      2004       2003       2004       2003
                                    --------   --------   --------   --------
   Service cost                     $    --    $    --    $    --    $    --
   Interest cost on projected
    benefit obligation                   155        152        465        456
   Actual return on plan assets         (178)      (157)      (534)      (471)
   Net amortization and deferral          28        (36)        84       (108)
                                    --------   --------   --------   --------
   Net pension cost (benefit)       $      5   $    (41)  $     15   $   (123)
                                    ========   ========   ========   ========

        No employer contributions were made for the nine months ended August 31,
   2004 and August 31, 2003, and no employer contributions are required to be
   made in fiscal 2004.

        POSTRETIREMENT HEALTH CARE BENEFITS

        We maintain certain postretirement health care benefits for eligible
   employees. Employees become eligible for these benefits if they meet certain
   age and service requirements. We pay a portion of the cost of medical
   benefits for certain retired employees over the age of 65. Effective January
   1, 1993, our contribution is a service-based percentage of the full premium.
   We pay these benefits as claims are incurred. Employer contributions expected
   for fiscal 2004 are approximately $70.

        Net periodic postretirement health care benefits cost for the three and
   nine months ended August 31, 2004 and August 31, 2003, included the following
   components:

                                    For the Three Months  For the Nine Months
                                      Ended August 31,      Ended August 31,
                                    -------------------   -------------------
                                      2004       2003       2004       2003
                                    --------   --------   --------   --------
   Service cost                     $     16   $     14   $     48   $     42
   Interest cost on accumulated
     postretirement benefit
     obligation                           20         20         60         60
   Amortization of prior service
     cost                                  4          4         12         12
   Amortization of net gain               (8)        (7)       (24)       (21)
                                    --------   --------   --------   --------
   Net periodic postretirement
     benefits cost                  $     32   $     31   $     96   $     93
                                    ========   ========   ========   ========


16. INCOME TAXES
    ------------

        We account for income taxes using the asset and liability approach as
   prescribed by SFAS No. 109, "Accounting for Income Taxes". This approach
   requires recognition of deferred tax assets and liabilities for the expected
   future tax consequences of events that have been included in the consolidated
   financial statements or tax returns. Using the enacted tax rates in effect
   for the year in which the differences are expected to reverse, deferred tax
   assets and liabilities are determined based on the differences between the
   financial reporting and the tax basis of an asset or liability. We record
   income tax expense in our consolidated financial statements based on an
   estimated annual effective income tax rate. Our tax rate for the three and
   nine months ended August 31, 2004 was 31% and 33%, respectively, as compared
   to 37% in the three and nine months ended August 31, 2003, respectively. The
   lower rates for the three and nine months ended August 31, 2004 reflect the
   implementation of a number of foreign and state tax planning initiatives,
   which include our determination during the third quarter of fiscal 2004 to
   reinvest indefinitely all undistributed earnings of Chattem (Canada), a
   wholly-owned subsidiary.

                                       13
<PAGE>

        Undistributed earnings of Chattem (Canada) amounted to approximately
   $496 and $1,441 for the three and nine months ended August 31, 2004,
   respectively. These earnings are considered to be reinvested indefinitely
   and, accordingly, no provision for U.S. federal and state income taxes has
   been provided thereon. Upon distribution of those earnings in the form of
   dividends or otherwise, we would be subject to U.S. income taxes (subject to
   an adjustment for foreign tax credits).

17. PRODUCT SEGMENT INFORMATION
    ---------------------------

        Net sales of our domestic product categories within our single
   healthcare business segment for the three and nine months ended August 31,
   2004 and 2003 are as follows:

                                    For the Three Months  For the Nine Months
                                      Ended August 31,      Ended August 31,
                                    -------------------   -------------------
                                      2004       2003       2004       2003
                                    --------   --------   --------   --------
   Topical analgesics               $ 20,118   $ 14,540   $ 53,964   $ 42,738
   Medicated skin care products       17,257     16,926     47,920     44,988
   Dietary supplements                 7,774      9,664     26,654     30,232
   Medicated dandruff shampoos
     and conditioner                   6,480      6,116     23,107     20,928
   Other OTC and toiletry products     8,210      6,490     27,485     23,711
                                    --------   --------   --------   --------
     Total                          $ 59,839   $ 53,736   $179,130   $162,597
                                    ========   ========   ========   ========

18. COMMITMENTS AND CONTINGENCIES
    -----------------------------

        GENERAL LITIGATION

        As of September 29, 2004, we were named as a defendant in approximately
   345 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. Most
   of the lawsuits seek an unspecified amount of compensatory and exemplary
   damages or punitive damages. The lawsuits that are federal cases have now
   been transferred to the United States District Court for the Western District
   of Washington before United States District Judge Barbara Jacobs Rothstein
   (IN RE PHENYLPROPANOLAMINE ("PPA") PRODUCTS LIABILITY LITIGATION, MDL NO.
   1407). The remaining cases are state court cases that have been filed in a
   number of different states.

        In an effort to achieve a global settlement of all DEXATRIM PPA product
   liability claims, on December 19, 2003, we entered into a memorandum of
   understanding with the Plaintiffs' Steering Committee ("PSC") in IN RE
   PHENYLPROPANOLAMINE ("PPA") PRODUCTS LIABILITY LITIGATION, MDL 1407, pending
   before the United States District Court for the Western District of
   Washington (the "Memorandum of Understanding"). The Memorandum of
   Understanding memorialized certain settlement terms concerning lawsuits
   relating to our DEXATRIM products containing PPA.

        On April 13, 2004, we entered into a class action settlement agreement
   with representatives of the plaintiffs' settlement class. The class action
   settlement agreement was generally consistent with the terms of and
   superceded the Memorandum of Understanding and provided for a national class
   action settlement of all DEXATRIM PPA claims. The court granted preliminary
   approval of the class action settlement on April 23, 2004.

        On August 26, 2004, a fairness hearing to consider final approval of the
   settlement was held before Judge Rothstein. At the conclusion of the hearing,
   Judge Rothstein stated that the court would prepare and enter an order
   certifying the class and granting approval of the settlement. We expect that
   the order will be entered in October 2004.

        The settlement includes claims against us involving alleged injuries by
   DEXATRIM products containing PPA that were alleged to have occurred after
   December 21, 1998, the date we acquired the DEXATRIM brand. In accordance
   with the terms of the class action settlement agreement, we previously
   published notice of the settlement and details as to the manner in which
   claims could be submitted. The deadline for submission of claims was July 7,
   2004. A total of 391 claims were submitted prior to the claims deadline. Of
   these 391 claims, 173 alleged stroke as an injury and 218 alleged other
   non-stroke injuries. These claims will be valued pursuant to the agreed upon
   settlement matrix that is designed to evaluate and determine the settlement
   value of each claim. A total of 16 claimants elected to opt out of the class
   settlement and may continue to pursue claims for damages against us in
   separate lawsuits.

        In accordance with the terms of the class action settlement agreement,
   $60,885 has been funded into a settlement trust from our first three layers
   of insurance coverage, as described below. In addition, on July 14, 2004, we
   entered into a settlement agreement with Sidmak Laboratories, Inc.
   ("Sidmak"), the manufacturer of DEXATRIM products containing PPA, pursuant to
   which Sidmak agreed to contribute $10,000 into the settlement trust within 30
   days after final court approval of

                                       14
<PAGE>

   the settlement. To the extent the amount in the settlement trust is
   insufficient to fully fund the settlement, we will be required to make
   additional contributions to the settlement trust in the future. We currently
   expect to use our cash on hand to fund any required additional contributions
   to the settlement trust. If we are required to fund significant other
   liabilities related to the PPA litigation beyond the settlement trust, either
   pursuant to the terms of the settlement, as a result of the opt out cases or
   otherwise, we will have significantly fewer sources of funds with which to
   satisfy such liabilities, and we may be unable to do so.

        We recorded a $3,463 charge in the second quarter of fiscal 2004 and an
   $834 charge in the third quarter of fiscal 2004 relating to settlement and
   administrative costs and expenses associated with the PPA litigation.
   Although we believe that an additional liability existed as of August 31,
   2004 related to the PPA litigation, due to the significant assumptions and
   uncertainty involved in estimating the value of cases included in the final
   settlement under the settlement matrix, as well as the opt out cases, we are
   not able to reasonably estimate if any additional payments by us will be
   required in excess of our insurance coverage and third party payments. As a
   result, we are not able to reasonably estimate the amount of such liability
   as of August 31, 2004 and have made no provision for this liability in the
   August 31, 2004 financial statements.

        We believe that approximately 206 or approximately 60% of the existing
   lawsuits in which we are named as a defendant relating to DEXATRIM containing
   PPA involve alleged injuries by DEXATRIM products containing PPA manufactured
   and sold prior to our acquisition of DEXATRIM on December 21, 1998. In these
   lawsuits, we are being defended on the basis of indemnification obligations
   assumed by The DELACO Company ("DELACO"), successor to Thompson Medical
   Company, Inc., which owned DEXATRIM prior to December 21, 1998. On February
   12, 2004, DELACO filed a Chapter 11 bankruptcy petition in the United States
   Bankruptcy Court for the Southern District of New York. Accordingly, it is
   uncertain whether DELACO will be able to indemnify us for claims arising from
   products manufactured and sold prior to our acquisition of DEXATRIM on
   December 21, 1998. However, DELACO is seeking to resolve all DEXATRIM cases
   with injury dates prior to December 21, 1998 as part of a liquidating Chapter
   11 bankruptcy plan. We understand that DELACO's product liability insurance
   carriers and other sources are expected to fund this plan. As part of
   DELACO's bankruptcy plan, if finally approved, we expect the bankruptcy court
   to release us from liability in DEXATRIM cases with injury dates prior to
   December 21, 1998, although there can be no assurances in this regard.

        On December 19, 2003, DELACO also entered into a Memorandum of
   Understanding with the PSC. If DELACO achieves resolution of the pre-December
   21, 1998 cases through its bankruptcy plan, we expect that the administrative
   process for DELACO's settlement will be similar to the process in our class
   action. We have filed a claim in DELACO's bankruptcy case in order to
   preserve our claims for indemnification against DELACO. As part of this
   Chapter 11 plan, we expect that after resolution of creditors' claims, DELACO
   will seek to liquidate and distribute all of its assets and will dissolve as
   a company.

        Our product liability insurance, as described below, would not apply to
   claims arising from products manufactured and sold prior to our acquisition
   of DEXATRIM. Although we expect the DELACO bankruptcy plan to resolve these
   cases, we will also seek to defend ourselves in these lawsuits on the basis
   that we did not manufacture and sell products containing PPA prior to
   December 21, 1998. In the approximately 206 cases that have been filed
   against us for products manufactured and sold prior to December 21, 1998,
   approximately half of the plaintiffs are in cases filed in states that we
   believe do not under current law impose liability upon a successor. The
   remaining plaintiffs are in cases filed in states that may in some
   circumstances permit liability against a successor. Even in these cases,
   although there can be no assurances, we do not believe that successor
   liability would be imposed against us. The reasons for our belief, among
   others, are that we did not purchase all of DELACO's assets and DELACO
   continued to operate its remaining business after December 21, 1998; we did
   not cause DELACO's bankruptcy; and many plaintiffs included in cases filed in
   states that in some circumstances impose successor liability are actually
   residents of other states.

        We have reached an agreement with Kemper Indemnity Insurance Company
   ("Kemper") to settle its lawsuit that sought to rescind our policy for
   $50,000 of excess coverage for product liability claims. After giving effect
   to the settlement with Kemper, we have available for the claims against us
   related to the PPA litigation, through our first three layers of insurance
   coverage, approximately $60,885 of the $77,000 of product liability coverage
   provided by these insurance policies. The $60,885 of available coverage
   consists of $37,500 of insurance under the Kemper policy and approximately
   $23,385 under policies with two other insurance companies. As indicated
   above, this $60,885 of coverage has been funded into a settlement trust in
   accordance with the terms of the class action settlement agreement.

        We continue to aggressively defend an action brought by Interstate Fire
   & Casualty Company ("Interstate") to rescind its $25,000 of excess coverage
   for product liability and pursue our available remedies at law against
   Interstate. We cannot ensure that we will be successful in retaining such
   excess coverage. The Interstate policy is in excess of the product liability
   insurance available from Kemper and the two other insurance companies
   referred to above. In the event the $60,885 of insurance funds available in
   the settlement trust and the $10,000 to be contributed by Sidmak, the
   manufacturer of the product, are exhausted under the PPA settlement or
   otherwise, coverage under the Interstate policy would not be available until
   we have paid $12,615 toward the settlement of PPA claims to reach the $83,500
   coverage point for the Interstate policy.

                                       15
<PAGE>

        We maintain a significantly lower level of insurance coverage for all
   other potential claims relating to our products including DEXATRIM products
   containing ephedrine. For the current policy period, our product liability
   insurance coverage for all of our other products, including DEXATRIM products
   containing ephedrine, consists of $10,000 of self-insured coverage through
   our captive insurance subsidiary, of which approximately $5,019 is currently
   funded, and a total of $40,000 of excess coverage through third party
   insurers.

        We have been named as a defendant in three lawsuits alleging that the
   plaintiff was injured as a result of the ingestion of DEXATRIM containing
   ephedrine. In addition, three individuals who allege injury caused by
   DEXATRIM containing ephedrine filed opt out notices in the PPA class action
   settlement. These three individuals have not filed lawsuits against us as of
   September 29, 2004. We intend to vigorously defend these lawsuits.

        We previously were named in a class action filed in the United States
   District Court for the Southern District of New York seeking certification of
   a class consisting of New York residents who have purchased DEXATRIM Results
   or DEXATRIM Natural since January 2000. The class action lawsuit sought
   compensatory and punitive damages arising out of allegedly false advertising
   in connection with the sale of DEXATRIM Results and DEXATRIM Natural
   products. None of the plaintiffs in this action alleged personal injury as a
   result of the ingestion of a DEXATRIM product. On March 29, 2004, a
   stipulation was submitted to the court dismissing the case on jurisdictional
   grounds. Pursuant to the stipulation, the plaintiffs may re-file the class
   action in New York state court. These plaintiffs have not refiled this
   lawsuit as of September 29, 2004.

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

        We have been named as a defendant in a putative class action suit filed
   in the Superior Court of the State of California for the County of Los
   Angeles. The lawsuit seeks certification of classes consisting of residents
   of the United States, or residents of the State of California, who have
   purchased our BULLFROG sun care products during the past four years. The
   lawsuit seeks injunctive relief and compensatory damages under the California
   Business and Professions Code against us arising out of alleged deceptive,
   untrue or misleading advertising, and breach of warranty, in connection with
   the manufacturing, labeling, advertising, promotion and sale of BULLFROG
   products. The plaintiff has stipulated that the amount in controversy with
   respect to plaintiffs' individual claim and each member of the proposed class
   does not exceed $75. We filed an answer on June 28, 2004 and intend to defend
   vigorously the 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 and other alleged injuries or damage. The outcome of
   such litigation cannot be predicted, but, in the opinion of management, based
   in part upon assessments from counsel, all such other pending matters are
   without merit or are of such kind or involve such other amounts as would not
   have a material adverse effect on our financial position, results of
   operations or cash flows if disposed of unfavorably.

        REGULATORY

        The FDA, the Drug Enforcement Administration and a number of state and
   local governments have enacted or proposed restrictions or prohibitions on
   the sale of products that contain ephedrine. Ephedrine can refer to the
   herbal substance derived from the plant ephedra or the plant heart leaf,
   which, until September 2002, was used in the manufacturing of some forms of
   DEXATRIM Natural and DEXATRIM Results, or synthetic ephedrine, an FDA
   regulated ingredient used in some OTC drug products, which has not been used
   in our products. These restrictions include the prohibition of OTC sales,
   required warnings or labeling statements, record keeping and reporting
   requirements, the prohibition of sales to minors, per transaction limits on
   the quantity of product that may be purchased and limitations on advertising
   and promotion.

        In 1997, the FDA published a proposed rule on the use of dietary
   supplements containing ephedrine alkaloids. In June 2002, the United States
   Department of Health and Human Services ("HHS") proposed an expanded
   scientific evaluation of ephedra which led to the issuance of a report by the
   RAND-based Southern California Evidence-Based Practice Center (the "RAND
   Report"). The RAND Report concluded that ephedrine, ephedrine plus caffeine
   and ephedra-containing dietary supplements with or without herbs containing
   caffeine all promote modest amounts of weight loss over the short term and

                                       16
<PAGE>

   use of ephedra or ephedrine plus caffeine is associated with an increased
   risk of gastrointestinal, psychiatric and autonomic symptoms. The adverse
   event reports contained a smaller number of more serious adverse events.
   Given the small number of such events, the RAND Report concluded that further
   study would be necessary to determine whether consumption of ephedra or
   ephedrine may be causally related to these serious adverse events. In
   connection with the RAND Report, HHS sought public comment on whether
   additional measures are required concerning the sale and distribution of
   dietary supplements containing ephedrine alkaloids.

        On December 30, 2003, the FDA issued a consumer alert on the safety of
   dietary supplements containing ephedrine alkaloids and on February 6, 2004
   published a final rule with respect to these products. The final rule
   prohibits the sale of dietary supplements containing ephedrine alkaloids
   because such supplements present an unreasonable risk of illness or injury.
   The final rule became effective on April 11, 2004. We discontinued the
   manufacturing and shipment of DEXATRIM containing ephedrine in September
   2002.

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

        Certain of our topical analgesic products are currently marketed under
   an FDA tentative final monograph. The FDA has proposed that the final
   monograph exclude external analgesic products in patch, plaster, or poultice
   form, unless the FDA receives additional data supporting the safety and
   efficacy of these products. On October 14, 2003, we submitted to the FDA
   information regarding the safety of our ICY HOT patches and arguments to
   support our product's inclusion in the final monograph. We have also
   participated in an industry effort coordinated by the Consumer Healthcare
   Products Association ("CHPA") to establish with the FDA a protocol of
   additional research that will allow the patches to be marketed under the
   final monograph even if the final monograph does not explicitly allow them.
   The CHPA submission to the FDA was made on October 15, 2003. This additional
   research may require a considerable amount of expensive testing and data
   analysis by expert consultants. Some of this cost may be shared with other
   patch manufacturers. We believe that the monograph is unlikely to become
   final and take effect before January 2006. If neither action described above
   is successful and the final monograph excludes such products, we would have
   to file and receive approval of a new drug application ("NDA") in order to
   continue to market the ICY HOT Patch or similar delivery systems under our
   other topical analgesic brands. In such case, we would have to remove the
   existing product from the market as of one year from the effective date of
   the final monograph, pending FDA review and approval of an NDA. The
   preparation of an NDA would likely take us six to 18 months and would be
   expensive. It typically takes the FDA at least 12 months to rule on an NDA
   once it is submitted.

        We have responded to certain questions with respect to efficacy received
   from the FDA in connection with clinical studies for pyrilamine maleate, one
   of the active ingredients used in certain of the PAMPRIN and PREMSYN 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. We have been actively monitoring the process and
   do not believe that either PAMPRIN or PREMSYN PMS will be materially
   adversely affected by the FDA review. We believe that any adverse finding by
   the FDA would likewise affect our principal competitors in the menstrual
   product category. In a letter dated January 22, 2004, the FDA wrote the
   boards of pharmacy in each state regarding the FDA's concern about products
   (both OTC and prescription) that contain acetaminophen. In that letter the
   FDA expressed concern about the potential toxicity due to concomitant use of
   OTC and prescription drugs that contain the ingredient acetaminophen, an
   ingredient also found in PAMPRIN and PREMSYN 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. There can be no assurance as to what action, if any, the
   FDA may take with respect to acetaminophen.

        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

                                       17
<PAGE>

   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 titantium dioxide on the
   state's list of suspected carcinogens. Titantium 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 titantium dioxide presents "no significant
   risk" to consumers.

19. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

        The condensed 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 August 31,
   2004 arose in conjunction with Chattem's issuance of the Revolving Credit
   Facility, the Floating Rate Notes and the 7.0% Subordinated Notes (See Note
   12). The maximum amount of future payments the guarantors would be required
   to make under the guarantees as of August 31, 2004 is $200,000.






















                                       18
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS

August 31, 2004
(Unaudited and in thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>
ASSETS
------

CURRENT ASSETS:
  Cash and cash equivalents                            $  15,849       $   2,523       $   8,383       $      --       $  26,755
  Accounts receivable, less allowances of $3,310          26,929           9,677           5,312          (9,677)         32,241
  Interest receivable                                         --             619              --            (619)             --
  Inventories                                             13,358           3,783           2,408              --          19,549
  Refundable income taxes                                  5,258              --              15              --           5,273
  Deferred income taxes                                    1,635              --              --              --           1,635
  Prepaid expenses and other current assets                3,224              --             145              --           3,369
                                                       ---------       ---------       ---------       ---------       ---------
    Total current assets                                  66,253          16,602          16,263         (10,296)         88,822
                                                       ---------       ---------       ---------       ---------       ---------

PROPERTY, PLANT AND EQUIPMENT, NET                        26,896             775             322              --          27,993
                                                       ---------       ---------       ---------       ---------       ---------

OTHER NONCURRENT ASSETS:
  Patents, trademarks and other purchased
    product  rights, net                                     836         307,087              --         (62,290)        245,633
  Debt issuance costs, net                                 5,348              --              --              --           5,348
  Investment in subsidiaries                             261,034          33,000          66,024        (360,058)             --
  Note receivable                                             --          33,000              --         (33,000)             --
  Other                                                    3,159              --             400              --           3,559
                                                       ---------       ---------       ---------       ---------       ---------
    Total other noncurrent assets                        270,377         373,087          66,424        (455,348)        254,540
                                                       ---------       ---------       ---------       ---------       ---------

      TOTAL ASSETS                                     $ 363,526       $ 390,464       $  83,009       $(465,644)      $ 371,355
                                                       =========       =========       =========       =========       =========

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

CURRENT LIABILITIES:
  Accounts payable and other                           $   8,560       $      --       $   1,836       $      --       $  10,396
  Accrued liabilities                                     19,320           1,306           1,851         (10,296)         12,181
                                                       ---------       ---------       ---------       ---------       ---------
    Total current liabilities                             27,880           1,306           3,687         (10,296)         22,577
                                                       ---------       ---------       ---------       ---------       ---------

LONG-TERM DEBT                                           200,000              --          33,000         (33,000)        200,000
                                                       ---------       ---------       ---------       ---------       ---------

DEFERRED INCOME TAXES                                       (786)         31,808             (47)             --          30,975
                                                       ---------       ---------       ---------       ---------       ---------

OTHER NONCURRENT LIABILITIES                               1,738              --              --              --           1,738
                                                       ---------       ---------       ---------       ---------       ---------

INTERCOMPANY ACCOUNTS                                     18,629         (19,627)            998              --              --
                                                       ---------       ---------       ---------       ---------       ---------

SHAREHOLDERS' EQUITY:
  Preferred shares, without par value,
    authorized 1,000, none issued                             --              --              --              --              --
  Common shares, without par value,
    authorized 50,000, issued 19,752                      83,425              --              --              --          83,425
  Share capital of subsidiaries                               --         330,586          38,647        (369,233)             --
  Retained earnings                                       37,543          46,391           6,749         (53,140)         37,543
                                                       ---------       ---------       ---------       ---------       ---------
    Total                                                120,968         376,977          45,396        (422,373)        120,968
                                                       ---------       ---------       ---------       ---------       ---------
  Unamortized value of restricted common
    shares issued                                         (2,668)             --              --              --          (2,668)
  Cumulative other comprehensive income,
  net of taxes:
    Interest rate cap adjustment                            (259)             --              --              --            (259)
    Foreign currency translation adjustment                 (336)             --             (25)             25            (336)
    Minimum pension liability adjustment                  (1,640)             --              --              --          (1,640)
                                                       ---------       ---------       ---------       ---------       ---------
    Total shareholders' equity                           116,065         376,977          45,371        (422,348)        116,065
                                                       ---------       ---------       ---------       ---------       ---------

      TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY       $ 363,526       $ 390,464       $  83,009       $(465,644)      $ 371,355
                                                       =========       =========       =========       =========       =========
</TABLE>

                                       19
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS

NOVEMBER 30, 2003
(In thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>
ASSETS
------

CURRENT ASSETS:
  Cash and cash equivalents                            $  18,702       $   1,964       $   6,265       $      --       $  26,931
  Accounts receivable, less allowances of $3,594          21,729           7,089           3,749          (7,089)         25,478
  Inventories                                             12,670           2,040           2,849              --          17,559
  Refundable income taxes                                  4,414              --              17              --           4,431
  Deferred income taxes                                    3,441              --              --              --           3,441
  Prepaid expenses and other current assets                4,401              --             142          (1,167)          3,376
                                                       ---------       ---------       ---------       ---------       ---------
    Total current assets                                  65,357          11,093          13,022          (8,256)         81,216
                                                       ---------       ---------       ---------       ---------       ---------

PROPERTY, PLANT AND EQUIPMENT, NET                        27,595             775             352              --          28,722
                                                       ---------       ---------       ---------       ---------       ---------

OTHER NONCURRENT ASSETS:
  Patents, trademarks and other purchased product
    rights, net                                            1,057         307,080              --         (62,290)        245,847
  Debt issuance costs, net                                 5,504              --              --              --           5,504
  Investment in subsidiaries                             236,053              --              --        (236,053)             --
  Other                                                    1,596              --             500              --           2,096
                                                       ---------       ---------       ---------       ---------       ---------
    Total other noncurrent assets                        244,210         307,080             500        (298,343)        253,447
                                                       ---------       ---------       ---------       ---------       ---------

      TOTAL ASSETS                                     $ 337,162       $ 318,948       $  13,874       $(306,599)      $ 363,385
                                                       =========       =========       =========       =========       =========

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

CURRENT LIABILITIES:
  Current maturities of long-term debt                 $   7,750       $      --       $      --       $      --       $   7,750
  Accounts payable and other                               9,804              --           1,120              --          10,924
  Accrued liabilities                                     21,417             628           2,190          (8,256)         15,979
                                                       ---------       ---------       ---------       ---------       ---------
    Total current liabilities                             38,971             628           3,310          (8,256)         34,653
                                                       ---------       ---------       ---------       ---------       ---------

LONG-TERM DEBT, less current maturities                  204,676              --              --              --         204,676
                                                       ---------       ---------       ---------       ---------       ---------

DEFERRED INCOME TAXES                                       (239)         26,788             (48)             --          26,501
                                                       ---------       ---------       ---------       ---------       ---------

OTHER NONCURRENT LIABILITIES                               1,689              --              --              --           1,689
                                                       ---------       ---------       ---------       ---------       ---------

INTERCOMPANY ACCOUNTS                                     (3,801)          3,469             332              --              --
                                                       ---------       ---------       ---------       ---------       ---------

SHAREHOLDERS' EQUITY:
  Preferred shares, without par value, authorized
    1,000, none issued                                        --              --              --              --              --
  Common shares, without par value, authorized
    50,000, issued 19,161                                 77,815              --              --              --          77,815
  Share capital of subsidiaries                               --         263,704           6,504        (270,208)             --
  Retained earnings                                       22,274          24,359           3,998         (28,357)         22,274
                                                       ---------       ---------       ---------       ---------       ---------
    Total                                                100,089         288,063          10,502        (298,565)        100,089
                                                       ---------       ---------       ---------       ---------       ---------
  Unamortized value of restricted common shares
    issued                                                (2,058)             --              --              --          (2,058)
  Cumulative other comprehensive income, net
  of taxes:
    Foreign currency translation adjustment                 (525)             --            (222)            222            (525)
    Minimum pension liability adjustment                  (1,640)             --              --              --          (1,640)
                                                       ---------       ---------       ---------       ---------       ---------
    Total shareholders' equity                            95,866         288,063          10,280        (298,343)         95,866
                                                       ---------       ---------       ---------       ---------       ---------

      TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY       $ 337,162       $ 318,948       $  13,874       $(306,599)      $ 363,385
                                                       =========       =========       =========       =========       =========
</TABLE>

                                       20
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2004
(Unaudited and in thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>

TOTAL REVENUES                                         $ 158,569       $  55,984       $  13,360       $ (30,449)      $ 197,464
                                                       ---------       ---------       ---------       ---------       ---------

COSTS AND EXPENSES:
  Cost of sales                                           45,211           7,701           5,401          (1,670)         56,643
  Advertising and promotion                               44,765           8,089           3,424              --          56,278
  Selling, general and administrative                     31,711             339             781              --          32,831
  Litigation settlement                                    4,491              --              --              --           4,491
  Equity in subsidiary income                            (24,783)             --              --          24,783              --
                                                       ---------       ---------       ---------       ---------       ---------
    Total costs and expenses                             101,395          16,129           9,606          23,113         150,243
                                                       ---------       ---------       ---------       ---------       ---------

INCOME FROM OPERATIONS                                    57,174          39,855           3,754         (53,562)         47,221
                                                       ---------       ---------       ---------       ---------       ---------

OTHER INCOME (EXPENSE):
  Interest expense                                       (11,678)             --          (1,856)          1,856         (11,678)
  Investment and other income, net                           100           1,859           1,352          (3,106)            205
  Loss on early extinguishment of debt                   (12,958)             --              --              --         (12,958)
  Royalties                                              (24,359)         (4,420)             --          28,779              --
  Corporate allocations                                    2,631          (2,545)            (86)             --              --
                                                       ---------       ---------       ---------       ---------       ---------
    Total other income (expense)                         (46,264)         (5,106)           (590)         27,529         (24,431)
                                                       ---------       ---------       ---------       ---------       ---------

INCOME BEFORE INCOME TAXES                                10,910          34,749           3,164         (26,033)         22,790
                                                       ---------       ---------       ---------       ---------       ---------

(BENEFIT FROM) PROVISION FOR INCOME TAXES                 (4,359)         11,467             413              --           7,521
                                                       ---------       ---------       ---------       ---------       ---------

NET INCOME                                             $  15,269       $  23,282       $   2,751       $ (26,033)      $  15,269
                                                       =========       =========       =========       =========       =========
</TABLE>







                                       21
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF INCOME

FOR THE NINE MONTHS ENDED AUGUST 31, 2003
(Unaudited and in thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>

TOTAL REVENUES                                         $ 138,026       $  53,896       $  14,225       $ (24,907)      $ 181,240
                                                       ---------       ---------       ---------       ---------       ---------

COSTS AND EXPENSES:
  Cost of sales                                           39,530           8,113           5,873          (2,117)         51,399
  Advertising and promotion                               41,218           8,333           4,458              --          54,009
  Selling, general and administrative                     28,510             208           1,727              --          30,445
  Equity in subsidiary income                            (22,792)             --              --          22,792              --
                                                       ---------       ---------       ---------       ---------       ---------
    Total costs and expenses                              86,466          16,654          12,058          20,675         135,853
                                                       ---------       ---------       ---------       ---------       ---------

INCOME FROM OPERATIONS                                    51,560          37,242           2,167         (45,582)         45,387
                                                       ---------       ---------       ---------       ---------       ---------

OTHER INCOME (EXPENSE):
  Interest expense                                       (15,431)             --              --              --         (15,431)
  Investment and other income, net                            69               3              47              --             119
  Royalties                                              (20,951)         (1,561)           (278)         22,790              --
  Corporate allocations                                    2,951          (2,870)            (81)             --              --
                                                       ---------       ---------       ---------       ---------       ---------
    Total other income (expense)                         (33,362)         (4,428)           (312)         22,790         (15,312)
                                                       ---------       ---------       ---------       ---------       ---------

INCOME BEFORE INCOME TAXES                                18,198          32,814           1,855         (22,792)         30,075

(BENEFIT FROM) PROVISION FOR INCOME TAXES
                                                            (749)         11,435             442              --          11,128
                                                       ---------       ---------       ---------       ---------       ---------

NET INCOME                                             $  18,947       $  21,379       $   1,413       $ (22,792)      $  18,947
                                                       =========       =========       =========       =========       =========
</TABLE>







                                       22
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED AUGUST 31, 2004
(Unaudited and in thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>

OPERATING ACTIVITIES:
  Net income                                           $  15,269       $  23,282       $   2,751       $ (26,033)      $  15,269
  Adjustments to reconcile net income to net cash
  provided by operating activities:
    Depreciation and amortization                          4,549              --              60              --           4,609
    Deferred income taxes                                  1,260           5,020              --              --           6,280
    Tax benefit realized from stock option exercises       4,036              --              --              --           4,036
    Loss on early extinguishment of debt                  12,958              --              --              --          12,958
    Other, net                                                33              --              20              --              53
    Equity in subsidiary income                          (26,033)             --              --          26,033              --
    Changes in operating assets and liabilities:
      Accounts receivable                                 (5,200)         (2,588)         (1,563)          2,588          (6,763)
      Interest receivable                                     --            (619)             --             619              --
      Inventories                                           (688)         (1,743)            441              --          (1,990)
      Refundable income taxes                               (844)             --               2              --            (842)
      Prepaid expenses and other current assets            1,223              --              (2)         (1,167)             54
      Accounts payable and accrued liabilities            (3,341)            678             377          (2,040)         (4,326)
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash provided by operating activities          3,222          24,030           2,086              --          29,338
                                                       ---------       ---------       ---------       ---------       ---------
INVESTING ACTIVITIES:
  Purchases of property, plant and equipment              (1,753)             --             (10)             --          (1,763)
  Purchases of patents, trademarks and other
    product rights                                            --              (8)             --              --              (8)
  Increase in note receivable                                 --         (33,000)             --          33,000              --
  (Increase) decrease in other assets, net                  (998)             --             404              --            (594)
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash (used in) provided by investing
        activities                                        (2,751)        (33,008)            394          33,000          (2,365)
                                                       ---------       ---------       ---------       ---------       ---------
FINANCING ACTIVITIES:
  Repayment of long-term debt                           (212,288)             --              --              --        (212,288)
  Proceeds from long-term debt                           200,000              --              --              --         200,000
  Proceeds from borrowings under revolving credit
    facility                                              25,000              --              --              --          25,000
  Payments of revolving credit facility                  (25,000)             --              --              --         (25,000)
  Proceeds from exercise of stock options                  5,139              --              --              --           5,139
  Repurchase of common shares                             (5,015)             --              --              --          (5,015)
  Increase in debt issuance costs                         (5,729)             --              --              --          (5,729)
  Retirement of debt issuance costs                       (7,861)             --              --              --          (7,861)
  Premium on interest rate cap agreement                  (1,375)             --              --              --          (1,375)
  Intercompany debt proceeds, net                             --              --          33,000         (33,000)             --
  Changes in intercompany accounts                        23,805          10,787         (34,592)             --              --
  Dividends paid                                              --          (1,250)          1,250              --              --
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash (used in) provided by financing
        activities                                        (3,324)          9,537            (342)        (33,000)        (27,129)
                                                       ---------       ---------       ---------       ---------       ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS                                          --              --             (20)             --             (20)
                                                       ---------       ---------       ---------       ---------       ---------
CASH AND CASH EQUIVALENTS:
  (Decrease) increase for the period                      (2,853)            559           2,118              --            (176)
  At beginning of period                                  18,702           1,964           6,265              --          26,931
                                                       ---------       ---------       ---------       ---------       ---------
  At end of period                                     $  15,849       $   2,523       $   8,383       $      --       $  26,755
                                                       =========       =========       =========       =========       =========
</TABLE>
                                       23
<PAGE>
                                                                         Note 19
CHATTEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED AUGUST 31, 2003
(Unaudited and in thousands)
<TABLE><CAPTION>
                                                                       GUARANTOR     NON-GUARANTOR
                                                                       SUBSIDIARY      SUBSIDIARY
                                                        CHATTEM        COMPANIES       COMPANIES      ELIMINATIONS    CONSOLIDATED
                                                       ---------       ---------       ---------       ---------       ---------
<S>                                                    <C>             <C>             <C>             <C>             <C>

OPERATING ACTIVITIES:
  Net income                                           $  18,947       $  21,379       $   1,413       $ (22,792)      $  18,947
  Adjustments to reconcile net income to net cash
   provided by operating activities:
    Depreciation and amortization                          4,451              --             114              --           4,565
    Deferred income taxes                                    713           5,401             (10)             --           6,104
    Tax benefit realized from stock option exercises       1,240              --              --              --           1,240
    Other, net                                              (101)             --               7              --             (94)
    Equity in subsidiary income                          (22,792)             --              --          22,792              --
    Changes in operating assets and liabilities:
      Accounts receivable                                 (3,293)        (15,821)            426          15,821          (2,867)
      Inventories                                         (1,321)            809            (497)             --          (1,009)
      Refundable income taxes                               (256)             --              --              --            (256)
      Prepaid expenses and other current assets             (664)             --            (104)             --            (768)
      Accounts payable and accrued liabilities            12,640           1,235             197         (15,821)         (1,749)
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash provided by operating activities          9,564          13,003           1,546              --          24,113
                                                       ---------       ---------       ---------       ---------       ---------

INVESTING ACTIVITIES:
  Purchases of property, plant and equipment              (3,800)             --            (133)             --          (3,933)
  Purchases of patents, trademarks and other
    products rights                                           --            (373)             --              --            (373)
  Increase in other assets, net                             (250)             --             (35)             --            (285)
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash used in investing activities             (4,050)           (373)           (168)             --          (4,591)
                                                       ---------       ---------       ---------       ---------       ---------

FINANCING ACTIVITIES:
  Repayment of long-term debt                            (10,000)             --              --              --         (10,000)
  Proceeds from exercise of stock options                  1,533              --              --              --           1,533
  Repurchase of common shares                             (5,351)             --              --              --          (5,351)
  Deferred debt issuance costs                               (25)             --              --              --             (25)
  Changes in intercompany accounts                         7,541         (10,277)          2,736              --              --
  Dividends paid                                           3,000          (3,000)             --              --              --
                                                       ---------       ---------       ---------       ---------       ---------
        Net cash (used in) provided by financing
        activities                                        (3,302)        (13,277)          2,736              --         (13,843)
                                                       ---------       ---------       ---------       ---------       ---------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS                                     --              --             118              --             118
                                                       ---------       ---------       ---------       ---------       ---------

CASH AND CASH EQUIVALENTS:
  Increase (decrease) for the period                       2,212            (647)          4,232              --           5,797
  At beginning of period                                  11,505           1,138           3,281              --          15,924
                                                       ---------       ---------       ---------       ---------       ---------
  At end of period                                     $  13,717       $     491       $   7,513       $      --       $  21,721
                                                       =========       =========       =========       =========       =========
</TABLE>






                                       24
<PAGE>

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 2003
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
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 Securities and Exchange Commission.

OVERVIEW
--------

     We are a leading marketer and manufacturer of a broad portfolio of branded
over-the-counter ("OTC") healthcare products, toiletries and dietary supplements
including such categories as topical analgesics, medicated skin care products,
medicated dandruff shampoos and conditioner, dietary supplements, and other OTC
and toiletry products. Our portfolio of products includes well-recognized brands
such as:

     o    Topical analgesics such as ICY HOT and ASPERCREME;

     o    Medicated skin care products such as GOLD BOND medicated skin care
          powder, cream, lotion, first aid, and foot care products; and
          PHISODERM medicated acne treatment products and skin cleansers;

     o    SELSUN BLUE medicated dandruff shampoos and conditioner;

     o    Dietary supplements including DEXATRIM, GARLIQUE and NEW PHASE; and

     o    Other OTC and toiletry products such as PAMPRIN, a menstrual
          analgesic; HERPECIN-L, a lip care product; BENZODENT, a dental
          analgesic cream; and toiletries such as BULLFROG, a line of sunblocks;
          ULTRASWIM, a chlorine-removing shampoo; and SUN-IN, a hair lightener.

     Our products typically target niche markets that are often outside the core
product areas of larger companies where we believe we can achieve and sustain
significant market penetration through innovation and strong advertising and
promotion support. Many of our products are among the U.S. market leaders in
their respective categories. For example, our portfolio of topical analgesic
brands and our GOLD BOND medicated body powders have the leading U.S. market
share in these categories. We support our brands through extensive and
cost-effective advertising and promotion, the expenditures for which represented
approximately 29% of our total revenues in the nine months ended August 31,
2004. We sell our products nationally through mass merchandiser, drug and food
channels principally utilizing our own sales force.

     Our strategy to achieve future growth is to generate new sales through
strong marketing and promotional programs, new product development, acquisitions
of new brands, development of strategic marketing alliances and expansion of our
international business. As previously high-growth brands mature, sales increases
will become even more dependent on the development of successful line
extensions, international expansion and acquisitions. During the first quarter
of fiscal 2004, we introduced the DEXATRIM All in One Bar, SELSUN BLUE
Conditioner, PAMPRIN All Day, BULLFROG SuperBlock Spray Lotion and PHISODERM
CLEAR CONFIDENCE Self Heating Daily Scrub and Herbal Astringent. In the second
quarter of fiscal 2004, we introduced the ICY HOT Medicated Sleeve. Line
extensions, product introductions and acquisitions require a significant amount
of introductory advertising and promotional support. For a period of time, these
products do not generate a commensurate amount of sales or earnings. As a
result, we may experience a short-term impact on our profitability due to line
extensions and acquisitions.

     In March 2002, we acquired worldwide rights (except in India) to
manufacture, sell and market SELSUN BLUE, which is marketed internationally as
SELSUN, plus related intellectual property and certain manufacturing equipment
from Abbott Laboratories ("Abbott"). Abbott, or manufacturers under contract to
Abbott, manufactured SELSUN BLUE for us domestically until June 2003 and
internationally until the end of March 2004. We have entered into an amendment
to the manufacturing agreement with Abbott under which Abbott will continue to
manufacture SELSUN for us for the European, Middle East and several Latin
American markets for an additional period ending July 2005 at agreed upon rates,
which vary by market. Abbott will also continue to serve as our distributor for
SELSUN in certain foreign countries under separate distribution agreements. All
of our North American SELSUN BLUE product lines are presently being manufactured
at our Chattanooga facilities. During a transition period which ended March 28,
2004, Abbott also marketed, sold and distributed SELSUN products for us in
certain foreign countries until we could satisfy various foreign regulatory
requirements, new distributors were in place and any applicable marketing
permits were transferred. During the transition period, Abbott paid us an
initial royalty equal to 28% of international

                                       25
<PAGE>

sales of SELSUN in these countries with the royalty reduced to 14% of
international sales in certain countries if foreign regulatory requirements were
satisfied prior to our assumption of sales and marketing responsibility in such
countries. During the transition period, Abbott paid all costs and expenses
related to the manufacture, marketing and sales of SELSUN in these countries. As
we assumed responsibility for the sales and marketing effort in a country, the
royalty arrangement with respect to such country terminated. We then recorded
these international sales directly as well as the costs and expenses associated
with these sales. Abbott has agreed to extend the transition beyond March 28,
2004 in several countries where we are still awaiting regulatory approval of the
transfer. In certain international markets, we sell SELSUN through a distributor
and receive a royalty based on a percentage of distributor sales.

     In January 2004, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $20.0 million.
For the nine months ended August 31, 2004, we repurchased 190,100 shares for
$5.0 million. The remaining availability under the board authorization was $15.0
million as of August 31, 2004. We are limited in our ability to repurchase
shares due to restrictions under the terms of our Senior Secured Revolving
Credit Facility due February 26, 2009 (the "Revolving Credit Facility") and the
indentures pursuant to which the Floating Rate Senior Notes due 2010 (the
"Floating Rate Notes") and 7.0 % Senior Subordinated Fixed Rate Notes due 2014
(the "7.0% Subordinated Notes") were issued.

     Our net income margin (net income/total revenues) was 13.2% and 11.6% for
the third quarter of fiscal 2004 and 2003, respectively, and 7.7% and 10.5% for
the nine months ended August 31, 2004 and 2003, respectively. Our net income
(excluding debt extinguishment and litigation settlement charges) margin (net
income (excluding debt extinguishment and litigation settlement charges)/total
revenues) was 14.1% and 13.7% for the three and nine months ended August 31,
2004, respectively. We believe that disclosure of net income (excluding debt
extinguishment and litigation settlement charges) margin provides investors with
useful information regarding the Company's financial performance and allows for
easier comparison with net income margin without the effect of these charges in
prior periods. A reconciliation of net income (excluding debt extinguishment and
litigation settlement charges) to net income for the three and nine months ended
August 31, 2004 is presented in the following table:

                                               For the Three      For the Nine
                                               Months Ended       Months Ended
                                              August 31, 2004    August 31, 2004
                                              ---------------    ---------------
                                                    (dollars in thousands)

Net income                                       $   8,734          $  15,269
Add:
       Loss on early extinguishment of debt            --              12,958
       Litigation settlement charges                   834              4,491
       Benefit from income taxes                      (275)            (5,758)
                                                 ---------          ---------
Net income (excluding debt extinguishment and
  litigation settlement charges)                 $   9,293          $  26,960
                                                 =========          =========

Net income (excluding debt extinguishment and
  litigation settlement charges) margin              14.1%              13.7%
                                                 =========          =========









                                       26
<PAGE>

     EBITDA, earnings before interest, taxes, depreciation and amortization, is
a key non-GAAP financial measure used by us to measure operating performance but
may not be comparable to similarly titled measures reported by other companies.
The most directly comparable GAAP financial measure is net income. EBITDA is
used by us to supplement net income as an indicator of operating performance and
not as an alternative to measures defined and required by U.S. generally
accepted accounting principles. We consider EBITDA an important indicator of our
operational strength and performance, including our ability to pay interest,
service debt and fund capital expenditures. EBITDA should be considered in
addition to, but not as a substitute for, operating income, net income and other
measures of financial performance reported in accordance with U.S. generally
accepted accounting principles. EBITDA is also one measure used in the
calculation of certain ratios to determine our compliance with the terms of our
Revolving Credit Facility.

     A reconciliation of EBITDA and EBITDA (excluding litigation settlement
charges) to net income is presented in the following table:
<TABLE><CAPTION>

                                                               For the Three Months Ended
                                                   -------------------------------------------------
                                                                               Dollar     Percentage
                                                   August 31,   August 31,    Increase     Increase
                                                      2004         2003      (Decrease)   (Decrease)
                                                   ----------   ----------   ----------   ----------
                                                                 (dollars in thousands)
<S>                                                <C>          <C>          <C>               <C>
     Net income                                    $    8,734   $    6,837   $    1,897        27.7%
     Add:
       Provision for income taxes                       4,002        4,016          (14)       (0.3)
       Interest expense, net (includes loss on
         early extinguishment of debt in 2004)          3,239        5,025       (1,786)      (35.5)
       Depreciation and amortization less
         amounts included in interest                   1,341        1,153          188        16.3
                                                   ----------   ----------   ----------
     EBITDA                                        $   17,316   $   17,031   $      285         1.7
                                                   ==========   ==========   ==========
        Litigation settlement charges                     834          --           834          nm
                                                   ----------   ----------   ----------
     EBITDA (excluding litigation settlement
        charges)                                   $   18,150   $   17,031   $    1,119         6.6
                                                   ==========   ==========   ==========

     EBITDA margin (EBITDA/total revenues)              26.2%        28.8%
                                                   ==========   ==========

     EBITDA (excluding litigation settlement
        charges) margin (EBITDA (excluding
        litigation settlement charges)/total
        revenues)                                       27.4%        28.8%
                                                   ==========   ==========


                                                               For the Nine Months Ended
                                                   -------------------------------------------------
                                                                               Dollar     Percentage
                                                   August 31,   August 31,    Increase     Increase
                                                      2004         2003      (Decrease)   (Decrease)
                                                   ----------   ----------   ----------   ----------
                                                                 (dollars in thousands)

     Net income                                    $   15,269   $   18,947   $   (3,678)     (19.4%)
     Add:
       Provision for income taxes                       7,521       11,128       (3,607)     (32.4)
       Interest expense, net (includes loss on
         early extinguishment of debt in 2004)         24,431       15,312        9,119       59.6
       Depreciation and amortization less
         amounts included in interest                   3,958        3,305          653       19.8
                                                   ----------   ----------   ----------
     EBITDA                                        $   51,179   $   48,692   $    2,487        5.1
                                                   ==========   ==========   ==========
        Litigation settlement charges                   4,491          --         4,491         nm
                                                   ----------   ----------   ----------
     EBITDA (excluding litigation settlement
        charges)                                   $   55,670   $   48,692   $    6,978       14.3
                                                   ==========   ==========   ==========

     EBITDA margin (EBITDA/total revenues)              25.9%        26.9%
                                                   ==========   ==========

     EBITDA (excluding litigation settlement
        charges) margin (EBITDA (excluding
        litigation settlement charges)/total
        revenues)                                       28.2%        26.9%
                                                   ==========   ==========
</TABLE>

     In an effort to achieve a global settlement of all DEXATRIM PPA product
liability claims, on December 19, 2003, we entered into a memorandum of
understanding with the Plaintiffs' Steering Committee ("PSC") in IN RE
PHENYLPROPANOLAMINE ("PPA") PRODUCTS LIABILITY LITIGATION, MDL 1407, pending
before the United States District Court for the Western District of

                                       27
<PAGE>

Washingtion (the "Memorandum of Understanding"). The Memorandum of Understanding
memorialized certain settlement terms concerning lawsuits relating to DEXATRIM
products containing PPA.

     On April 13, 2004, we entered into a class action settlement agreement with
representatives of the plaintiffs' settlement class. The class action settlement
agreement was generally consistent with the terms of and superceded the
Memorandum of Understanding and provided for a national class action settlement
of all DEXATRIM PPA claims. The court granted preliminary approval of the class
action settlement on April 23, 2004.

     On August 26, 2004, a fairness hearing to consider final approval of the
settlement was held before Judge Rothstein. At the conclusion of the hearing,
Judge Rothstein stated that the court would prepare and enter an order
certifying the class and granting approval of the settlement. We expect that the
order will be entered in October 2004.

     The settlement includes claims against us involving alleged injuries by
DEXATRIM products containing PPA that were alleged to have occurred after
December 21, 1998, the date we acquired the DEXATRIM brand. In accordance with
the terms of the class action settlement agreement, we previously published
notice of the settlement and details as to the manner in which claims could be
submitted. The deadline for submission of claims was July 7, 2004. A total of
391 claims were submitted prior to the claims deadline. Of these 391 claims, 173
alleged stroke as an injury and 218 alleged other non-stroke injuries. These
claims will be valued pursuant to the case scoring system and settlement matrix
agreed upon as part of the class action settlement agreement that is designed to
evaluate and determine the settlement value of each claim. A total of 16
claimants elected to opt out of the class settlement and may continue to pursue
claims for damages against us in separate lawsuits.

     In accordance with the terms of the class action settlement agreement,
$60.9 million has been funded into a settlement trust from our first three
layers of insurance coverage, as described below. In addition, on July 14, 2004,
we entered into a settlement agreement with Sidmak Laboratories, Inc.
("Sidmak"), the manufacturer of DEXATRIM products containing PPA, pursuant to
which Sidmak agreed to contribute $10.0 million into the settlement trust within
30 days after final court approval of the settlement. To the extent the amount
in the settlement trust is insufficient to fully fund the settlement, we will be
required to make additional contributions to the settlement trust in the future.
We currently expect to use our cash on hand to fund any required additional
contributions to the settlement trust. If we are required to fund significant
other liabilities related to the PPA litigation beyond the settlement trust,
either pursuant to the terms of the settlement, as a result of the opt out cases
or otherwise, we will have significantly fewer sources of funds with which to
satisfy such liabilities, and we may be unable to do so.

     Based upon the court's stated intention to approve the class action
settlement, the number of claims submitted in the settlement, the number of
claims which elected to opt out of the settlement and contributions from
insurers and other third parties, we currently expect to record pre-tax charges
totaling $10.0-15.0 million, or $7.0-10.0 million net of taxes (approximately
$.35-.50 per share), for settlement costs, administrative expenses and costs of
defense related to resolving the PPA litigation. We paid or accrued the first
portion of this charge, $3.5 million, or $2.3 million after tax ($.11 per share)
during the second fiscal quarter ended May 31, 2004, and $0.8 million, or $0.6
million after tax ($.03 per share), during the third fiscal quarter ended August
31, 2004. Although we believe an additional liability existed as of August 31,
2004 related to our PPA litigation, due to the significant assumptions and
uncertainty involved in estimating the value of cases included in the final
settlement under the settlement matrix, as well as the opt out cases, we are not
able to reasonably estimate if any additional payments by us will be required in
excess of our insurance coverage and third party payments. As a result, we are
not able to reasonably estimate the amount of such liability as of August 31,
2004 and have made no provision for this liability in the August 31, 2004
financial statements.

     We have reached an agreement with Kemper Indemnity Insurance Company
("Kemper") to settle its lawsuit that sought to rescind our policy for $50.0
million of excess coverage for product liability claims. After giving effect to
the settlement with Kemper, we have available for the claims against us related
to the PPA litigation, through our first three layers of insurance coverage,
approximately $60.9 million of the $77.0 million of product liability coverage
provided by these insurance policies. The $60.9 million of available coverage
consists of $37.5 million of insurance under the Kemper policy and approximately
$23.4 million under policies with two other insurance companies. As indicated
above, this $60.9 million of coverage has been funded into a settlement trust in
accordance with the terms of the class action settlement agreement.

     We continue to aggressively defend an action brought by Interstate Fire &
Casualty Company ("Interstate") to rescind its $25.0 million of excess coverage
for product liability and pursue our available remedies at law against
Interstate. We cannot assure you that we will be successful in retaining such
excess coverage. The Interstate policy is in excess of the product liability
insurance available from Kemper and the two other insurance companies referred
to above. In the event the $60.9 million of insurance funds available in the
settlement trust and the $10.0 million to be contributed by Sidmak, the
manufacturer of the product, are exhausted under the PPA settlement or
otherwise, coverage under the Interstate policy would not be available until we
have paid $12.6 million toward the settlement of PPA claims to reach the $83.5
million coverage point for the Interstate policy.

                                       28
<PAGE>

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

RESULTS OF OPERATIONS
---------------------

     The following table sets forth net income, and for the periods indicated,
certain items from our Condensed Consolidated Statements of Income expressed as
a percentage of total revenues:
<TABLE><CAPTION>
                                                For the Three Months Ended     For the Nine Months Ended
                                                --------------------------     -------------------------
                                                 August 31,     August 31,     August 31,     August 31,
                                                    2004           2003           2004           2003
                                                 ----------     ----------     ----------     ----------
<S>                                                  <C>            <C>            <C>            <C>
     TOTAL REVENUES                                  100.0%         100.0%         100.0%         100.0%
                                                  --------       --------       --------       --------

     COSTS AND EXPENSES:
       Cost of sales                                  28.9           27.0           28.7           28.4
       Advertising and promotion                      28.2           28.9           28.5           29.8
       Selling, general and administrative            17.4           17.3           16.6           16.8
       Litigation settlement                           1.3            --             2.3            --
                                                  --------       --------       --------       --------
         Total costs and expenses                     75.8           73.2           76.1           75.0
                                                  --------       --------       --------       --------

     INCOME FROM OPERATIONS                           24.2           26.8           23.9           25.0
                                                  --------       --------       --------       --------

     OTHER INCOME (EXPENSE):
       Interest expense                               (5.0)          (8.5)          (5.9)          (8.5)
       Investment and other income, net                0.1            0.1            0.1            0.1
       Loss on early extinguishment of debt            --             --            (6.6)           --
                                                  --------       --------       --------       --------
          Total other income (expense)                (4.9)          (8.4)         (12.4)          (8.4)
                                                  --------       --------       --------       --------

     INCOME BEFORE INCOME TAXES                       19.3           18.4           11.5           16.6

     PROVISION FOR INCOME TAXES                        6.1            6.8            3.8            6.1
                                                  --------       --------       --------       --------

     NET INCOME (1)                                   13.2%          11.6%           7.7%          10.5%
                                                  ========       ========       ========       ========
</TABLE>
--------
(1) For net income (excluding debt extinguishment and litigation settlement
charges) margin, see "Overview" in this Item 2, Management's Discussion and
Analysis of Financial Condition and Results of Operations.

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 August 31, 2004 condensed consolidated
financial statements:

     ALLOWANCE FOR DOUBTFUL ACCOUNTS

     As of August 31, 2004, 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.

                                       29
<PAGE>

     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 any known specific events that affect
the accrual. 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.

     In accordance with industry practice, we allow our customers to return
unsold sun care products (our BULLFROG line of products) at the end of the sun
care season. We record the sales at the time the products are shipped and title
transfers. At the time of shipment, we also record a reduction in sales and an
allowance on our consolidated balance sheet for anticipated returns based upon
an estimated return level. The level of returns may fluctuate from our estimates
due to several factors including weather conditions, customer inventory levels
and competitive conditions. Each percentage point change in our return rate
would impact our net sales by approximately $0.1 million. For the three and nine
months ended August 31, 2004, we reduced our estimate of returns related to our
BULLFROG line of products by approximately $0.6 million and $1.8 million,
respectively, which resulted in an increase to net sales in our condensed
consolidated financial statements. During the third quarter of fiscal 2004, we
also reduced our estimate of non-seasonal returns by approximately $0.3 million,
which resulted in an increase to net sales in our condensed consolidated
financial statements.

     We routinely enter into agreements with our customers to participate in
promotional programs. These programs generally take the form of coupons,
temporary price reductions, scan downs, display activity and participations in
advertising vehicles provided uniquely by the customer. The ultimate cost of
these programs is often variable based on the number of units actually sold.
Estimated unit sales of a product under a promotional program are used to
estimate the total cost of the program, which is recorded as a reduction of
sales. Actual results can differ from the original estimate. We also consider
customer delays in requesting promotional program payments when evaluating the
required accrual. Many customers audit programs significantly after the date of
performance to determine the actual amount due and make a claim for
reimbursement at that time. As a result, changes in the unit sales trends under
promotional programs as well as the timing of payments could result in changes
in the accrual. For the three and nine months ended August 31, 2004, we reduced
our estimate of promotional accruals by approximately $0.6 million and $1.1
million, respectively, which resulted in an increase to net sales in our
condensed consolidated financial statements.

     INCOME TAXES

     We account for income taxes using the asset and liability approach as
prescribed by Statement of Financial Accounting Standards ("SFAS") No. 109,
"Accounting for Income Taxes". This approach requires recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the consolidated financial statements or tax returns.
Using the enacted tax rates in effect for the year in which the differences are
expected to reverse, deferred tax assets and liabilities are determined based on
the differences between the financial reporting and the tax basis of an asset or
liability. We record income tax expense in our consolidated financial statements
based on an estimated annual effective income tax rate. Our tax rate for the
three and nine months ended August 31, 2004 was 31% and 33%, respectively, as
compared to 37% in the three and nine months ended August 31, 2003,
respectively. The lower rates for the three and nine months ended August 31,
2004 reflect the implementation of a number of foreign and state tax planning
initiatives, which include our determination during the third quarter of fiscal
2004 to reinvest indefinitely all undistributed earnings of Chattem (Canada), a
wholly-owned subsidiary.

     For a summary of our significant accounting policies, see Note 2 of Notes
to Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended November 30, 2003 filed with the Securities and Exchange
Commission.

                                       30
<PAGE>

COMPARISON OF THREE MONTHS ENDED AUGUST 31, 2004 AND 2003
---------------------------------------------------------

     To facilitate discussion of our operating results for the three months
ended August 31, 2004 and 2003, we have included the following selected data
from our Condensed Consolidated Statements of Income:

                                                             Increase (Decrease)
                                                             -------------------
                                          2004      2003     Amount   Percentage
                                        -------   -------   -------   ----------
                                                (dollars in thousands)

Domestic net sales                      $59,839   $53,736   $ 6,103      11.4%
International revenues (including
  royalties)                              6,296     5,446       850      15.6
Total revenues                           66,135    59,182     6,953      11.7
Cost of sales                            19,135    15,995     3,140      19.6
Advertising and promotion expense        18,666    17,075     1,591       9.3
Selling, general and administrative
  expense                                11,525    10,234     1,291      12.6
Litigation settlement charges               834       --        834        nm
Interest expense                          3,284     5,057    (1,773)    (35.1)
Net income                                8,734     6,837     1,897      27.7

     DOMESTIC NET SALES

     Domestic net sales for the three months ended August 31, 2004 increased
$6.1 million or 11.4% as compared to the corresponding period of 2003. Domestic
net sales increased in all product categories except for the dietary supplements
category. A comparison of domestic net sales for the categories of products
included in our portfolio of OTC healthcare products is as follows:

                                                             Increase (Decrease)
                                                             -------------------
                                          2004      2003     Amount   Percentage
                                        -------   -------   -------   ----------
                                                (dollars in thousands)

Topical analgesics                      $20,118   $14,540   $ 5,578      38.4%
Medicated skin care products             17,257    16,926       331       2.0
Dietary supplements                       7,774     9,664    (1,890)    (19.6)
Medicated dandruff shampoos and
  conditioner                             6,480     6,116       364       6.0
Other OTC and toiletry products           8,210     6,490     1,720      26.5
                                        -------   -------   -------
  Total                                 $59,839   $53,736   $ 6,103      11.4
                                        =======   =======   =======

     Net sales growth in the topical analgesics category was led by a 70%
increase in sales of ICY HOT, which was primarily driven by the continued
strength of the ICY HOT Back Patch and the newly introduced ICY HOT Medicated
Sleeve. Net sales growth in this category also resulted from 33%, 22% and 8%
sales increases in CAPZASIN, ASPERCREME, and SPORTSCREME, respectively. The
overall sales growth in this category was partially offset by a decline in sales
for the balance of the topical analgesic brands as competition from inside and
outside the category increased and media support was reduced.

     Net sales growth in the medicated skin care products category resulted from
a 7% increase in the GOLD BOND franchise. GOLD BOND sales growth was
attributable to 60% and 18% increases from the lotion and foot care lines,
respectively, and was partially offset by declines in the first aid portion of
the business. The increase in sales from the GOLD BOND lotion line of products
was attributable to the successful launch of GOLD BOND ULTIMATE Healing Skin
Therapy Lotion in the third quarter of fiscal 2003. Sales growth in the
medicated skin care products category was also offset by a 17% decrease in
PHISODERM sales due to increased competition.

     Net sales for the dietary supplements category declined primarily due to a
41% decrease in DEXATRIM diet pill sales and a 25% and 20% decline in GARLIQUE
and NEW PHASE sales, respectively, from the corresponding year-ago quarter.
Sales of DEXATRIM were impacted by the overall decline in the diet pill market
resulting in part from negative ephedrine publicity and the emergence of low
carbohydrate diet products. The decline in net sales of DEXATRIM diet pills,
GARLIQUE and NEW PHASE was partially offset by sales of the DEXATRIM All in One
Bar, which was introduced in the first quarter of fiscal 2004. The DEXATRIM All
in One Bar sales were lower than expected for the third fiscal quarter of 2004,
as the category has proved to be more promotional and seasonal than we expected.
If DEXATRIM sales continue to decline, the related intangible asset may be
subject to impairment based on the provisions of SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142").

     Domestic net sales of SELSUN BLUE medicated dandruff shampoo increased due
to an effective advertising campaign and sales of SELSUN BLUE conditioner, which
was launched in the first quarter of fiscal 2004.

                                       31
<PAGE>

     The increase in net sales for the other OTC and toiletry products category
was due primarily to sales increases of PAMPRIN and BULLFROG. The increase in
sales of PAMPRIN was primarily attributable to the introduction of PAMPRIN All
Day in the first quarter of fiscal 2004. The increase in sales of BULLFROG was
primarily attributable to expanded distribution and increased sales of pre-pack
displays.

     Domestic sales variances were principally the result of changes in unit
sales volumes with the exception of PAMPRIN, PREMSYN PMS, PHISODERM, FLEXALL,
ASPERCREME, CAPZASIN and SPORTSCREME, which experienced a unit sales price
increase.

     INTERNATIONAL REVENUES

     For the third quarter of fiscal 2004, international revenues increased $0.9
million or 15.6% as compared to the third quarter of fiscal 2003 due principally
to increases in SELSUN sales in Canada, Europe and Latin America. International
sales variances were principally the result of changes in unit sales volumes.

     COST OF SALES

     Cost of sales as a percentage of total revenues was 28.9% for the third
quarter of fiscal 2004 as compared to 27.0% for the third quarter of fiscal
2003. Cost of sales in the third quarter of fiscal 2004 increased $3.1 million
due primarily to sales of the DEXATRIM All in One Bar, the ICY HOT Back Patch
and the ICY HOT Medicated Sleeve, all of which have lower profit margins than
most of our other products.

     ADVERTISING AND PROMOTION EXPENSE

     Advertising and promotion expenses in the third quarter of fiscal 2004
increased $1.6 million or 9.3% as compared to the same quarter of fiscal 2003
and were 28.2% of total revenues for the three months ended August 31, 2004
compared to 28.9% for the comparable period of fiscal 2003. Support for new
product introductions drove an increase in advertising and promotion
expenditures in the current period for ICY HOT, PAMPRIN, DEXATRIM All in One
Bar, SELSUN BLUE and the GOLD BOND lotion and foot care lines.

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

     Selling, general and administrative expenses increased $1.3 million or
12.6% as compared to the same quarter of fiscal 2003. Selling, general and
administrative expenses were 17.4% and 17.3% of total revenues for the third
quarter of fiscal 2004 and 2003, respectively. An increase in sales was
primarily responsible for the increase in selling expense. In addition, freight
expenses increased due to the increase in fuel costs. The increase in general
and administrative expenses was largely a result of increased incentive
compensation and new product development expenses as well as expenses related to
compliance with the Sarbanes-Oxley Act of 2002.

     LITIGATION SETTLEMENT CHARGES

     Litigation settlement charges were $0.8 million in the third quarter of
fiscal 2004. This expense was attributable to legal services related to our
DEXATRIM with PPA litigation. No corresponding expenses were recorded in the
three months ended August 31, 2003.

     INTEREST EXPENSE

     Interest expense decreased $1.8 million or 35.1% in the third quarter of
fiscal 2004 as compared to the same quarter of fiscal 2003. The decrease was
largely the result of lower interest rates and a reduction in outstanding debt
as a result of our debt refinancing completed during the first quarter of fiscal
2004. Until our indebtedness is reduced substantially, interest expense will
continue to represent a significant percentage of our total revenues.


                                       32
<PAGE>

COMPARISON OF NINE MONTHS ENDED AUGUST 31, 2004 AND 2003
--------------------------------------------------------

     To facilitate discussion of our operating results for the nine months ended
August 31, 2004 and 2003, we have included the following selected data from our
Condensed Consolidated Statements of Income:

                                                            Increase (Decrease)
                                                            -------------------
                                         2004      2003     Amount   Percentage
                                       --------  --------  --------  ----------
                                               (dollars in thousands)

Domestic net sales                     $179,130  $162,597  $ 16,533     10.2%
International revenues (including
  royalties)                             18,334    18,643      (309)    (1.7)
Total revenues                          197,464   181,240    16,224      9.0
Cost of sales                            56,643    51,399     5,244     10.2
Advertising and promotion expense        56,278    54,009     2,269      4.2
Selling, general and administrative
  expense                                32,831    30,445     2,386      7.8
Litigation settlement charges             4,491         -     4,491       nm
Interest expense                         11,678    15,431    (3,753)   (24.3)
Loss on early extinguishment of debt     12,958        -     12,958      nm
Net income                               15,269    18,947    (3,678)   (19.4)

     DOMESTIC NET SALES

Domestic net sales for the nine months ended August 31, 2004 increased $16.5
million or 10.2% as compared to the corresponding period of 2003. Domestic net
sales increased in all product categories except for the dietary supplements
category. A comparison of domestic net sales for the categories of products
included in our portfolio of OTC healthcare products is as follows:

                                                            Increase (Decrease)
                                                            -------------------
                                         2004      2003     Amount   Percentage
                                       --------  --------  --------  ----------
                                               (dollars in thousands)
Topical analgesics                     $ 53,964  $ 42,738  $ 11,226      26.3%
Medicated skin care products             47,920    44,988     2,932       6.5
Dietary supplements                      26,654    30,232    (3,578)    (11.8)
Medicated dandruff shampoos and
  conditioner                            23,107    20,928     2,179      10.4
Other OTC and toiletry products          27,485    23,711     3,774      15.9
                                       --------  --------  --------
  Total                                $179,130  $162,597  $ 16,533      10.2
                                       ========  ========  ========

     Net sales growth in the topical analgesics category was led by a 58%
increase in sales of ICY HOT, which was primarily driven by the continued
strength of the ICY HOT Back Patch and the newly introduced ICY HOT Medicated
Sleeve. Net sales growth in this category also resulted from a 24% and 5% sales
increase in CAPZASIN and ASPERCREME, respectively. The overall sales growth in
this category was partially offset by a decline in sales for the balance of the
topical analgesic brands as competition from inside and outside the category
increased and media support was reduced.

     Net sales growth in the medicated skin care products category resulted from
a 14% increase in the GOLD BOND franchise. GOLD BOND sales growth was
attributable to 52%, 28% and 23% increases from the lotion, cream and foot care
lines, respectively, and was partially offset by declines in the first aid
portion of the business. The increase in sales from the GOLD BOND lotion line of
products was attributable to the successful launch of GOLD BOND ULTIMATE Healing
Skin Therapy Lotion in the third quarter of fiscal 2003. Sales growth in this
category was further offset by a 16% decrease in PHISODERM sales due to
increased competition.

     Net sales for the dietary supplements category declined primarily due to a
48% decrease in DEXATRIM diet pill sales and an 8% decline in GARLIQUE sales
from the corresponding year-ago period. Sales of DEXATRIM were impacted by the
overall decline in the diet pill market resulting in part from negative
ephedrine publicity and the emergence of low carbohydrate diet products. The
decline in net sales of DEXATRIM diet pills and GARLIQUE was partially offset by
sales of the DEXATRIM All in One Bar, which was introduced in the first quarter
of fiscal 2004. The DEXATRIM All in One Bar sales were lower than expected for
the nine months ended August 31, 2004, as the category has proved to be more
promotional and seasonal than we expected. If DEXATRIM sales continue to
decline, the related intangible asset may be subject to impairment based on the
provisions of SFAS 142.

     Domestic net sales of SELSUN BLUE medicated dandruff shampoo increased due
to an effective advertising campaign and sales of SELSUN BLUE conditioner, which
was launched in the first quarter of fiscal 2004.

                                       33
<PAGE>

     The increase in net sales for the other OTC and toiletry products category
was due primarily to sales increases of PAMPRIN and BULLFROG. The increase in
sales of PAMPRIN was primarily attributable to the introduction of PAMPRIN All
Day in the first quarter of fiscal 2004. The increase in sales of BULLFROG was
primarily attributable to expanded distribution and increased sales of pre-pack
displays. HERPECIN-L also experienced net sales growth in the nine months ended
August 31, 2004 due primarily to effective advertising.

     Domestic sales variances were principally the result of changes in unit
sales volumes with the exception of PAMPRIN, PREMSYN PMS, PHISODERM, FLEXALL,
ASPERCREME, CAPZASIN and SPORTSCREME, which experienced a unit sales price
increase.

     INTERNATIONAL REVENUES

     For the nine months ended August 31, 2004, international revenues decreased
$0.3 million or 1.7% as compared to the same period in fiscal 2003 due
principally to the termination of certain European distributor relationships and
a decrease in GOLD BOND sales in Canada. This decrease was offset by an increase
in SELSUN sales in Canada, Europe and Latin America. International sales
variances were principally the result of changes in unit sales volumes.

     COST OF SALES

     Cost of sales as a percentage of total revenues was 28.7% for the nine
months ended August 31, 2004 as compared to 28.4% for the comparable period of
fiscal 2003. Cost of sales in the nine months ended August 31, 2004 increased
$5.2 million due primarily to sales of the DEXATRIM All in One Bar, the ICY HOT
Back Patch and the ICY HOT Medicated Sleeve, which are lower margin products.
The increase was partially offset by a fiscal 2003 charge of approximately $0.7
million related to DEXATRIM charges for product returns containing ephedrine.

     ADVERTISING AND PROMOTION EXPENSE

     Advertising and promotion expenses in the nine months ended August 31, 2004
increased $2.3 million or 4.2% as compared to the same period in fiscal 2003 and
were 28.5% of total revenues for the nine months ended August 31, 2004 compared
to 29.8% for the comparable period of fiscal 2003. Support for new product
introductions drove an increase in advertising and promotion expenditures in the
nine months ended August 31, 2004 for ICY HOT, PAMPRIN, DEXATRIM All in One Bar,
SELSUN BLUE and the GOLD BOND cream, lotion and foot care lines.

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

     Selling, general and administrative expenses increased $2.4 million or 7.8%
as compared to the same period of fiscal 2003. Selling, general and
administrative expenses were 16.6% and 16.8% of total revenues for the nine
months ended August 31, 2004 and 2003, respectively. An increase in sales was
primarily responsible for the increase in selling expense. In addition, freight
expenses increased due to the increase in fuel costs. The increase in general
and administrative expenses was largely a result of increased incentive
compensation and new product development expenses as well as expenses related to
compliance with the Sarbanes-Oxley Act of 2002.

     LITIGATION SETTLEMENT CHARGES

     Litigation settlement charges were $4.5 million for the nine months ended
August 31, 2004. This expense was attributable to legal and administrative costs
of our DEXATRIM with PPA litigation, costs of public notices related to the PPA
settlement and reimbursement of legal and administrative costs in accordance
with a settlement with one of our insurance providers. No corresponding expenses
were recorded in the nine months ended August 31, 2003.

     INTEREST EXPENSE

     Interest expense decreased $3.8 million or 24.3% in the nine months ended
August 31, 2004 as compared to the same period in fiscal 2003. The decrease was
largely the result of lower interest rates and a reduction in outstanding debt
as a result of our debt refinancing completed during the first quarter of fiscal
2004. 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

     During the first half of fiscal 2004, we retired $204.5 million principal
amount of our 8.875% Subordinated Notes and the remaining outstanding balance of
our $60,000 senior secured credit facility from a syndicate of commercial banks
led by Bank of America, N.A., as agent, which resulted in a loss on early
extinguishment of debt of $13.0 million and a related tax benefit of $4.3
million.

                                       34
<PAGE>

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 $29.3 million and $24.1 million was provided by operations for the
nine months ended August 31, 2004 and 2003, respectively. Cash flows from
operations were impacted by an increase in the tax benefit realized from stock
option exercises as compared to the corresponding period of fiscal 2003 offset
by an increase in working capital attributable to an increase in accounts
receivable and a decrease in accounts payable and accrued liabilities. The
increase in accounts receivable relates primarily to an increase in sales, an
increase in international receivables and a decrease in the allowance for
returns. The decrease in accounts payable and accrued liabilities relates
primarily to a decrease in accrued advertising offset by a lower increase in
interest payable as compared to the corresponding period of fiscal 2003. In
addition, a loss on early extinguishment of debt of $13.0 million and a tax
benefit of $4.3 million was recorded in the first half of fiscal 2004.

     Investing activities used cash of $2.4 million and $4.6 million in the nine
months ended August 31, 2004 and 2003, respectively. The decrease in usage of
cash was primarily due to reduced spending on capital expenditures. In fiscal
2003, capital expenditures related primarily to equipment and facility
modifications to produce SELSUN BLUE domestically and the construction of the
product development building. Capital expenditures are anticipated to increase
in the fourth quarter of fiscal 2004.

     Financing activities used cash of $27.1 million and $13.8 million in the
nine months ended August 31, 2004 and 2003, respectively. The increase in cash
used in financing activities in the current period was attributable to a net
repayment of long-term debt of $12.3 million, an increase in and retirement of
debt issuance costs of $13.6 million related to the refinancing transactions, a
payment of $1.4 million for a premium on the interest rate cap agreement and
$5.0 million used to repurchase shares offset by proceeds from the exercise of
stock options of $5.1 million.

     As of August 31, 2004, our total debt consisted of our Floating Rate Notes
of $75.0 million and 7.0% Subordinated Notes of $125.0 million. As of August 31,
2004 and September 29, 2004, we had no borrowings outstanding under our
Revolving Credit Facility with available borrowings up to $50.0 million.
Borrowings under our Revolving Credit Facility bear interest at LIBOR plus
applicable percentages of 1.75% to 2.50% or a base rate (the higher of the
federal funds rate plus 0.5% or the prime rate) plus applicable percentages of
0.25% to 1.0% ( 5.00% as of August 31, 2004). The applicable percentages are
calculated based on our leverage ratio. The Floating Rate Notes bear interest at
a three-month LIBOR plus 3.00% per year (4.31% as of August 31, 2004). On March
8, 2004, we entered into an interest rate cap agreement effective June 1, 2004
with decreasing notional principal amounts and cap rates ranging from 4.0% to
5.0% over the life of the agreement. We paid a $1.4 million premium to enter
into the interest rate cap agreement, which will be amortized over the life of
the agreement. The current portion of the premium on the interest rate cap
agreement of $47,000 is included in prepaid expenses and other current assets,
and the long-term portion of $0.9 million is included in other noncurrent
assets. The amortized value of the premium on the interest rate cap was compared
to its fair value as of August 31, 2004, and a charge of $0.3 million, net of
tax, was recorded to other comprehensive income. The interest rate cap agreement
terminates on March 1, 2010.

     In an effort to achieve a global settlement of all DEXATRIM PPA product
liability claims, on December 19, 2003, we entered into a Memorandum of
Understanding with the PSC, which memorialized certain settlement terms
concerning lawsuits relating to DEXATRIM products containing PPA. On April 13,
2004, we entered into a class action settlement agreement with representatives
of the plaintiffs' settlement class. The class action settlement agreement was
generally consistent with the terms of and superceded the Memorandum of
Understanding and provided for a national class action settlement of all
DEXATRIM PPA claims. The court granted preliminary approval of the class action
settlement on April 23, 2004.

     On August 26, 2004, a fairness hearing to consider final approval of the
settlement was held before Judge Rothstein. At the conclusion of the hearing,
Judge Rothstein stated that the court would prepare and enter an order
certifying the class and granting approval of the settlement. We expect that the
order will be entered in October 2004.

     The settlement includes claims against us involving alleged injuries by
DEXATRIM products containing PPA that were alleged to have occurred after
December 21, 1998, the date we acquired the DEXATRIM brand. In accordance with
the terms of the class action settlement agreement, we previously published
notice of the settlement and details as to the manner in which claims could be
submitted. The deadline for submission of claims was July 7, 2004. A total of
391 claims were submitted prior to the claims deadline. Of these 391 claims, 173
alleged stroke as an injury and 218 alleged other non-stroke injuries. These
claims will be valued pursuant to the case scoring system and settlement matrix
agreed upon as part of the class action

                                       35
<PAGE>

settlement agreement that is designed to evaluate and determine the settlement
value of each claim. A total of 16 claimants elected to opt out of the class
settlement and may continue to pursue claims for damages against us in separate
lawsuits.

     In accordance with the terms of the class action settlement agreement,
$60.9 million has been funded into a settlement trust from our first three
layers of insurance coverage, as described below. In addition, on July 14, 2004,
we entered into a settlement agreement with Sidmak Laboratories, Inc.
("Sidmak"), the manufacturer of DEXATRIM products containing PPA, pursuant to
which Sidmak agreed to contribute $10.0 million into the settlement trust within
30 days after final court approval of the settlement. To the extent the amount
in the settlement trust is insufficient to fully fund the settlement, we will be
required to make additional contributions to the settlement trust in the future.
We currently expect to use certain of our cash on hand to fund any required
additional contributions to the settlement trust. If we are required to fund
significant other liabilities related to the PPA litigation beyond the
settlement trust, either pursuant to the terms of the settlement, as a result of
the opt out cases or otherwise, we will have significantly fewer sources of
funds with which to satisfy such liabilities, and we may be unable to do so.

     In lawsuits in which we are named as a defendant relating to DEXATRIM
containing PPA involving alleged injuries by DEXATRIM containing PPA
manufactured and sold prior to our acquisition of DEXATRIM on December 21, 1998,
we are being defended on the basis of indemnification obligations assumed by the
DELACO Company ("DELACO"), successor to Thompson Medical Company, Inc., which
owned Dexatrim prior to December 21, 1998. On February 12, 2004, DELACO filed a
Chapter 11 bankruptcy petition in the United States Bankruptcy Court for the
Southern District of New York. Accordingly, it is uncertain whether DELACO will
be able to indemnify us for claims arising from products manufactured and sold
prior to our acquisition of DEXATRIM on December 21, 1998. However, DELACO is
seeking to resolve all DEXATRIM cases with injury dates prior to December 21,
1998 as part of a liquidating Chapter 11 bankruptcy plan. We understand that
DELACO's product liability insurance carriers and other sources are expected to
fund this plan. As part of DELACO's bankruptcy plan, if finally approved, we
expect the bankruptcy court to release us from liability in DEXATRIM cases with
injury dates prior to December 21, 1998, although there can be no assurances in
this regard. If DELACO achieves resolution of the pre-December 21, 1998 cases
through its bankruptcy plan, we expect that the administrative process for
DELACO's settlement will be similar to the process in our class action. We have
filed a claim in DELACO's bankruptcy case in order to preserve our claims for
indemnification against DELACO. As part of this Chapter 11 plan, we expect that
after resolution of creditors' claims, DELACO will seek to liquidate and
distribute all of its assets and will dissolve as a company.

     Based upon the court's stated intention to approve the class action
settlement, the number of claims submitted in the settlement, the number of
claims which elected to opt out of the settlement and contributions from
insurers and other third parties, we currently expect to record pre-tax charges
totaling $10.0-15.0 million, or $7.0-10.0 million net of taxes (approximately
$.35-.50 per share), for settlement costs, administrative expenses and costs of
defense related to resolving the PPA litigation. We paid or accrued the first
portion of this charge, $3.5 million, or $2.3 million after tax ($.11 per share)
during the second fiscal quarter ended May 31, 2004, and $0.8 million, or $0.6
million after tax ($.03 per share), during the third fiscal quarter ended August
31, 2004. Although we believe an additional liability existed as of August 31,
2004 related to our PPA litigation, due to the significant assumptions and
uncertainty involved in estimating the value of cases included in the final
settlement under the settlement matrix, as well as the opt out cases, we are not
able to reasonably estimate if any additional payments by us will be required in
excess of our insurance coverage and third party payments. As a result, we are
not able to reasonably estimate the amount of such liability as of August 31,
2004 and have made no provision for this liability in the August 31, 2004
consolidated financial statements.

     We have reached an agreement with Kemper to settle its lawsuit that sought
to rescind our policy for $50.0 million of excess coverage for product liability
claims. After giving effect to the settlement with Kemper, we have available for
the claims against us related to the PPA litigation, through our first three
layers of insurance coverage, approximately $60.9 million of the $77.0 million
of product liability coverage provided by these policies. The $60.9 million of
available coverage consists of $37.5 million of insurance under the Kemper
policy and approximately $23.4 million under policies with two other insurance
companies. As indicated above, this $60.9 million of coverage has been funded
into a settlement trust in accordance with the terms of the class action
settlement agreement

     We continue to aggressively defend an action brought by Interstate to
rescind its $25.0 million of excess coverage for product liability and pursue
our available remedies at law against Interstate. We cannot assure you that we
will be successful in retaining such excess coverage. The Interstate policy is
in excess of the product liability insurance available from Kemper and the two
other insurance companies referred to above. In the event the $60.9 million of
insurance funds available in the settlement trust and the $10.0 million to be
contributed by Sidmak, the manufacturer of the product, are exhausted under the
PPA settlement or otherwise, coverage under the Interstate policy would not be
available until we have paid $12.6 million toward the settlement of PPA claims
to reach the $83.5 million coverage point for the Interstate policy.

     In January 2004, our board of directors increased the total authorization
to repurchase our common stock under our stock buyback program to $20.0 million.
For the nine months ended August 31, 2004, we repurchased 190,100 shares for
$5.0 million. The remaining availability under the board authorization was $15.0
million as of August 31, 2004. We are limited in

                                       36
<PAGE>

our ability to repurchase shares due to restrictions under the terms of our
Revolving Credit Facility and the indentures pursuant to which the Floating Rate
Notes and 7.0% Subordinated Notes were issued.

     We believe that cash provided by operating activities, our cash and cash
equivalents balance and funds available under our Revolving 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.

FOREIGN OPERATIONS
------------------

     Historically, our primary foreign operations have been conducted through
our Canadian and United Kingdom ("U.K.") subsidiaries. The functional currencies
of these subsidiaries are Canadian dollars and British pounds, respectively.
Fluctuations in exchange rates can impact operating results, including total
revenues and expenses, when translations of the subsidiary financial statements
are made in accordance with SFAS No. 52, "Foreign Currency Translation". For the
nine months ended August 31, 2004 and 2003, these subsidiaries accounted for 7%
and 8% of total revenues, respectively, and 3% of total assets for both periods,
respectively. It has not been our practice to hedge our assets and liabilities
in Canada and the U.K. 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. Following our acquisition of
SELSUN BLUE, which is sold in more than 75 foreign countries, our international
business operations have expanded significantly, which will increase our
exposure to fluctuations in foreign exchange rates. During the nine months of
fiscal 2004, a portion of these foreign sales was reflected as royalties, which
have been paid to us in U.S. dollars. In addition, Abbott has continued to
supply a portion of our international product where appropriate and bill us in
U.S. dollars. Beginning April 1, 2004, we were billed in local currencies.
Historically, gains or losses from foreign currency transactions have not had a
material impact on our operating results. Gains of $7,000 and $0.2 million for
the nine months ended August 31, 2004 and 2003, respectively, resulted from
foreign currency transactions and are included in selling, general and
administrative expenses in the Condensed Consolidated Statements of Income.

RECENT ACCOUNTING PRONOUNCEMENTS
--------------------------------

     In April 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). We adopted SFAS
145 on December 1, 2002. SFAS 145 requires us to classify gains and losses on
extinguishments of debt as income or loss from continuing operations rather than
as extraordinary items as previously required under SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt". We are also required to reclassify any
gain or loss on extinguishment of debt previously classified as an extraordinary
item in prior periods presented. SFAS 145 also provides accounting standards for
certain lease modifications that have economic effects similar to sale-leaseback
transactions and various other technical corrections. The application of SFAS
145 resulted in recording a loss on early extinguishment of debt of $13.0
million in fiscal 2004, which was classified in the condensed consolidated
financial statements in accordance with the provisions of SFAS 145.

     In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). We adopted SFAS 146
on January 1, 2003. SFAS 146 supercedes Emerging Issues Task Force ("EITF")
Issue No. 94-3. SFAS 146 requires that the liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred, not
at the date of an entity's commitment to an exit or disposal plan. SFAS 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. As of August 31, 2004, the application of SFAS 146 resulted
in recording $35,000 of accrued liabilities related to the restructuring of the
U.K operations. We expect to record additional charges related to the
restructuring of the U.K. operations in the fourth quarter of fiscal 2004.

     In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires a company to consolidate
a variable interest entity ("VIE"), as defined, when the company will absorb a
majority of the VIE's expected losses, receives a majority of the VIE's expected
residual returns or both. FIN 46 also requires consolidation of existing,
non-controlled affiliates if the VIE is unable to finance its operations without
investor support, or where the other investors do not have exposure to the
significant risks and rewards of ownership. FIN 46 applies immediately to a VIE
created or acquired after January 31, 2003. For a VIE created before February 1,
2003, FIN 46 applies in the first fiscal year or interim period beginning after
March 15, 2004, our third fiscal quarter beginning June 1, 2004. Application of
FIN 46 is also required in financial statements that have interests in
structures that are commonly referred to as special-purpose entities for periods
ending after December 15, 2003. The adoption of FIN 46 did not have an impact on
our financial position, results of operations or cash flows.

     In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosure about Pensions and Other Postretirement Benefits" ("SFAS 132"). The
revision of SFAS 132 provides for additional disclosures including the
description of the types of plan assets, investment strategy, measurement
date(s), plan obligations, cash flows and components of net periodic benefit
cost recognized in interim periods. The revisions of SFAS 132 are effective for
financial statements with fiscal years

                                       37
<PAGE>

ending after December 15, 2003 and interim periods beginning after December 15,
2003. The adoption of the revised SFAS 132 did not have an impact on our
financial position, results of operations or cash flows.

FORWARD LOOKING STATEMENTS
--------------------------

     Statements in this Quarterly Report on Form 10-Q which are not historical
facts are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
involve risks, uncertainties and assumptions that could cause actual outcomes
and results to differ materially from those expressed or projected.





























                                       38
<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
-------------------------------------------------------------------

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

     Our exposure to interest rate risk currently consists of our Floating Rate
Notes and our Revolving Credit Facility. The aggregate balance outstanding under
the Floating Rate Notes as of August 31, 2004 was $75.0 million. The Floating
Rate Notes bear interest at a three-month LIBOR plus 3.00% per year (4.31% as of
August 31, 2004). Loans under our Revolving Credit Facility bear interest at
LIBOR plus applicable percentages of 1.75% to 2.50% or a base rate (the higher
of the federal funds rate plus 0.5% or the prime rate) plus applicable
percentages of 0.25% to 1.0%. The applicable percentages are calculated based on
our leverage ratio. As of August 31, 2004, no amounts had been borrowed under
the Revolving Credit Facility, and the variable rate on the Revolving Credit
Facility was 5.00%. The 7.0% Subordinated Notes are fixed interest rate
obligations. On March 8, 2004, we entered into an interest rate cap agreement
effective June 1, 2004 with decreasing notional principal amounts and cap rates
ranging from 4.0% to 5.0% over the life of the agreement. The amortized value of
the premium on the interest rate cap was compared to its fair value as of August
31, 2004, and a charge of $0.3 million, net of tax, was recorded to other
comprehensive income. The interest rate cap agreement terminates on March 1,
2010. The impact on our results of operations of a one-point rate change on the
balance currently outstanding of our Floating Rate Notes for the next twelve
months would be approximately $0.5 million, net of tax.

     We are subject to risk from changes in the foreign exchange rates relating
to our Canadian and U.K. subsidiaries. Assets and liabilities of these
subsidiaries are translated to U.S. dollars at year-end exchange rates. Income
and expense items are translated at average rates of exchange prevailing during
the year. Translation adjustments are accumulated as a separate component of
shareholders' equity. Gains and losses, which result from foreign currency
transactions, are included in the Condensed Consolidated Statements of Income.
During the nine months ended August 31, 2004, pursuant to our manufacturing
agreement with Abbott, we were billed in U.S. dollars for purchases of SELSUN
for foreign markets. In many cases in the future, we will be billed in the
respective foreign currency. The potential loss resulting from a hypothetical
10.0% adverse change in the quoted foreign currency exchange rate amounts to
approximately $1.0 million as of August 31, 2004.

     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
-------------------------------

     (a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such terms are defined in Rules
13(a)-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") as of August 31, 2004 of this Form 10-Q (the
"Evaluation Date"). Based on such evaluation, such officers have concluded that,
as of the Evaluation Date, our disclosure controls and procedures are effective
in alerting them on a timely basis to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic filings under the Exchange Act.

     (b) Changes in Internal Controls. Since the Evaluation Date, there have not
been any significant changes in our internal controls or in other factors that
could significantly affect such controls.







                                       39
<PAGE>

                           PART II. OTHER INFORMATION
                           --------------------------

ITEM 1. LEGAL PROCEEDINGS
-------------------------

     See Note 18 of Notes to Condensed Consolidated Financial Statements
included in Part 1, Item 1 of this Report.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-------------------------------------------------

     A summary of the common stock repurchase activity for our third quarter of
fiscal 2004 is as follows:
<TABLE><CAPTION>
                                                   Total Number of       Maximum Dollar
                                                   Shares Purchased      Value that may
                      Total Number    Average     as Part of Publicly   yet be Purchased
                       of Shares     Price Paid   Announced Plans or    under the Plans
      Period           Purchased    Per Share(1)     Programs(2)          or Programs
-------------------    ---------    ------------     -----------          -----------
<S>                     <C>           <C>              <C>               <C>
June 1-June 30               --        $   --              --             $16,765,825
July 1-July 31           61,100        $ 29.14          61,100            $14,985,202
August 1- August 31          --        $   --              --             $14,985,202
Total Third Quarter      61,100        $ 29.14          61,100            $14,985,202
</TABLE>

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

     (2)  Our stock buyback program authorizing the purchase of up to $10.0
          million of our common stock was announced in January 2003. In January
          2004, our board of directors increased the total authorization to
          repurchase our common stock under our stock buyback program to $20.0
          million. There is no expiration date specified for our stock buyback
          program.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
---------------------------------------

        None.

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

        None.

ITEM 5. OTHER INFORMATION
-------------------------

        None.








                                       40
<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
----------------------------------------

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

     Exhibit Number    Description
     --------------    -----------

          10.1         Settlement Agreement dated July 14, 2004 between Chattem,
                       Inc. and Sidmak Laboratories, Inc.

          10.2         DEXATRIM Case Scoring System & Matrix for the Chattem
                       DEXATRIM Class Action Settlement

          31.1         Certification required by Rule 13a-14(a) under the
                       Securities Exchange Act of 1934

          31.2         Certification required by Rule 13a-14(a) under the
                       Securities Exchange Act of 1934

           32          Certification required by Rule 13a-14(b) under the
                       Securities Exchange Act of 1934 and 18 U.S.C. Section
                       1350


(b)  During the third quarter ended August 31, 2004, we filed the following Form
     8-K reports with the Securities and Exchange Commission:

     Form 8-K, filed June 17, 2004, containing a copy of our press release
     announcing our financial results for the second quarter of fiscal 2004.

     Form 8-K, filed August 27, 2004, containing a copy of our press release
     regarding the phenylpropanolamine (PPA) litigation and announcing that the
     Company expects to exceed prior guidance on financial results for the third
     quarter of fiscal 2004.











                                       41
<PAGE>

                                  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: October 1, 2004                   /s/ A. Alexander Taylor II
       ------------------                --------------------------
                                         A. Alexander Taylor II
                                         President, Chief Operating Officer and
                                         Director (Chief Operating Officer)



Dated: October 1, 2004                   /s/ Richard D. Moss
       ------------------                ----------------------------
                                         Richard D. Moss
                                         Vice President and Chief Financial
                                         Officer (Principal Financial Officer)













                                       42
<PAGE>

                         CHATTEM, INC. AND SUBSIDIARIES
                         ------------------------------
                                  EXHIBIT INDEX
                                  -------------


Exhibit Number     Description of Exhibit
--------------     ----------------------

     10.1          Settlement Agreement dated July 14, 2004 between Chattem,
                   Inc. and Sidmak Laboratories

     10.2          DEXATRIM Case Scoring System & Matrix for the Chattem
                   DEXATRIM Class Action Settlement

     31.1          Certification required by Rule 13a-14(a) under the Securities
                   Exchange Act of 1934

     31.2          Certification required by Rule 13a-14(a) under the Securities
                   Exchange Act of 1934

      32           Certification required by Rule 13a-14(b) under the Securities
                   Exchange Act of 1934 and 18 U.S.C. Section 1350












                                       43